Opinion

Hugo Dixon

Cyprus will pay dearly for its sins

By Hugo Dixon
March 22, 2013

Cyprus will pay dearly for its sins. The Mediterranean island has committed many follies over the years – and is still making mistakes.

The Cypriots seem congenitally inclined to overestimate their negotiating position. In recent years, their first big folly was to reject in 2004 the United Nations plan for uniting their island. That irritated their European Union partners, meant that Cyprus still has a weak strategic position vis-à-vis Turkey and leaves a jagged scar across the island.

The last Communist government was also criminal in its failure to act as the crisis in Greece threatened to swamp Cyprus. If it had been willing to restructure the banks, the Cypriot economy would now be in a lot better shape. It was also much easier to do a deal with Germany then than now, when Angela Merkel is only months away from an election.

The new centre-right president, Nicos Anastasiades, has been in office for less than a month. But he has managed to turn a crisis into a disaster by initially backing a plan to impose a 6.75 percent tax on insured depositors.

Of course, the other euro zone governments, the European Central Bank and the International Monetary Fund shouldn’t have said OK to this terrible idea either. And Anastasiades certainly had a gun to his head: he had to rustle up money somehow given that the euro zone was rightly unwilling to lend Cyprus more than 10 billion euros, leaving the country with a 5.8 billion euro funding gap.

But the Cypriot president is ultimately responsible for his actions. There was an alternative: tax the uninsured depositors at 15.5 percent and leave the insured ones untouched. Anastasiades didn’t want to do this as it would have angered Russia and undermined Cyprus as an offshore financial centre. But both of these have happened anyway.

When Anastasiades found he couldn’t sell the deposit grab to his people, he backtracked. There was jubilation in the streets. How quickly the mood has changed now that queues have started forming outside cash machines.

The Cypriot government then asked Russia for help. But again Nicosia overestimated its negotiating position. Moscow wasn’t interested in buying a bankrupt bank or lending more money. Michael Sarris, Cyprus’ finance minister, was sent home empty handed.

Meanwhile, the ECB has threatened to pull the plug on insolvent Cypriot banks unless there is a deal with the euro zone by Monday night. The government has therefore scrabbled together a “plan” with three elements: “resolving” Cyprus Popular Bank, the country’s second-largest and most troubled lender; imposing capital controls; and creating a national “solidarity fund”.

The best of these ideas, apparently originally proposed by the IMF, is to resolve CPB. It would be divided into a good bank and a bad one. The insured depositors would go with the good assets; the uninsured with the rotten ones. They might suffer 40 percent losses. That’s a lot more than the original deposit tax but the losses would be focused on one bank. The government’s bill for shoring up banks would be cut by 2.3 billion euros.

Imposing capital controls may be necessary. But it is hardly a cause for joy. Even if the banks re-open on Tuesday, there could be so many restrictions on taking out money that it will look like they are still partially shut.

The solidarity fund is a half-good idea. The plan is to pop pension fund assets, offshore gas reserves, the Cyprus church’s wealth and some state property into a fund. The hope seems to be to raise enough cash to fill the rest of the 5.8 billion euro hole. Even if it worked, it would amount to a fire sale of the county’s assets.

But this scheme has already run into a roadblock. Merkel says she will not be party to a scheme to grab pension assets.

Cyprus’ problems are far worse than finding a billion or two to make up the gap from pension assets. Last week, it had a chance of salvaging most of its financial centre. Now that will be largely destroyed. Last week it was staring at a middling recession. Now, with confidence crushed, its economy faces a slump.

All the number-crunching behind last week’s deal with the troika is therefore out of date. The country will need more than 17 billion euros because the fiscal deficit will rise and an avalanche of bad debts will push up the cost of shoring up the banks. Meanwhile, Nicosia won’t be able to sustain even 10 billion euros of extra debt because its economy will be smaller than envisaged.

Euro zone finance ministers indicated last night that they were willing to go along with a deal based on the old numbers. But even then Cyprus would be stuck with a zombie economy and zombie banks. It’s also unclear whether the IMF, which has argued strenuously for debt sustainability, could sign off on such a deal without destroying its own credibility.

It may be best to recognise this and go for an even more severe restructuring of the banking sector. At the minimum, Bank of Cyprus, the country’s largest lender, would need to be resolved along with CPB.

The Cypriot MPs won’t like any of this. But what is the alternative? Endless capital controls? Printing a parallel currency so people get Cypriot Pounds instead of euros from the cash machines? Or quitting the euro entirely?

