The term bailout has become popular throughout recent
times describing how major Eurozone economies; headed by Angela Merkel's
Germany have come to the rescue of ailing co-members. The most recent bailout issued by the Troika
however, appears to be less of a bailout in the traditional sense of the
word. Where previous deals for Ireland
and Greece's economy's involved funds to the total of approximately 85bn and
130bn euros respectively, and some measure of austerity and bank recapitalization and Spain to some extent, which was allowed up to 100bn euros
in borrowing for its financial sector (the term bailout being strongly disputed
in the Spanish case), the Cypriot bailout resembles more of a bail-in and
furthermore, sets a dangerous precedent.
The roots of the Cypriot crisis stem from a previously
weakening and indecisive Socialist government; from which President
Anastasiades took over at the end of February, and crippling exposure of the
banking sector (which had already grown extremely rapidly in the years up to
2008) to foreign finance. In 2011
figures from the IMF show that Cypriot bank assets amounted to 835% of Cyprus's
GDP; with a large majority owned abroad. Furthermore, purely Cypriot assets
from local banks had been lent to the Greek economy; an amount itself believed
to be a staggering 160% of GDP. It was
hence no surprise that the Southern European economy's financial tribulations
began to crescendo when the Greek's were on the receiving end of a haircut on
their bonds in 2011. The Cypriot government,
with little financial leverage to lessen the detrimental effects of Cypriot
exposure, coupled with rising unemployment and increasing debt to sustain
unemployment benefits, requested a bailout given the prospect of a
crumbling-down of the local financial system; the contents and ramifications of
which have only just recently been agreed after a gruelling period of
negotiations between the Cypriot officials and the Troika.
It would be misleading and incomplete to not mention the
role of the Russians within the confines of the Cypriot situation; with private
Russian citizens and institutions investing heavily and strongly believed to be
behind the prominence and growth of the Cypriot banking sector, which itself
was triggered by the reputation Cyprus had forged itself as being an 'offshore tax
haven' of some sorts, with little or no controls on money laundering. One of the very first glimpses of aid in
direction of Cyprus following the economic decline was in provenance of Russia
in early 2012, an amount of 2.5bn euros intended towards helping at covering
the budget deficit. It was hence with
little surprise that Cyprus' finance minister Michael Sarris was in Russia trying to conjure up more funds using Cypriot gas reserves as collateral; however
this recent attempt failed and rather yielded a renegotiation on the terms of
the original 2.5bn euros lent by Russia.
This seemingly innocuous Russian involvement in Cyprus's affair; may
help understand the motivations behind a bailout deal which has and will
continue to evoke controversy for some time.
The initial framework of the deal involved levies on
customer bank deposits combined with the usual prescription of some austerity
we have come to expect from the policymakers in Brussels. The specifics which involved a 6.7% levy on
bank deposits up to 100,000 euros (which are in principle supposed to be guaranteed)
and 9.9% on those in the upper band of that limit yielded outrage across
Cyprus; and uncertainty around Europe as the prospect of up-until then
untouched private savings and assets being seemingly usurped. This particular clause was the talking point
of a deal in which savers were due bank shares as compensation for any losses,
and Cyprus would receive 10bn euros from the Eurozone bailout funds (either the
European Financial Stability Facility or the European Stability Mechanism) on
the condition its government raise at least 5.8bn euros (hence the bank
levies). This proposed deal however was
swiftly rejected in Cypriot parliament; amid fears the relatively small economy
(as it accounts for less than a quarter of a per cent of Eurozone GDP) would be
heading towards the door of the Eurozone club.
These fears were eased in the past week as a revised deal was
drawn up and agreed; less harsh on proprietors of guaranteed amounts in banks
(up to 100,000 euros), draconian for those within the upper band of that
limit, and with unavoidable bleak times ahead for the Cypriot economy and its
people. The new deal involves a recapitalization of Cyprus's largest bank; Bank of Cyprus, as well as it being
transferred the accounts of guaranteed depositors from Cyprus's second largest
bank; Laiki Bank, which is to be wound up with any losses being absorbed by its
bondholders and unguaranteed depositors. Unguaranteed depositors from Bank of
Cyprus have also not been spared; with the banks recapitalization also expected
to inflict heavy losses on said agents.
Furthermore; it is expected of Cyprus by Eurozone leaders that some or a
considerable amount of control be exerted on its once liberal financial system;
in effect washing away all hope that Cyprus may once regain its status as a tax
haven.
Why the hard line on a relatively inconsiderable economy
by the Troika? At this point it is important to refer back to Russian involvement
on the Southern Island. Angela Merkel
has been on the receiving end for some time, of a considerable amount of
criticism at home where it is believed German taxpayers are unfairly incurring
most of the costs when it comes to bailing out their less prominent neighbours.
Why should they bail out Cyprus when
foreigners who injected the large portions of capital (mostly Russian financial
giants) are not required to? Given the
forthcoming elections; it is possible and understandable that Chancellor Merkel
may have given in to pressure or sought to put herself in a favourable light
ahead of the polls in September. This is
not to say that the view shared by Germans vis-a-vis the Cypriot situation is
not shared by other Eurozone economies; and hence a dangerous precedent has
been set given that the Cypriot bailout deal, resembles more of a bail-in where
senior creditors are very realistically going to make considerable losses.
Some observers have noted that the final deal is a better
alternative to guaranteed depositors being left open to losses; however I
strongly believe the outcome is the same in both cases, if less detrimental to
more 'ordinary' agents. Cyprus will eventually have to find a viable and
efficient foothold from which more progress can be made; as its banking sector has
been irreversibly damaged (at least for the near future), and economic prospects
for the next few years put into jeopardy.
Not only does it have to push on with programs of austerity and
structural reforms (both commonly coined Germany's dose of 'medicine' for
countries receiving bailout funds), but it will also face slumps in demand caused
by prospectively extensive shortages of credit at least until the banking
sector is back on its feet, and then there's also the matter of consumer
dissatisfaction and disillusionment.
Unguaranteed depositors do not yet know the full extent of their losses;
but early estimates are aiming in the range of initial losses of 37.5% and further losses of 22.5% if more capitalization is needed; this combined with the
current capital flow controls and restrictions in place (to prevent cash leaving
the country) implies no decent investor would even consider the idea of
approaching Cyprus now, or in the near future.
The ramifications for the wider Eurozone however, seem
less dire given the relative size of the Cypriot economy, some creditors however; especially those with considerable amounts invested
in precarious economies such as Italy or Spain, may shudder at the thought of
their funds also being used in future bailout programs. This was reflected in bank shares sharply
falling last week following a suggestion by Jeroen Dijsselbloem,
President of the Eurogroup that the stipulations of the Cypriot deal might be
used as a template for any further bailouts; shifting risk to private sector
creditors. These fears however were
eased later by a board member of the European Central Bank; Ewald
Nowotny, who implied the Cypriot situation, was indeed a one-off and special
case.
The fact remains Cypriots will find this latest deal
extremely hard to take, a dose of 'medicine' perhaps too strong or with too
many side-effects; the costs of staying in a club which has yet to yield the grandiose
membership benefits predicted from the onset.
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