The Cyprus Problem and its consequences
Kindly translated by Anne-Marie de Grazia. Text augmented to keep with current developments.
The Eurozone and the IMF announced on last Saturday morning March 16th that they had found an agreement on a rescue plan for Cyprus. But, whereas the Cypriot government was asking for 17 billions, this plan grants it only a maximum of 10 billions. In order to make up for the difference, an exceptional tax on bank deposits must be implemented which one hopes will bring in, as matters stand, some 5.8 to 6 billions, as indicated on Saturday by the leader of the Eurogroup, Jeroen Dijsselbloem. Nicosia becomes then the fifth country in the Eurozone to have the dubious benefit of a program of European and international aid. Brussels bureaucrats were expecting that the Cypriot case would be under control. Of course the size of Cyprus economy is 0.2% of the Eurozone aggregated GDP. But the Cyprus case is not to be assessed from its GDP share point of view. The problem stems from the fact that the size of the Cypriot banking system is without common measure with the country’s economy. It appears now that the idea of taxing bank deposits far to be a bright one was a massive blunder, and one which is spreading all around Cyprus in other Eurozone countries.
The Plan of March 16th
In order to reduce their participation to 10 billions, the backers have therefore asked Nicosia to implement an exceptional tax of 6.75% on bank accounts below 100,000 euros, and 9.9% beyond. This direct debit, the principle of which is by no means scandalous, becomes such through its strongly unegalitarian aspect, but also because it is accompanied by a withholding at the source on the interests of theses deposits. To these taxes are added privatisations which are foreseen (but not yet evaluated) and an increase of the taxes on businesses which will go up from 10% to 12.5%.
Cyprus’ backers have given up on a debt write-off which would have made private creditors encur heavy losses (yet this has been done in Greece in the Spring of 2012). It must be added that such a measure was firmly rejected by Nicosia because of the implications for the confidence in the banking system. Yet the proposed measures are hardly better. All savers are affected by these new taxes, be they Cypriots or foreigners, particularly Russian, but also British. Indeed, Great-Britain keeps two important bases in Cyprus, where several thousand troops and their families are stationed. Authorities have already taken measures to freeze sums in the accounts, and a law should be voted during the week-end in order to allow this operation and to prevent a massive flight of capital. Now, the voting of this law has been postponed until Monday (which is a holiday) because of the oppositions in the Parliament. It is likely that the law, should it be voted at all, will not be voted before Tuesday or Wednesday. Banks will have to remain closed until then, and this will certainly encourage panic and discontent, which are already quite perceptible.
The reactions of the creditors
A lot of efforts has been made to describe theSsaturday agreement as « balanced ». « We are not penalizing Cyprus« , declared Jeroen Dijsselbloem, adding: « We are standing by the side of the Cypriot government, this package will allow the restructuration of the banking sector and will make the debt sustainable. » As for the director of the IMF, Christine Lagarde, whose institution should participate in the Cypriot aid plan, she declared: « The solution brought forward is durable, perennial, and in the interest of the economy of Cyprus. » For the time being, no order of size has been publicly evoked, but the IMF’s contribution could approach a billion euros. Taxes and other withholdings will be entirely compensated through the distribution of shares, indicated Cyprus’ Minister of Finances, Michalis Sarris, stressing that the measures taken have made it possible to avoid « cuts in salaries and pensions . » Nevertheless, the President of Cyprus has indicated that he has been confronted to a « fait accompli » from the part of the EU and the IMF.(ici). Indeed, it seems that the measures have been imposed, not negotiated. Moreover, we still don’t know at this hour if the accounts of businesses will be included in these measures, which could provoke the demise of a very great number of small and middle size enterprises. As it is now, it is hard to regard the measures adopted in the first hours of Saturday, March 16 as being, according to the words of Mme Lagarde, « durable and perennial. » Everything leads one to think that we are witnessing a massive crisis of confidence in Cypriot banks. But, other blunders have been done during the last week-end, and they could trigger a massive bank run not jkust in Greece but also in Spain and Italy.
