By: Andrea Cohen
That Cyprus financial system (and country) in general is in a dire state and requires external assistance has been a known fact for a long time now. Yet, with massive austerity plans and public debt crises in much larger (and let’s admit, much more important) countries such as Italy, Spain and Greece, Cyprus’ problems were pushed back in line when it came to media and policy makers’ attention.
Here we will try to give a summary of the background to the current situation and a description of the measures taken. Also, we will try to identify “players” whose actions and interests should be taken into consideration.
In terms of economic activity, Cyprus is a drop in a bucket for the Eurozone. With about 0.2% of Eurozone GDP, an isolated collapse of the country should have almost no effect on the rest of the union. However, the Cypriot crisis is not unfolding in a vacuum – the eyes of other distressed nations, politicians and citizens alike, are fixated on the island in an attempt to figure out what’s next in store for themselves.
A very significant portion of the Cypriot economy is the financial services sector. With extremely low corporate tax rates (10%) and a reputation for loose anti-money-laundering enforcement. This attracted many corporations to open offices in Cyprus and set it as their European hubs as well as huge sums of money out of the former Soviet Union that have been deposited in Cypriot banks (where few questions are asked about the origins of this money). What did Cypriot banks did with so much money? Among other things, they bought a lot of Greek sovereign debt. That’s right, Cypriot banks are among the largest holders of GGBs and as private institutions they became subject to the terms of the Private Sector Involvement (PSI) which slashed the value of their balance sheets’ “Assets” column.
At the brink of despair, bank turned to Cypriot government for help. Yet, with the public debt at about 80% of GDP, the Cypriot government is in no position to bail out the banks. That leaves the bank about €17bn short. Talks between the Cypriot government and the Troika (EC, ECB and IMF) as well as finance ministers meetings have culminated last week. European leaders (well, Germany, but we don’t want to point fingers right now) have advocated for a one-time tax on bank deposits. Initial Cypriot resistance was overcome when it was made clear to the new president Anastasiades that refusing this measure means no financial aid from the ECB.
The deal that was announced on Saturday is this: the ECB will contribute €10bn to the cause. Another €1-2bn are loans from Russia, which will be rolled forward. The rest has to come from depositors. For deposits of under €100,000 the one-time tax was set to 6.7% and for larger deposits it was set to 9.9%.
The outrage of Cypriots reminded politicians there that supporting this tax on all savers is a political death-wish. We would be as bold as to say that with the dubious origin of many of the larger deposits, it’s not a stretch to imagine that supporting the tax could be a death-wish period.
The parliament convened today (Tuesday) to vote on a revised proposal (exempting small deposits of up to €20,000 from the tax), but eventually postponed the vote until next Monday. In the meantime, banks remain close (currently until Thursday, but we have no doubt they will remain closed until a resolution is reached) to prevent a total run on the banks. For now, locals have to settle for limited access to their money through ATMs.
It seems to us that European policy makers grossly underestimated citizens’ outrage in response to the initial offer. That reaction and the reaction of politicians to it, sent a clear message to leaders in other troubled countries which will probably eliminate similar attempts in the future (at least in regards to deposits by “ordinary” people).
Any Solutions?
So another solution is being sought. One such option is that the Russian energy behemoth Gazprom will recapitalize Cypriot banks in return to exploration rights in its territorial water. There is much confusion about this still (an item on CNBC no less was titled “Gazprom Is or Is Not Offering Cyprus a Bailout”. We kid you not), but with so much Russian money on the line here, we are not surprised by this offer. As an anecdote, Russian President, Vladimir Putin was quoted today as saying the tax proposal was “unfair” and “dangerous”. We would have smiled at this comment thinking that perhaps some Russian politicians have money stashed in Cyprus too, only that then we recalled that Russia is a major source of oil to Europe and can hurt those they deem responsible for the “unfair” measure by turning the faucet off.
At the moment, the situation is unresolved. We believe Germany is the biggest loser at the moment as it (together with other “important” member states) twisted Cypriot leadership arm into agreeing to this tax only to see how even an apparently inconsequential state like Cyprus stands up to it. We will continue to closely monitor the situation, but if we have to assess the situation now, we would say that it is a major bearish sign for Europe and the EUR, at least in the short term.