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Q&A: why does the Cyprus bailout matter?
What has happened and what does it mean for the future of the eurozone?
What has happened?
International lenders have agreed a €10 billion bailout for Cyprus, the small eurozone nation with the over-sized financial sector.
Cyprus, with an economy equal to just 0.2% of total eurozone GDP and fewer than 800,000 inhabitants, will become the fifth eurozone country to receive financial aid, in an effort to see off a banking collapse and default.
But the deal, if approved by the Cypriot parliament – and then European parliaments – sets a new precedent: it will be the first time that holders of bank deposits will have to shoulder costs.
What are the details?
Contrary to the new EU bank deposit guarantee for up to €100,000, Cyprus will impose a levy of 6.75% on bank deposits of less than €100,000 and 9.9% above that to raise some €5.8 billion.
In exchange, depositors will receive shares in their banks and, if they hold onto deposits for two years, securities linked to future revenues from the country’s gas reserves.
With one of its banks teetering on the brink president Nicos Anastasiades told the country the deal was essential to avoid financial collapse and losses of over 60% for depositors. Without the bailout Cyprus risked defaulting on its debts in May.
Address to the Nation by the President of the Republic, Mr Nicos Anastasiades
My fellow Cypriots,
A fortnight ago you entrusted me with the leadership of the country. Assuming my duties, I promised that I would do everything possible to confront the deep economic crisis in which our country was led. At the same time, I committed myself to speak to you always with consistency and with the language of truth, as you know that I always do, without taking account of any political cost.
At the same time all the citizens individually and collectively are aware that Cyprus is in a state of emergency. We are living through the most tragic moments since 1974. You know that we have received a country in a state of bankruptcy.
How and who led our country to this predicament is not a matter for discussion at present. It is not my intention, instead of focusing attention on how to deal with the crisis, at this moment to get into an unnecessary controversy over who and to what extent they are responsible for the current situation.
With a sense of absolute responsibility I consider it my duty to inform you about the last meeting of the Eurogroup and honestly to set before you the real options that were put before us in the European Council.
The first option was one that would lead to disorderly bankruptcy as a result of the decision of the European Central Bank to immediately discontinue the provision of emergency assistance to preserve the liquidity of the two large banks.
The second option is a very difficult but controllable and manageable condition that will eventually lead to the stabilization of the economy and to recovery.
I have to remind you here that in December, in his announcement regarding the acceptance of the memorandum, the former President Mr Christofias said that "it would be irresponsible and criminal for the place and people" to let the banks fail, because 'that would drag the entire economy into destruction and bring untold misery to thousands of families of ordinary people. "
It is not my intention to gloss over the decisions taken because I do not underestimate the difficulties and risks we will face.
But it is with a sense of historical responsibility that I took a decision. Even if I fully disagree with specific provisions. I had to decide which of the two would have the least painful consequences and ensure the prospect of saving the island's economy.
The choice of disorderly bankruptcy would have the following consequences:
1. One bank would instantly cease operation. Following that the other major bank would suspend operations and we would finally be led to the collapse of the banking sector.
2. As a result, depositors would lose direct access to their deposits, while a large number of depositors would be subject to significant losses.
3. Thousands of SMEs and other businesses would risk bankruptcy.
4. Equally important, however, would be the direct loss of thousands of jobs in the banking sector. I cannot also ignore the consequent loss of thousands of other jobs related to banking activities.
5. The culmination of disorderly bankruptcy would be our potential coercion to exit the eurozone. A similar development would doubtless lead to a significant devaluation of our currency and our national wealth, with all that that would entail.
My fellow Cypriots,
Faced with the above I had to choose between persistence in a clear commitment that I will not accept in any way the cut of deposits or a course that would lead to consequences that would be painful for depositors but also for the local economy.
I want to assure you that my faith in what I declared was absolutely sincere and what was what I fought for to the end. I have undertaken my responsibilities. The solution that we have reached is certainly not the one we wanted, but it is the least painful under the circumstances because, above all, it leaves the management of our economy in our own hands.
In taking my decision I took note, apart from the negative effects that I have already identified, a number of other reasons too, including:
1) The proposed contribution of depositors is limited to interest income of not more than two years.
