Sunday, 17 March 2013

Cyprus bank bailout: the issues we must consider

Below are some provisional thoughts I’ve been publishing on my Twitter account on the decision taken by the Eurogroup on Saturday morning regarding Cyprus’ request for a bank bailout. I won’t go into the details of the decision because you probably all know what’s being proposed, suffice it to say that we must think beyond what the immediate economic impact of the bail-in/out would be – it is not just a question of taking seven and 10 percent from people’s savings – and consider the wider political and geo-political implications.  

As of 12:00 pm:

12. Melian dialgoue from Thucydides always comes to mind in circumstances in which Cyprus finds itself:

11. Cyprus socialists announce they will vote against bail-in/out. Will demand renegotiation of terms.

10. In fact, what do Greece, Cyprus, Serbia, all devastated by the EU, have in common? They’re not quite ‘European’, are they.

9. Here’s an ugly truth. Cyprus has been hung out to dry because as Greeks and Orthodox Christians, Cypriots have no powerful allies in EU.

8. Everything Cyprus does must take into account Turkey’s occupation & continuing threats. As in 1974, Turkey sits there waiting for mistakes.

7. UK’s decision to compensate soldiers affected by Cyprus bank levy amounts to direct UK government contribution to Cyprus bail-in/out.

6. Anastasiades is a serial blinker. He blinked in 2004 and backed the Annan plan; and he has blinked again in 2013 over bail-in/out. 

5. Given Anastasiades is fatally damaged, implications for Cyprus issue serious. UN, Turkey and others will have noted his capitulation.

4. Anastasiades, given no depositor haircut promises, barely 2 weeks into presidency, is politically finished. Five years of lame duck.

3. Geopolitics of driving Russians out of Cyprus has also to be considered. EU & others irked by Cyprus’ political & economic links to Russia.

2. Also correct. Troika hitting large (foreign) savers is designed to wreck Cyprus’ economic model as financial centre:

1. @Frances_Coppola is correct. Anastasiades hit small savers in (futile) effort to preserve Cyprus as financial centre.


Hermes said...

This is not an easy problem to solve. Some thoughts. The inescapable fact is that Cyprus's financial sector grew out of all proportion of what the country support. A large part of the Cypriot economic model was to provide financial services helped by high deposit rates, low corporate taxes etc (as well as tourism); particularly, to Russians. When those deposits came pouring in, they needed to invest that money somewhere and they invested in Greek bonds. Greek bonds fell and the banks were basically screwed. The Cypriot government could not bail out the banks because as I wrote above they had grown too large for its economy. Therefore, the risk fell on the EU. The Europeans turned around and said to themselves why should we bail out the savings of Russians. Of course, the same applies to other offshore financial centres but other financial centres are not asking for money from the EU. Because the Cypriots were unprepared to raise income taxes further the Europeans levied depositors for bank shares in return despite assurances that deposits below 100,000 euros were guaranteed – which creates serious distrust of the authorities in Cyprus and elsewhere in the EU. Sadly, most of the Russian money has probably already left based on rumours and also because the Russian government is trying to repatriate outflows, leaving most of the pain to be felt by the Cypriots. Of course, although they do not like to admit it, many of the Cypriots should bear some of the pain because they were beneficiaries of this economic model i.e. real estate prices increases following the influx of Russian money, high deposit rates (which signifies high risk), corporate taxes were low etc. However, the levy is not very egalitarian in that they are taxing small and large depositors and all deposits regardless of how solvent the bank’s are. Also, there will be some very unfortunate victims like 80 year old grandmothers who will see their savings decline. I am not sure how they benefited from the previous system.

I am not sure why the Cypriot politicians agreed to this deal. If it was to preserve Cyprus as an offshore financial centre; particularly, for Russian money, well have they not noticed that the Russian government has been making efforts to repatriate offshore Russian money, so maybe the days of Cyprus being an offshore centre were ending anyway. What is there to preserve? However, let’s say the Russians are really planning to stay in Cyprus, then why agree to German plans? Has the EU provided protection against Turkey? Or, is the access to EU funds and other benefits worth screwing the remaining Russian depositors? Will Russia continue to support Cyprus in the UN and in other negotiations.

