Cyprus and the euro: 'Aphrodite’s indebted island'

Could a country smaller than Sicily reignite the euro crisis?

Πηγή: The Economist
Jan 26 2013

IN JUNE 2012 the Cypriot government asked for a bail-out after the two largest banks, stacked with Greek bonds, fell victim to the 2011 write-down of Greek debt. Seven months on, time is running out. The finance minister, Vassos Shiarly, says he has to find €1 billion a month to refinance loans and for other spending. Yet the bail-out could be blocked—or approved only with conditions that spark renewed alarm among investors.

This week Jörg Asmussen, a European Central Bank board member, said the problems of Cyprus could be “systemic for the rest of the euro area”. Charles Dallara, head of the Washington-based Institute of International Finance, warned of “underestimating the potential contagion impact” coming from the island.

The government says it needs €7.5 billion ($10 billion). But its banks also need more capital. A committee including Greek-Cypriot officials and the troika of the European Commission, the ECB and the IMF asked Pimco, a big American bond investor, to advise how much, and the provisional answer was €10.3 billion. But in Germany, especially, any idea of using taxpayers’ money to underwrite deposits in Greek-Cypriot banks meets stiff resistance. Last year Germany’s foreign intelligence service declared that the main beneficiaries would be Russian oligarchs, businessmen and mafiosi.

Cyprus has outsized banks with big non-resident deposits (see chart). Taxes are low and the authorities encourage Russians to invest. Central-bank officials do not have an exact figure for Russian deposits, but estimate they are less than 10% of the total. Yet commercial bankers talk of a figure of 35%, as many Russian investments are disguised as local ones.

Not all of the money is dirty. Yet claims of Russian gangsters benefiting from German toil are a gift to the German opposition, whose votes will be needed to get a bail-out through the Bundestag. “In the context of the euro area’s new €500 billion European Stability Mechanism,” notes Jacob Kirkegaard of the Peterson Institute of International Economics in Washington, DC, “[Cyprus’s] financial problems look like a rounding error”. But a €17.8 billion bail-out would be almost the size of the Greek-Cypriot economy. It would also increase the government’s total debts to around 140% of GDP, which might well make them unsustainable.

That spooks the IMF and may explain why Pimco’s final report has yet to emerge. Behind the scenes, Cypriot officials are pressing for a lower figure and have hired other experts to scrutinise Pimco’s methods. The Germans suggest that more state assets should be privatised. That might be easier after President Demetris Christofias, a Communist, leaves office following the election on February 17th. His successor is likely to be Nicos Anastasiades, leader of the centre-right Democratic Rally (DISY). But DISY’s spokesman, Harris Georgiades, says Cyprus’s publicly owned firms are either “in such a bad state no one would buy them, or they would not generate enough revenue to have a significant impact”.

The IMF is widely thought to favour a Greek-style haircut of government debt. But since much of the government’s borrowing was from banks that need recapitalising, only a small share—barely €2 billion, by some estimates—could be written down. Another objection is that the European institutions have promised that the Greek exercise would never be repeated.

Hence talk of writing down the banks’ debt securities (again, relatively small beer at €1.8 billion) or inflicting a haircut on rich depositors. The Russian government might also be asked to help. Or the troika could lend Cyprus the full amount, but delay repayments until the benefits of a huge gasfield find off its southern coast begin to flow. Yet this is where the island’s intractable inter-communal politics come in.

For political reasons, the Cypriots plan to export the gas via a costly LNG terminal that could take 15 years to generate revenue. But Cyprus’s creditors may press for the faster (and cheaper) option of building a pipeline to Turkey: something that, with settlement talks with the Turkish-Cypriot north stalled, Greek-Cypriots would find hard to swallow.