IREF - Institute for Research in Economic and Fiscal issues
Fiscal competition and economic freedom
The European Union is about to bail out Cyprus but no details on how it could be done are released yet. Joerg Asmussen, ECB board member, announced that “the troika of European Union, International Monetary Fund and the European Central Bank would send a mission of experts to Cyprus on Tuesday for a technical analysis of the country’s financing needs and to get a better understanding of the new Cypriot government.” Owing to the importance of the event for the Euro zone, it is worth reminding what Enrico Colombatto, IREF scientific director, wrote on Cyprus’ bailout.
Enrico Colombatto’s analysis on February 13th:
With a contribution of only 0.2% of the Eurozone’s GDP, Cyprus may be the smallest of the 17 Eurozone countries but, ironically, it may yet exert a disproportionate influence on the structure and culture of sovereign bailouts in the months to come.
On the first working day of 2013, President Christofias announced Cyprus’ response to the standard Troika (ECB, EU and IMF) bailout offer. Cyprus would like to receive the money, but preferred to decline the reciprocal obligation of selling state assets and raising its corporate tax rates to please the Troika; and it would want all its citizen stakeholders in banks to be protected.
Was this brinkmanship? Possibly not. It may turn out to be a clever poker play. The repeated position of the EU and ECB is that no country should be ‘let go’ or allowed to collapse financially. This of course invites moral hazard. Cyprus argues that its position is reasonable since its banking system is so heavily exposed to Greece that its problems are substantially the result of the haircuts twice imposed on Greek bondholders by the Troika in 2012. Cyprus had agreed to the Greek deals without asking for any special exemption for Cypriot banks.
The €10bn requested by Cypriot banks (of the €17.5 bn total package) equates to 50% of the country’s GDP, and it is hard to see the government’s obligations, absent forgiveness, fail to jump from 83% of GDP in June 2012 to a 150% ratio a year later. By mid month, government debt was trading at yields of 11 – 12%.
Furthermore, given that bank deposits equivalent to 130% of GDP belong to investors from Russia and Eastern Europe, a ‘standard’ full bailout of Cyprus’ banks might represent a step too far for Germany and the wealthier nations. Perhaps for this reason, at the time of writing the terms are still under discussion, with suggestions that haircuts may be imposed on depositors in excess of the €100,000 guaranteed ceiling. But if that were to happen, might it not destabilise some banks in supposedly stable countries by encouraging capital flight?