What next for Cyprus?

Written By limadu on Rabu, 20 Maret 2013 | 14.44

Officials in Cyprus are caught between angry protesters and potential EU lenders partners intent on having the country pay in to a bailout.

LONDON (CNNMoney)

The tiny nation with giant banks and a crushing government debt has soundly rejected a €10 billion bailout offer from the European Union because of public revulsion over the main string attached: a tax on bank deposits.

Just days ago, the country's newly-elected president had negotiated the bailout deal. Then on Tuesday he couldn't even persuade his own party in parliament to back the unpopular and unprecedented raid on bank deposits it required.

In trying to convince Cypriots to support the EU deal, struck in the early hours of Saturday, President Nicos Anastasiades warned that the alternative --- bankruptcy, exit from the euro and devaluation -- would be even more painful.

Anastasiades and the leaders of Cyprus' political parties will meet Wednesday, but they'll have to come up with a workable solution quickly.

Banks are due to open Thursday for the first time this week and the chance of a run on deposits is high.

So what are the alternatives?

The government could still bring a revised proposal back to the Cypriot parliament, possibly safeguarding all deposits below €100,000. But that would mean a much bigger tax than 9.9% on larger accounts and could prompt foreign depositors -- many of them Russians -- to withdraw cash.

The point of the tax was to help fund the bailout. So Cyprus could keep the proposed levy on large accounts at 9.9% and look to make up the funding shortfall from elsewhere. But where? Perhaps from Russia, which has kept Cyprus afloat over the past couple of years.

Cyprus Finance Minister Michalis Sarris is set to be in Moscow for talks on Wednesday. But any tax on bank accounts, even if mitigated by a loan from Russia, would still carry the risk of a serious flight of capital.

Related: U.K. flies cash to Cyprus for soldiers

Eurozone finance ministers, while ready to accept changes to the way the levy is applied, are not prepared to stump up more than €10 billion and insist that large depositors should help Cyprus deal with a crisis that has its roots in an outsized, offshore banking sector. The EU is also anxious that taxpayers' money isn't used to bail out money launderers.

The German finance minister put it in sparse terms Tuesday after the vote.

"Cyprus has a banking sector that is way too big and they are insolvent with that model and no one outside of Cyprus is at fault for that," Wolfgang Schaeuble said on German public broadcaster ZDF. "This business model is not sustainable, there is no alternative."

Meanwhile, funding measures taken in other eurozone bailouts are not readily available to Cyprus.

In bailing out Greece, Eurozone finance ministers promised that the haircut it forced on government bonds was a one-off event. And Cyprus banks are heavily funded by depositors, so tapping bank bondholders won't raise enough.

Related: Bank run expert: Cyprus plan was absurd

Austerity would seem to be a trap. The EU plan already includes an increase in corporate taxes, and extra tax increases and spending cuts appear to be a nonstarter.

The Cyprus economy is deep in recession, and it is forecast to remain so for the next two years. Its €5.8 billion contribution to the EU bailout program is equivalent to about a third of its GDP. Trying to cover a fraction of that with an austerity program would drive the economy even deeper into the ground, slash revenues and raise borrowing.

Cyprus will have to get creative.

One option would be to ask Russia for much more support than simply improving the terms of its existing loan. Russians account for about a third of all deposits in Cypriot banks, and Russian banks have lent heavily to businesses on the island.

But help would come at a price -- possibly a stake in Cyprus' undeveloped offshore gas reserves. To top of page

First Published: March 20, 2013: 12:54 AM ET


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