Tuesday, March 19, 2013

Where Is Cyprus?

To most of us, we do not even know the locations of Cyprus, maybe even the fact that it was admitted into the European Union as well. How can something so small be so significant? How can it drag markets down so much? In hindsight, the weaker markets gave the lawmakers a big signal. Its not so much that they can whack the depositors in Cypriot banks, they are scared that such tough and unreasonable measures may be employed at other difficult countries such as Spain or Italy.

What is likely to happen: the Cypriot lawmakers will vote down the rule. This will anger the ECB and may pave the way for Cyprus exit. I mean, seriously, in the whole scheme of things, its only $7bn. You may actually see a minor bank run at places such as Italy and Spain as well, which may bring back the ECB, IMF and EU finance ministers to the discussion room. Likelihood, the tax will only apply to deposits above 100,000 euros ... paving the way to tax the rich but not the poorer citizens - that may be acceptable, the shortfall can easily be made up by the trioka.

Global markets were rattled slightly. However as more news on the backlash by so many parties, it is likely that the rule has to be changed significantly to gain acceptance, and more importantly restore confidence in the ECB's recovery and restoration plan. Cyprus ia small issue, no one will risk pushing the silly rule through at the risk of major fallouts in bigger EU nations. Last thing they need in Italy and Spain is a bank run.

(excerpts from Bloomberg & NYT)

A plan to rescue the tiny European country of Cyprus, assembled overnight in Brussels, has left financial regulators, German politicians, panicked Cypriot leaders and a disgruntled Kremlin with a bailout package that has outraged virtually all the parties. Russia was angry it was left out of talks to aid Cyprus, where it has billions in banks. Aha, you see, Cypriot banks was seen as a haven for a lot of riche Russians to stash their millions and billions.

As markets tumbled and the Cypriot Parliament fell into turmoil. It now looks likely that the Cypriot lawmakers will vote down the measures.

Officials scrambled to explain what went wrong and how best to control the damage of completely irrational decision to make bank depositors liable for part of the bailout. The deal flopped so badly that finance ministers who came up with it shortly before dawn on Saturday were on the phone to each other Monday night talking about ways to revise it. Whatever the outcome, the dispute is a vivid demonstration of why Europe, which until recently was congratulating itself on having weathered the worst of the financial storm, has trouble making decisions with so many different interests represented at the table.

Politics, both domestic and international, get in the way of economics and make it difficult for wealthy countries to line up behind a plan to help the smallest ones. The northern European nations have grown so weary of bailouts for their southern neighbors that they were intent on exacting a hefty contribution from their latest supplicant. Germany in particular, with parliamentary elections looming in September, was set on driving a hard bargain.

A wild card in this instance were the Russians, who have deposited billions in Cypriot banks, extended a $3.25 billion line of credit to Nicosia in 2011 and were in negotiations to help out Cyprus once again. Cypriot leaders apparently were so concerned with keeping their wealthy offshore Russian customers happy that they pushed their own citizens to pay even more than some of the lenders were demanding.

The Russians reacted angrily to a so-called stability tax on deposits in Cyprus, and at being left out of the negotiations. On Monday, Russia’s minister of finance, Anton Siluanov, warned that Russia might not extend the existing credit line because the Europeans had not consulted authorities in Moscow about the deposit levy plan. On Sunday, one Russian official was reported by the Interfax news agency as advising Russians to withdraw funds from Cyprus, saying the banking system was untrustworthy.

The all-night discussions began Friday and ran for 10 hours, ending shortly before dawn on Saturday. Cyprus needed to come up with billions of dollars to help cover the costs of the bailout of the country’s financial sector, or its European allies said they would leave it to face the prospect of collapse alone.

Each of the major stakeholders, which included the International Monetary Fund, the European Central Bank and euro zone finance ministers, entered the room with a conflicting goal. Protecting the small-time saver was at the top of no one’s list. The result was a compromise solution everyone is now unhappy with, officials say, one that stands to cost ordinary Cypriot depositors 6.75 percent of their savings.

The Germans and their northern European allies wanted to exact a maximum contribution from Cyprus to ensure the deal could pass their recalcitrant, bailout-weary parliaments at home. A confidential report by the German foreign intelligence agency, known by its German initials as the B.N.D., was making the rounds, one that painted the island as a haven for money-laundering. The stigma attached to helping the Cypriots — and the political cost in an election year — was rising rapidly.

The I.M.F. was dead set on keeping the debt at what its number-crunchers considered a sustainable level. The Cypriots, meanwhile, wanted to spread the pain around.

The European Central Bank also had reservations about levying higher taxes, but the Germans wanted $9.2 billion from depositors, officials said. That was an enormous contribution for a country the size of Cyprus.

Cypriot lawmakers is likely now to shoot down an unprecedented levy on bank deposits, risking the island’s membership in the euro. Cypriot President Nicos Anastasiades warned German Chancellor Angela Merkel in a call yesterday that he may not be able to win passage, said a Cypriot government official. 

Finance chiefs from the 17-member euro area late yesterday urged Cyprus to spare small-scale savers, while keeping unchanged the size of their demand on account holders. While Cyprus accounts for less than half a percent of the euro economy, the fight over the bank tax risks triggering new turmoil in the financial crisis that began in 2009 in Greece.

A complete rejection of the measure would forego European assistance and could lead to a sovereign default, or even an exit from the currency union. What we have seen in the last few days is a very serious blunder by European governments that essentially are blackmailing the government of Cyprus to confiscate the money that belongs rightfully to depositors.

Once banks on the island reopen, the country could see more than 7 billion euros in outflows, or about 10 percent of the total, Central Bank Governor Panicos Demetriades told a parliamentary committee.

Anastasiades was rebuffed in a call to German Chancellor Angela Merkel yesterday. Merkel told him that he can only negotiate a rescue with the so-called troika, which comprises the European Commission, the ECB and the International Monetary Fund, according to a German government official.

The bank levy and additional tax measures reduced the overall rescue package to 10 billion euros from about 17 billion euros to meet the IMF’s demand for debt sustainability and German politicians’ skepticism over financial transfers.
German Finance Minister Wolfgang Schaeuble said there was no other option if the troika wanted to keep the price tag for the bailout at 10 billion euros. Naturally, the Cypriot president tried to find a way around it, but there was none, and that the levy doesn’t violate deposit guarantees, because such protections are “only as good as a state’s solvency.

Russian President Vladimir Putin called the tax “unfair, unprofessional and dangerous,” according to a statement posted on the Kremlin website. Russian companies and individuals have $31 billion of deposits in Cyprus, according to Moody’s.