John Akritas said...

Your last point is particularly interesting. If Cyprus ceases to be of benefit to Russia as financial centre, will Russia feel less inclined to support Cyprus in UN?

My perception is that precisely because Cypriots, as you imply, have done well out of the tax haven economic model and there’s lots of disposal income around, they would have taken the pain of this tax, had Anastasiades not insisted that a deposit tax was a red line and that he had sufficient good will in the EU, particularly from Merkel (who even came to Cyprus to back Anastasiades during the election campaign), for this not to happen. So people feel shocked and betrayed and don’t know if they can trust the state and Cyprus’ economic and political system. Several lines have been crossed.

Moreover, it seems with this decision, Cyprus is not going to be given time to downsize its banks, but will have to do it immediately, in days, and the impact on the economy, already in recession, will be devastating, with more businesses closing, less spending and higher unemployment. People thought that by voting in the pro-EU Anastasiades they would be avoiding Greece and Spain’s fate, but apparently not.

The latest is that Anastasiades, to get the necessary votes in parliament, which is going to be very difficult, is scrambling to impose a bigger hit on €100,000 plus deposits and lessen the burden on those below. This makes sense to me, since the wealthier Russians and Britons are going to withdraw their money anyway and there is no point in giving them an incentive to stay put, so it’s fair to hit them harder for sake of less well off Cypriots.

Ted said...

This is a horrible decision for cypriots and the world at large.

First all of your points are valid and I believe they are primarily targetting russian money. I hate the holier than thou attitude the rest of the european's are taking. Cyprus has only ill gotten gains from Russia. Well how about the criminals the UK is housing like Berevosky. Where are all those african dictators money sitting? Not cyprus.

Also I think they are trying to destroy the cypriot economy and impose another annan plan. I am tired of the comparison of the cypriot economy to the greek. From what I understand cyprus had a healthy economy and this crises was from outside forces, the prime one the greek crisis and the banks having to much exposure.

But this is also bad for the world. This deal punishes savers. Banks need savers its ludicrous to punish the class of people we need to get out of this crisis. It is evident that the big banking cartels and crooked western governments are trying to inflate their way out of this crisis. This will be evident for everyone now. And you just know Cyprus is step one with this solution if they get away with it some other country is next. This could lead to a potential worldwide bankrun.

John Akritas said...

I'm not sure the Germans etc wanted to break Russia's links with Cyprus because they genuinely believed the story about the island being a haven for Russian mafia money. Cyprus being a magnet for dodgy Russian money is a myth propagated partly for internal German political reasons – the SPD and Greens in an election year banging on about German taxpayers' money being used to bail out those barbaric Slavs – and also because this was a good opportunity, for geopolitical reasons, to drive Russia out of Eastern Mediterranean.

Hermes said...

John, I do not mean to say that all Cypriots have done well out of the tax haven economic model but a good number have, and they, as well as foreign depositors and the senior bank lenders, should be expected to pay the bill. Not old widows. But, the unfortunate reality is that the old widow’s money is more easily captured compared to the money of foreign depositors which has been leaking out for months.

It does seem like some more sanity will prevail and the tax on deposits below 100,000 euro will be reduced in favour of a higher levy for deposits above 100,000 euro.

The point about Russian support will depend on what the Russian State wants, and not depositors. They do not always see eye to eye. In fact, recently the Russian state has been trying to repatriate funds. Perhaps, the Russian state will support the levy, because it will mean some money will find its way back to Russia and they will avoid having to bail out the depositors by providing a loan to the state of Cyprus to bail them out. The levy might not worry them too much as they will see it as a penalty to Russians for having funds offshore rather than in Russia. If this is the case, Russian diplomatic support for Cyprus might continue.

