IREF - Institute for Research in Economic and Fiscal issues
Fiscal competition and economic freedom
If an agreement could not be found with the previous Cyprus communist-led government, negotiations resumed intensively between the Troika of European Union, International Monetary Fund and the European Central Bank and the newly elected President Nicos Anastasiades. The Euro zone is again at stake: Cyprus’ bailout would amount to 17 billion euros, equal to Cyprus’ annual economic output. But would it be able to repay?
"Even if you come from a big EU country, you should be aware that every member of the euro zone is systemically relevant," declared Olli Rehn, the European commissioner for economic affairs, "if Cyprus becomes disorderly insolvent, it is very likely that would lead to it exiting the euro zone." Before this extreme solution happens, other proposals will be made.
A Sustainable Bailout
Cyprus’s bailout would amount to 17 billion euros. But the country may not be able to repay it since it would increase Cyprus’s debts to around 145 percent of GDP. Managing such bailout would prove to be very hard. That is why the ministers of the Eurogroup are studying several solutions to finance Cyprus’ bailout and make it “sustainable”: Cyprus must repay what it borrows.
Last week, European experts were sent to Cyprus for a technical analysis of the country’s financing needs. What they have in mind could be the privatization of Government’s assets, starting with the island’s telecoms company, which could raise up to 1.5 billion euros. Other solutions are considered: capital gains tax could be limited to three years; corporate tax could be raised from 10% to 12.5%; bailout fatigue could be eased by Russia joining rescue since Russia has strong business ties with Cyprus.
Another idea proposed by German officials and backed by Netherlanders and Finlanders: the “bail-in”. In other words, the depositors in Cypriot banks – mainly Russian and British - would help pay for the cost of the rescue. Such idea is based on the fact that the bank assets areeight times larger than the island’s 17 billion-euro economy, amounting to 136 billion euros.
But the “bail-in” is fought by Cypriot finance minister Michael Sarris: "Really and categorically - and this doesn’t only apply in the case of Cyprus but for the world over and the euro zone - there really couldn’t be a more stupid idea."Germany may not enjoy this comment.
The “bail-in” proposal is actually revealing the main trouble of Cyprus’ banks: money-laundering suspicions. Indeed, Germany is afraid that Cyprus, with its low corporate tax rate and liquid banking system, has become a haven of money-laundering. A concern worsened by the fact that Russian individuals and companies have a high level of deposits in the banking sector.As a consequence Cyprus itself fears any "bail-in" would cause the withdrawal of funds from the island and destabilize its entire business model, making the economic situation even worse.
Between bailout and “bail-in”, Cyprus is at stake. The Euro zone too. The final decision on Cyprus is likely to come at an extraordinary meeting of the ministers later in March.