There are no good options. But the longer it takes for Cyprus to get real, the greater the damage.

Comments
6 comments so far | RSS Comments RSS

“The Cypriots seem congenitally inclined to overestimate their negotiating position.”

Such ignorance. A weaker position is not an invitation for foreign bodies to exploit and bully a country into submitting to their will. It is not an overestimation. It is a stand against the unjust.

And as for the 2004 Annan plan you refer to: selling Cyprus away for a ‘strategic’ gain? As a British person I would never have voted in support of it had it been regarding Great Britain.

Of course Cyprus can be faulted with a lot of things. But to use this as an argument to gain support for the dire conditions being imposed is weak.

Posted by NotOnMyWatch | Report as abusive
 

Sins? Do you speak for the King? We dared to resist the slaughter?

I know who you work for. You think you are somebody as a result. But in the end, the “sin” of Cyprus to not surrender in disgrace to the powers that be may benefit your grandchildren, who will read this article by you in shame.

Posted by cyresistance | Report as abusive
 

It’s your opinion i don’t agree with you i find that rude and shame bcs if we can’t help Cyprus ppl don’t make worst !!!!!!

Posted by Papi66 | Report as abusive
 

Dear Sir,

I think you are unwillingly unfair with Cypriots. What we are inclined to overestimate is the validity of values and principles of the free Western World and the free economic model.

They claim:
1- We have an oversized banking sector.
2- We are laundering money.
3- We have low company tax rates
4- We are a special non-systemic case.

We answer:
1- We have a big banking sector because as a small country without – until only recently – we had no significant natural resources, very small agricultural sector – half of our fertile land is under Turkish occupation since 1974 – and we needed to create jobs for our thousands of graduates from UK’s and USA’s and Europe’s best universities. Hence our big banking and financial sector. Banks and accountancy firms providing decent and honest jobs for decent and honest people.

2-We offer secure, fast and attractive banking services for entrepreneurs from all across the globe. Like Luxembourg. Channel Islands, New Jersey and other financial centers.

3- We have low tax rates to motivate businessmen and entrepreneurs like we have been taught at London Business School,Warwick Business School, Harvard Business School and Stanford Business School and of course the many other business school were we have been taught free market economics and proper business ethics.

4- We are not a special case. We are the first testing ground for the new German approach to free markets economy were the basic principle of TRUST can be removed from our business dealings and where from today onwards it is an axiom of descent, honest and trustworthy business agreements that when I lend you 100 bucks and you agree to give them back to me anytime I want it is okey for you to say “here have your 100 bucks handsomely trimmed and manicured down to 80 bucks. You may leave your tips with the concierge,Sir”!

Nonetheless, I sincerely wish to thank you for taking an active interest into what is happening to my country today. I hope you will not be finding yourself into the unhappy position to be covering similar events near soon in Italy, Portugal, Spain, Greece and what comes next. Finally I earnestly hope that you, or any other citizen of Europe or the World at large doesn’t get treated the way we Cypriots are being treated today.

Posted by TempoModerato | Report as abusive
 

Excellent rational analysis.

If Greece has been the spoiled child of Europe in the past, getting away with everything, Cyprus (the Greek part) has been the spoiled child of Greece. They are spoiled squared. It is well known that Greece effectively blackmailed EU to get Cyprus inside while divided, by threatening to veto the rest of the expansion. On top of that, before their EU membership was approved, the Cypriot government openly lied to the EU (and specifically in the person of Ollie Rehn) that they will support a “Yes” vote on reunification and after they secured membership (but before the referendum), their president appeared on TV with tears in his eyes begging his people to vote “No”!

Of course, the Greek Cypriots, just like their brothers in Greece, will cry foul and blame everything on the Germans, without ever admitting responsibility.. Do they ever look around and wonder how come (after all that self-pity about how poor they have become, etc.) they have still by far the highest GDP/capita in the region from Italy to Israel without actually having a real economy too speak of? There is no such thing as a free lunch. At least not forever..

Posted by xpat | Report as abusive
 

In response to your comment ‘….their first big folly was to reject in 2004 the United Nations plan for uniting their island. That irritated their European Union partners, meant that Cyprus still has a weak strategic position vis-à-vis Turkey and leaves a jagged scar across the island’ I assume you or your family have not lost your homes, lives, friends and/or family from an illegal invasion of your country? If your answer to that is no, then therein lies the root cause of your complete lack of compassion or understanding of the situation.

Posted by victory2 | Report as abusive
 

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