What now?

March 20, 2013


The slow motion Cypriot car crash of the past five days reached impact point last night when not a single lawmaker voted for the bailout with bank levy attached – the first time a euro zone legislature has simply said no.

So what next? The finance minister is in Russia, ostensibly to seek an extension on an existing 2.5 billion euros loan on better terms, but could there be more on offer besides? The Eurogroup made clear last night that the 10 billion euros bailout was still on the table but that Nicosia had to come up with 5.8 billion euros of its own – the sum that a levy on bank depositors was supposed to raise. Could Moscow fill that gap, maybe in return for a slice of the island’s untapped offshore gas reserves? It looks unlikely but not impossible and there are powerful geopolitics at play. That there will be no more money from the euro zone looks like a given and there seems to be a resolve that it would be better to let Cyprus default then buckle at the last moment.

Finance minister Sarris has just said he hopes for a deal on the existing Russian loan today. In Nicosia, the president is meeting party leaders.

The most sensible solution would be to spare Cypriot depositors with less than 100,000 euros – who were supposed to be protected anyway – and hit the big boys. That would go some way to negating the fear of a bank run elsewhere by belatedly respecting the deposit guarantee. Nicosia has rejected that up to now, fearing the destruction of its banking model but at eight times the size of the economy, that’s no sort of model anyway. What is crystal clear is that Germany will not accept another bailout foisted wholely on euro zone taxpayers, nor would the Bundestag ratify it.

The euro zone has some leverage. Cyprus’s main two banks are basically only standing because of the European Central Bank, which said last night that it would continue to provide liquidity “within the rules” i.e. to banks which are solvent. That means money flows for now but the bulk of the bailout will go to sort out the banks so if it completely falls apart they could not be viewed as solvent.

There is also a strong story to tell about why Cyprus is a one-off and richer depositors should take a hit, though it conspicuously has not been told yet in a shocking failure of communication. With high returns come risk and the rates Cyprus was offering should have given any sensible investor pause for thought. Unicredit have crunched the numbers and found that since 2008, a depositor would have earned a 31 percent return in Cyprus, versus 15 or so in Italy and Spain and 8 in Germany. If it looks too good to be true, it probably is. No other euro zone banking sector is remotely comparable.

The only real systemic risk that Cyprus poses to the euro zone is if people elsewhere in the bloc watch fellow citizens being kept away from their money and deposit guarantees being reneged on and think it’s time to pull their own cash out of the banks. So far there’s little sign of that but Cyprus’s banks remain shut, at least until Thursday. When they reopen, images of people battering down the doors could well up the ante and if they stay closed, sooner or later there’s going to be a riot. But in sovereign terms, Cyprus, at 0.2 percent of euro zone GDP, is a minnow and the European Central Bank has plenty of ammunition – maybe via its bond-buying programme or even a new round of cheap money for the banks (an LTRO in the jargon) – to stop any contagion to Spain, Italy and elsewhere.

Markets still seem relatively sanguine, perhaps reflecting the above view. It’s worth remembering Mario Draghi’s precise words when he promised last year to do whatever it takes to save the euro. “Believe me, it will be enough,” he said. Paul Carrel will be exploring the ECB’s options today.

Italy is utterly overshadowed but it shouldn’t be – it poses far more of a systemic risk to the euro zone than Cyprus does. Today, President Napolitano attempts to find a way out of the stalemate left by last month’s inconclusive elections which left no party with the numbers in parliament to form a government. He will meet leaders of all the main groups and is expected to give a so-called “exploratory mandate” to centre-left leader Pier Luigi Bersani, who leads the largest bloc in parliament but who does not have a majority. His prospects of forming a government are slim given the divisions with the other parties but it is not clear what the alternatives are, apart from another try at a Monti-style “technocrat” government.

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