As for the Cypriot economy being healthy, that is not wholly accurate. Cyprus has run persistent government and current account deficit for a number of years which has meant it has relied on external financing. If it was structured like a normal economy, i.e. taxes at the levels of most other countries, then this might not happen. But if it had higher taxes then economic growth would not had been so strong.

John Akritas said...

I’m not sure that the Russians wanted the money in Cyprus repatriated. It suited Russia for geopolitical reasons that a Russian colony was being founded in Cyprus and the Russian authorities were complicit in Russians using the island as a financial centre. I note the Russians are now saying they weren’t consulted by the EU about the levy, which they’re furious about, and Medvedev has said Russian will have to review its relations with Cyprus, which is perhaps what the Germans et al wanted.

Hermes said...

The Russians should also learn to accept some pain. They deposited their money in an offshore haven which rewarded them with high returns, low taxes and the ability to shift that money to Switzerland and thereby reducing its ‘dirtiness’. After all those gains, a 10% loss is not that significant. A small price to pay. Higher returns equals higher risk.

The question is what will they do with Cyprus and with the EU? I reckon they will do nothing with the EU as they need them; particularly, Germany for technology transfers and markets. However, they may dump Cyprus and shift their money to Latvia or somewhere else.

Apart from breaking the promise of keeping deposits below 100,000 euro sacrosanct, which is very serious, the plan is actually not a bad idea compared to others. Rather than push through a series of tax increases and expenditure cuts which can take a long time for the State to collect (just look at Greece), the deposit levy collects the funds almost immediately. Time is of the essence in these situations. Many of the Greeks of Cyprus that are complaining should probably consider this a better deal. However, the levy on small depositors is very poor economic policy.

John Akritas said...

My sense is that Cypriots aren’t complaining so much because they stand to lose money – 6.75 percent is not catastrophic or impoverishing, you’ll lose about two grand on savings of €30,000 – but because the overall bailout plan will destroy Cyprus as a financial centre, alienate Russians, who Cyprus needs as tourists and to buy property, and will deepen the recession. Financial services, property and tourism is the lifeblood of the Cyprus economy. Until the gas arrives, there is little else, and even with the gas, international companies will only invest if they feel there is a sound and trustworthy financial system.

Hermes said...

John, I am not sure they have much option. Where else will they get the money? Perhaps, they need to sit down with the Russians and say, "we were forced into this by those Europeans, but we still love you. And, what is 10% when you already get huge concessions and safety when you park your money here compared to anywhere else!"

John Akritas said...

Varoufakis says similar to you H. on the correctness of hitting the €100,000 plus savers and the error of hitting those below and he’s somewhat contemptuous of Cyprus’ efforts to become the Switzerland of the Mediterranean so he’s not that worried about Russian money fleeing Cyprus. But I would still maintain that it’s not simply Russian money fleeing Cyprus we have to worry about – and I doubt whether the Russians will say, okay we’ll take the 10 percent hit and still stay in Cyprus, rather they’ll take the 10 percent hit and take the other 90 percent to Latvia – but the dilution of Russian political support for Cyprus against the Turkish occupation. Indeed, the Russians have every right to say to the Cypriots: all these years at the UN we’ve been backing you, protecting you from UK and US machinations, and now you go and do this to us! Cyprus will have to do a lot of crawling to keep the Russians sweet.

Hermes said...

Varoufakis fails to see the broader geopolitical dimension.

On further thought, I do not think the Russian will leave. They might yell and and scream for a few weeks, maybe even a few months, but they will look through this issue and see the longer term and broader benefits of maintaining significant influence in Cyprus; especially, as the gas resources are developed in the Eastern Med by Israel, Lebanon and Cyprus and if the Syrian situation means that a Alawi-Christian enclave is created along the coast. Basically, they will have a chain of influence stretching through all these countries.