2) More important is the fact that any contribution will be a one time only contribution, since through this proposal the sustainability of public debt is definitively and irrevocably secured. Furthermore future generations are not saddled with our mistakes.
3) Any contribution made will not constitute a final loss to depositors, since in return they will be immediately allocated shares of the relevant banks for all their losses.
4) The state, recognizing its obligations will offer to those who keep their deposits for a period of two years half the value of their contribution in bonds, associated with future state revenues from natural gas.
5) Through the same decision pension and welfare funds are safeguarded and the taking of other tough measures such as wage and pension cuts and tax on financial transactions that were on the table is avoided.
6) The most important thing is that we are avoiding the vicious circle of a second Memorandum.
My Fellow Cypriots,
I fully share the unpleasant feelings caused by a difficult and painful decision. That's why I continue to struggle so that the decisions of the Eurogroup may be differentiated in the next few hours so as to limit the impact on savers.
It is obvious that the most painless option for me would be the most painful for the country and the people. I chose the more painful for myself taking the political cost, in order to restrict as much as possible the impact on the economy and the citizens.
Of course, my own decision, if it is to have the expected results, requires the approval of the House of Representatives. Therefore I appeal to the parliamentary parties whose decision I will respect fully, to decide in the light of the best interests of the citizens and our homeland.
I hope that all of us together, with things as they stand, will take the wisest decisions.
Our way is not easy. But I have absolute confidence in the persistence, diligence and determination of Cypriot Hellenism. With collective and responsible decisions I am sure that we will succeed.
This is part of a rescue programme that means Cyprus won’t have to rely on bond markets until the end of 2016.
Punishing savers avoids imposing haircuts on Cypriot sovereign debt and means that Russians with deposits in Cyprus will participate in the costs amid concerns that Russian money was being laundered through Cypriot banks. Greeks also have large deposits in Cyprus, having sought a safe haven from their own problems.
Why is this ‘taboo’?
Economists, journalists and the Cypriot people have slammed the deal as another rubbish, short-sighted rescue effort. Lenders have ‘crossed a sacred line’ says Jim Reid of Deutsche Bank. They’ve ‘broken a taboo’ say Morgan Stanley.
And why impose such conditions when the amounts of money involved are so piddly?
Gary Jenkins of Swordfish, a bond market consultancy, made comparisons with other rescue mechanisms: ‘The 3 year LTROs? A gross figure of over €1 trillion. Bailouts thus far? Hundreds of billions. Yet all this for just €6bn.’
Is it a done deal?
The Cypriot parliament, voting today, could scupper the package, or at least change the amount smaller deposit holders must pay. In particular there are calls to exempt small deposit holders of €20,000
Russia may not go along with it. Vladimir Putin has already spoken out against the ‘unfair, unprofessional and dangerous’ deal (via a spokesperson).
Legal challenges cannot be ruled out.
European national governments and parliaments still have to agree to the deal.
Will there be a bank run?
News of the deal lead to heavy cash withdrawals from Cypriot banks at the weekend, according to press reports.
Measures have been taken to prevent a bank run in Cyprus: today is a bank holiday and the Cypriot authorities were said to be considering keeping banks closed on Tuesday too. Enough deposits to pay a levy were frozen.
Are depositors in other eurozone countries safe?
The bigger concern is that savers in other eurozone countries withdraw cash for fear that they could face a similar raid as part of conditions for future aid.
A precedent may have been set where debt sustainability takes priority over depositors. Independent expert Ros Altmann warned the deal ‘undermines trust in the whole system’.
Economists at major banks largely dismiss such fears.
UBS noted the situation elsewhere was ‘broadly stable’ and they ‘see no reason why depositors in any of these countries should fear bail-in’. Cyprus is after all a ‘special case’ with its over-sized banking system and the lenders’ desire to penalise Russian deposit holders.
If a run were to happen though, Paul Donovan of UBS reminds us that history shows ‘monetary unions die because of bank runs’.
What about Cypriot banks’ UK arms?
Banks including Laiki and Bank of Cyprus have confirmed that the levy will not affect customer deposits held with overseas branches.
Meanwhile the UK Treasury plans to compensate British military and government personnel with money in Cypriot banks.
What else has Cyprus committed to?