Nine months of delays and procrastinations
Cyprus had asked the EU as well as the IMF for a financial aid as early as June 2012, in order to bail out its two main banks, victims of the Greek crisis and of the restructuring imposed on private creditors. But the backers were not ready to grant it 17.5 billion euros, which is equivalent to its GDP. The principal fear was that the country would be unable to repay so large a sum and that the debt would explode to unsustainable levels once the aid had been collected, as had happened in Greece. The question of the restructuring of these banks has therefore dragged on for months, while the situation in Cyprus was becoming ever more explosive.
Yet, the Prime Minister of Luxemburg, Jean-Claude Juncker, who was head of the Ministers of Finances of the Eurozone for eight years, had declared: « I cannot imagine that we will let the week-end pass without having resolved the Cypriot problem. » Germany, who had shown reticence about the possibilities of an agreement these past days, had put pressure on Cyprus to fight actively against money laundering. So that Nicosia has had to submit to an audit, the first conclusions of which are expected for the end of March 2013.
A Russian contribution
There is also the possibility that Nicosia will turn to Russia, a country to which it is close economically and culturally. We know that Cyprus has become an « off-shore » location for many Russian companies who have exported capital, often under shady circumstances, during the 1990s and the beginning of the 2000s. Cyprus is also a vacationing place for certain layers of Russian society. Last but not least, some well established Russian company are using Cyprus to have a footholmd inside the Eurozone. In the end it is estimated that 37% of bank deposits belong to non-Cypriots, which include the Russians as well as the British, but also part of the Greek bourgeoisie who found Cyprus a convenient place to practice tax evasion. If Moscow’s contribution is assured, it seems for the time being that it will be limited. « The country is ready to extend the [delay] of repayment of a loan and to reduce the rate of interest, but it doesn’t plan to go beyond this, » the European commissioner in charge of economic affairs, Olli Rehn, has warned. The loan in question amounts to 2.5 billion euros and becomes due in 2016. But it is not known what could be the actual reaction of the Russian government, whose relations with European countries are not exactly warm today. The new tax is to amount to a direct levy on operations done by large Russian enterprises. There is no doubt that the Russian government could and would support them. But it is also clear that this is to raise another issue in the current context of Russian-European relations.
A « masked » devaluation?
It has also been suggested that this tax on deposits could be similar to a disguised devaluation in Cyprus. This is not so. This measure will not make the goods and services produced there any cheaper, nor more expensive those imported. It is therefore a thorough misinterpretation. In fact, the problem of Cyprus is of finding exceptional fiscal resources in order to be able to recapitalize its banks, considering that the European aid was reduced from 17 to 10 billions. A tax on deposits can be considered like a tax on wealth which is exceptional. But the tax basis used makes it in fact a very inegalitarian tax. It is surprising that nobody thought of establishing a minimum sum (of the order of 30,000 to 50,000 euros) which would be exempt of any withholding. This would have permitted not to hurt small depositors. Also, it would have been useful to state from the beginning that the accounts of businesses would not be affected by these direct debits, as this will provoke a drain on circulating capital which will be intolerable for a great many small and middle sized companies. Still, all this is nothing when one considers that the main problem resides in the crisis of confidence towards the banking system which will be provoked by this measure. The beginning of a bank run which we have witnessed on Saturday March 16th is proof of it. This panic should probably continue during the coming days. Considering that the confidence of savers into the solidity of their banks is already relatively weak in a large part of SouthernEurope, this measure is tantamount to waving a red flag in front of their eyes. The risk is therefore great that we will see a contagion which will touch at first Greece, then Spain and finally Italy.
The tax on bank deposit is to be voted by the Cyprus Parliament either Monday or Tuesday. Nobody can say right now what will be the result of this vote as the center-right President has no majority in the Parliament. But the problem now is no more just a Cyprus one. Through blunders and misguided decisions Euriopean authorities have discredited the European banking system. What was said as « impossible » for years has happened. This is an ominous signal for people first in Greece but then in Italy and Spain.
This note has been translated by Anne-Marie de Grazia from “Le problème de Chypre et ses conséquences”, billet publié sur le carnet Russeurope le 17/03/2013, URL: http://russeurope.hypotheses.org/1034