Despite the fact that the agreement in the Eurogroup of March 25 prevented an immediate and disorderly bankruptcy of Cyprus, there is no doubt that the coming months are going to be really difficult -even dramatic- for its citizens. At a press conference after the marathon meeting of the finance ministers of the Eurozone, early in the morning of Monday, the vice president of the Commission, Olli Rehn, implicitly likened the situation faced by Cypriots to the invasion of 1974: “The situation has reached such a point that no optimal solutions exist, but rather hard choices. The immediate future will be harsh for the country and its people. We will do everything we can in order to mitigate social consequences, especially for the weakest among the Cypriot citizens. The Cypriots have had tough times again -you are well aware of what I mean- but they were able to overcome the difficulties. I am confident that they will do so again,” Rehn stressed out.
The agreement to place Cyprus under the European Stability Mechanism provides that the second largest bank of the country -i.e. Laiki Bank– will directly be declared bankrupt. Beyond the fact that such a development will -sooner or later- lead to job losses, it also means that all deposits of natural or legal persons exceeding € 100,000 will virtually be wiped out. Maybe it will take years before the clearance procedure is complete and depositors receive some kind of compensation which, in any case, would be much smaller than the sums lost due to the haircut.
The customers of the Bank of Cyprus with deposits over € 100,000 will also suffer heavy losses. In fact, the decision provides that, at least for a specific period, uninsured deposits in the country’s largest bank will remain frozen, until the exact amount of their “haircut” is decided, in order to define the capital adequacy of the Bank at 9%. According to Jeroen Dijsselbloem’s statement in the press conference, who is currently holding the presidency of the Eurogroup, an amount which accounts for approximately 25% of the Cypriot GDP (€ 4.2 billion) will be lost, due to the collapse of Laiki Bank. Another amount among the uninsured deposits of Cyprus, which still remains undetermined, will be frozen. These developments, in combination with the imposition of restrictions on the free movement of capital -also for an unspecified time period- raise serious doubts as to whether the economy of the island will be able to function properly from March 26 onwards.
The unprecedented in scale abolition of capital, the loss of confidence in the banking system, which had served as a basic pillar of the economy of the island as well as a pool for jobs, the inevitable outflow of deposits along with the general uncertainty, are expected to deepen the recession in Cyprus beyond even the most pessimistic forecasts. In this sense, sustainability projections of the draft memorandum between the Troika and Nicosia should be considered as already obsolete, since the programme is already out of track. But given that the Eurozone is not willing to provide funding beyond €10 billion, as it was made clear in the morning of Monday, the biggest question that arises is how the inevitable gap in the funding of the Cypriot Programme is going to be covered, at a time when the economy is sinking and unemployment is spiraling. Whether the Bank of Cyprus will survive is equally dubious, since it is forced to assume the obligations of Laiki Bank towards the European Central Bank, through the Emergency Liquidity Assistance (ELA) of € 9 billion, besides the outflows of deposits it will suffer.
According to the heads of the Eurogroup – Jeroen Dijsselbloem, and the International Monetary Fund – Christine Lagarde, the Troika is planning to conduct a new sustainability study (Debt Sustainability Analysis), in order for the debt of Cyprus to fluctuate around 100% of its GDP by 2020. Subsequently, within the first half of April, the Memorandum will have been brought for voting in the national parliaments of the Eurozone, whereas the first installment of the support programme will be deposited in May, according to the head of the European Stability Mechanism, Klaus Regling. However, as we have already explained, the unknown variables combined with uncertainty could possibly blow the current planning apart.
Moreover, it is worth noting that the unfortunate handling of the situation by the Eurogroup and the Cypriot government over the last few days has shaken the trust of Cypriot citizens in the European trajectory of the country, as it has emerged from recent polls. Equally fragile is the confidence of citizens and markets in the crisis management skills of the Eurozone. If the -undoubtedly substantial- difficulties of a small economy like Cyprus are able to cause so much trouble, what then should be expected if a major crisis occurs in Italy or Spain? In fact, the initial decision of the Eurogroup, which imposed a levy on deposits below € 100,000, makes it clear that in case of a major crisis in the future, the Eurozone is ready to “cross the Rubicon.”
Perhaps the only positive aspects of an otherwise bad deal are that the depositors of sound banks in Cyprus did not suffer any losses, the deposits below € 100,000 remained intact, whereas the proper order was maintained in sharing the losses that accompanied the bankruptcy of Laiki Bank (shareholders, bondholders, uninsured depositors). Ultimately, a total breakdown and immediate exit of Cyprus from the Eurozone has been avoided, considering that the ECB had warned, on March 16, that it would shut down the liquidity provision in case that the Troika and Nicosia reached no agreement. Nevertheless, the future of the economy of Cyprus remains highly uncertain.
Could things have taken a different turn? Of course they could, provided that the necessary political will was present. First of all, there was absolutely no reason to demand from a small nation to pay in advance 30% of its GDP in cash, within three days. Such an outrageous request had not been made to any other bailed out country and it ridiculed the pro-European government of the island in the eyes of its people. Secondly, it was not the national debt of Cyprus that was unsustainable, but the country’s banks. And there was a solution to that: after wiping out shareholders and junior bondholders, and imposing a haircut to senior bondholders, the European Stability Mechanism could have taken over the Cypriot banks. Then, it would shrink them and put them in a resolution course, while forcing out “Russian oligarchs with black money,” if it wished to do so. This process would be carried out gradually, in order for Cyprus to buy the necessary time to come up with an alternative plan of economic development, excluding the financial sector. Although Berlin correctly realized that the model of the Cypriot economy, which was based on the financial bubble, was not sustainable, the dissolution of this model in a few days’ period is bound to cause more problems than it will solve, given that no alternative plan has been implemented yet. This option theoretically exists (it was decided by an EU Summit last June), but the legal modalities are not there yet to implement it, because Germany has since changed its mind. Cyprus could, in exchange for this arrangement, securitize future revenues from its gas reserves and offer them as guarantees, together with a strict fiscal consolidation programme. However, the damage has already been done. The question is how to mitigate its consequences.