The total measures aim to allow Cyprus’s debt/GDP ratio to reach 100% by 2020. Without the aid, this was expected to reach 150%
Aside from the levy on deposit holders, there will be an increase of the withholding tax on capital income, a restructuring and recapitalisation of banks, an increase of the statutory corporate income tax rate and a bail-in of junior bondholders.
16 March 2013
Eurogroup Statement on Cyprus
The Eurogroup welcomes the political agreement reached with the Cypriot authorities on the cornerstones of the policy conditionality underlying a future macroeconomic adjustment programme. The programme will be based on ambitious measures to ensure the stability of the financial sector, determined action to carry out the required fiscal adjustment and structural reforms to support competitiveness as well as sustainable and balanced growth, allowing for the unwinding of macroeconomic imbalances.
The Eurogroup welcomes the Terms of Reference for an independent evaluation of the implementation of the anti-money laundering framework in Cypriot financial institutions, involving Moneyval alongside a private international audit firm, and is reassured that the launch of the audit is imminent. In the event of problems in the implementation of the framework, problems will be corrected as part of the programme conditionality.
The Eurogroup commends the Cypriot authorities on the steps already taken to adopt fiscal measures agreed with the Commission, in liaison with the ECB, and the IMF. This notably concerns the adoption of consolidation measures amounting to 4 ½ % of GDP. The Eurogroup welcomes the Cypriot authorities' commitment to step up efforts in the area of privatisation
The Eurogroup further welcomes the Cypriot authorities' commitment to take further measures mobilising internal resources, in order to limit the size of the financial assistance linked to the adjustment programme. These measures include the introduction of an upfront one-off stability levy applicable to resident and non-resident depositors. Further measures concern the increase of the withholding tax on capital income, a restructuring and recapitalisation of banks, an increase of the statutory corporate income tax rate and a bail-in of junior bondholders. The Eurogroup looks forward to an agreement between Cyprus and the Russian Federation on a financial contribution.
The Eurogroup is confident that these initiatives as well as a strict implementation of the agreed policy conditionality will allow Cyprus' public debt, which is projected to reach 100% of GDP in 2020, to remain on a sustainable path and enhance the economy's growth potential. The current fragile situation of the Cypriot financial sector linked to its very large size relative to the country's GDP will be addressed through an appropriate downsizing, with the domestic banking sector reaching the EU average by 2018, thereby ensuring its long-term viability and safeguarding deposits. Moreover, the Eurogroup welcomes that an agreement could be reached on the Greek branches of the Cypriot banks, which protects the stability of both the Greek and the Cypriot banking systems, and does not
burden the Greek debt-to-GDP ratio.
Against this background, the Eurogroup considers that – in principle - financial assistance to Cyprus is warranted to safeguard financial stability in Cyprus and the euro area as a whole by providing a financial envelope which has been reduced to up to EUR 10bn. The Eurogroup would welcome a contribution by the IMF to the financing of the programme.
The Eurogroup calls upon the authorities and the Commission, in liaison with the ECB, and the IMF to swiftly finalise the MoU. The Eurogroup will review the programme documentation prepared by the Commission, in liaison with the ECB, and the IMF as well as the ESM once it becomes available. The relevant national procedures required for the approval of the ESM financial assistance facility agreement will be launched.
The Eurogroup expects that the ESM Board of Governors will be in a position to formally approve the proposal for a financial assistance facility agreement by the second half of April 2013 and subject to completion of national procedures.
What does it all mean for markets?
Financial markets like nothing less than uncertainty and the deal brings that in spades. It’s a further blow to the growing calm in the eurozone, after the inconclusive Italian elections.
Shares indices across Europe – and Asia – fell today, as did commodity prices. The euro initially fell on the news but has since stabilised.
After all, the European Central Bank’s guarantee of doing ‘whatever it takes’ remains.
‘Market participants know of the special situation in Cyprus and trust the ECB’s crisis instruments’, noted Commerzbank.
Kevin Gardiner of Barclays adds that ‘the amounts involved are small in the macro context’. He tells clients of the bank to use volatility as an opportunity to buy more shares in developed equity markets - including the euro area.
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by Gavin Lumsden on May 23, 2013 at 10:05