Cyprus: Euro Drama, Act Two?

The Euro crisis in Cyprus has taken a new turn after 12 hours of dramatic discussions that went on late into Sunday night among the main actors in the crisis, the Cyprus President, the Euro-zone finance ministers a.k.a. the Eurogroup, the EU Commission and the IMF. And all this drama was caused by the European Central Bank's threat to withdraw support to the Cypriot banking system starting this morning Monday 25 March.

So what happened? I blogged about the meaning of the crisis last week and now it's only fair that I give you an update. The New York Times reported this morning that "the deal would scrap the highly controversial idea of a tax on bank deposits, although it would still require forced losses for depositors and bondholders."

"Forced losses?" That's delicate diplomatic speak for saying that 
(1) the second major bank in Cyprus, Laiki, will be wound down (read: closed, its employees laid off) and the first, The Bank of Cyprus, will be "restructured", absorbing Laiki's "good assets" and
(2) only deposits under €100,000 are left untouched (those are the ones legally insured, hence considered safe from any government levy in the Euro-zone). All the others are going to get hit, and if one is to believe gossip circulating this morning, they will get hit very hard: up to 30%. Yes, that's not a typo: thirty percent levy on deposits over €100,000. 

Actually, it's a new principle in Euro bailouts: for the first time bank depositors and senior bondholders will be forced to "take a hit" - read they will be the first to lose while taxpayers of the rich Northern countries will be protected.

Tough! Very tough on foreign deposits in Cypriot banks that are around half of a total €90 billion - of these some €20 billion are Russian.  But we all saw last week that the Russian government doesn't appear to care much - presumably that money is largely illicit. Indeed, Cyprus has a sulphurous reputation internationally as both a financial turntable for fast money and a tax haven. Some €250 billion go through Cyprus every year to finance eat-west trade, especially with Russia and international corporations pay only a 10 percent tax here as opposed to 12.5% in Ireland - compare this to the over 29% tax in Germany and 33% tax in France and you get the idea. 

However, when the Cypriot finance minister flew to Moscow to get aid, he got nothing. So far, the Russians have given a €2.5 billion loan to Cyprus to help it develop its huge offshore gas field and don't seem to want to get into a fight with the EU over Cyprus. It probably wants to keep its stake in the Cyprus gas reserves and there's every good reason to want to do so: after all, it is expected that Cyprus gas will be able to cover some 40% of the EU needs. Moreover the Turks have warned Cyprus not to use its gas reserves as collateral in any bailout deal since the Turkish part of Cyprus has as much claim to it as the part within the EU.

Yet IMF's Chief Christine Lagarde and the new head of the Eurogroup, the Dutch Finance Minister Jeroen Dijsselbloem, a close friend of Germany, both sounded relieved this morning in their respective press conferences, as if they had really solved the Cyprus problem. They touted  this new deal as a victory, highlighting the fact that it left the original, highly controversial 16 March deal largely untouched. The ECB short-term lending to Cypriot banks will continue. And Cyprus will get, starting in May, the €10 billion bailout it needs to save its banking system from collapse and good weather has returned over the Euro-zone. It would seem that Asian markets this morning believed this was the case (they were all pointing up) and the Euro exchange rate was (relatively) stable. By the end of the day however, European markets had dipped. 

The Cyprus bailout conditions set a precedent nobody likes. Least of all the Cypriots. The local press this morning highlighted that Cyprus was on its way down a road of suffering with austerity measures along the lines of those imposed on Ireland, Portugal, Spain and Italy, with no light at the end of the tunnel. You can't blame them, a lot of people are going to find themselves out of work, and not only at the Laiki bank that has to fold. It is clear that the Cypriot economy based on the island's peculiar financial role as a tax haven and financial turntable will be seriously damaged, and this for a long time.

Is it good for the Euro? Not really. Once again, we have the spectacle of Germany imposing its views on Europe with the staunch support of two countries in particular, the Netherlands and Finland. Germany makes €750 billion on its trade within the Euro-zone, you would expect it to feel a little more generous towards struggling Euro members. What happened to Cyprus is basically a replica of what happened in every other European country whose financial system went under water. As to the immediate cause of the Cypriot banking collapse - something Cyprus has suffered from since June of last year - , it is a knock-on effect from the Greek crisis. The Greek debt held by Cypriot banks went sour, it's as simple as that. One might perhaps add to it the effect of the world crisis in ship finance that began in 2008, though due to the lack of transparency in banking, it is hard to prove anything.

We are still dealing with the same systemic crisis.

And Germany's response is still the same. Angela Merkel is out to protect national taxpayers and never ceases talking about haircuts that banks must take. She knows how she has to act to get her votes when elections come up next September. Don't expect her to have a vision of Europe, she's only thinking of saving her job as Chancellor, full stop.

Does Cyprus matter to the rest of the world? On the face of it, not much, it's a small country of less than one million inhabitants with a GDP worth 0,2% of the Euro-zone. It's  just one more tax haven that goes down the drain, and with it a few corrupt banks. Should you be happy over the clean-up? Yes and no. Because the crisis, remember, is systemic: the way it is handled by the European authorities (and the IMF) affects the Euro. Sure, exit of Cyprus out of the Euro-zone has been averted, but at what price?

The Euro is looking less credible, Europe is getting economically weaker...Is that good for the world?



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