Gold Magazine May - June 2013, Issue 26 | Seite 37

opinion

Problem Solved?
The implications of the bailout agreement
for Cyprus’ economy and banking sector

E

urozone officials may be satisfied
that Cyprus has been ‘saved’
following the agreement on a
bailout package but it is now
clear that the recession in
Cyprus will be far deeper and
longer than envisaged, requiring
greater government spending on ‘benefits’ and tax
increases. Troubled local banks might require further
recapitalisation due to the knock-on increase in nonperforming loans and, consequently, loan provisions.
That will ‘squeeze’ even further those large depositors
who have already lost a great chunk of their funds
above €100,000. Importantly, tough austerity and
the current recessionary environment will lock Cyprus
into a negative feedback loop with the possibility of
requiring a second bailout. The imposition of heavy
austerity measures on countries in the middle of an
economic recession has proved more damaging for
their economies than policymakers had anticipated.
Cyprus is expected to carry out fiscal consolidation
equivalent to circa 5%-7% of GDP which is likely to
shrink its economy by 16%-18%. The island’s debt is
still expected to increase to 140% of GDP, a level that
many consider unsustainable.
The immediate problem facing Cyprus is how to
restore confidence in its banking sector. Commercial banks and Co-ops need to maintain the flow of
money to the local economy. Disrupting that flow
is similar to disrupting the blood flow to the heart.
Capital controls and the suspension of lending prevent normal economic operations, with potentially disastrous consequences for individuals and businesses.
The Central Bank needs to recognise the implications
of keeping these measures in place for too long. For
instance, when businesses are limited in their ability
to pay suppliers (especially international ones) for an
extended period of time, they may have to lay off staff
(and consequently increase unemployment) or sell off
valuable assets (as distressed assets) in order to survive
since suppliers will be unwilling to maintain existing
credit lines. Moreover, they may also default on existing loans, thus damaging the bank’s loan portfolio
with possibly catastrophic implications for the local
economy and banking sector.
Even if confidence is restored and restrictions are
lifted, the banks will be unable to perform their role
as systemic lenders for years to come (especially Bank

Cyprus should
promote
itself as a
transparent and
professional
financial centre

By
George
Mountis

of Cyprus which will have to bear the burden of Laiki
Bank’s ELA funding and the administration of all
Laiki’s problematic loans as well as its own). To restore confidence in the system, the ECB must provide
unlimited liquidity to the Cypriot banks (especially to
Bank of Cyprus) once they are restructured and recapitalised. Cyprus is only the smallest of many countries
that find themselves trapped between heavy bank
deleveraging and significant government austerity.
Spain, Italy, Ireland, Greece and, increasingly, France
are all experiencing the same tough consequences in
their economies, so Germany may soon find itself in a
minority over its demands for additional austerity.
A long-term concern is whether Cyprus’ financial/
banking services sector has a future. German officials
suggested as a condition of the bailout that ‘offshore
depositors’ should bear losses as well as local depositors. Russian and Eastern European businessmen
have undoubtedly lost a lot of money in Cyprus.
However, it is unclear whether this will affect how
such businesses use Cyprus as their financial hub.
Choosing Cyprus as a tax jurisdiction does not necessarily require that investors hold all their funds in the
country. Whether offshore/fiduciary businesses have a
bright future ultimately depends on political decisions
made in Moscow, Brussels and Berlin. Cyprus should
promote itself as a transparent and professional financial centre with the aim of attracting Asian and other
international investors, while retaining international
businesses currently operating here.
Nobody doubts that, after such a severe blow to
Cyprus’ lucrative banking sector, the country will be
pushed into deep recession. A key question is this:
once the banks have been ‘cleaned up’, recapitalised
and shrunk, where will Cyprus find real economic
growth? The promise of offshore gas deposits is still
too uncertain and tourism may well decline if the
Russians suddenly find the island less hospitable
(although early signs indicate that this is not the case).
No matter how small Cyprus may be, its bailout
is an embarrassing reminder that the euro remains
vulnerable to banking and sovereign debt problems.
The risk for the eurozone is that the cessation of the
free movement of money across borders may be seen
as a precedent, causing nervous investors and lenders
to pull their money out of other economies and
banking systems perceived to be weak, such as those
of Italy and Spain.

info: Dr. George Mountis is a Partner at Leaf Research, a real estate, banking and investment consulting firm.
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