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Cyprus, European Union

What comes next for Cyprus and the EU following Friday’s haircut ‘bail-in’?

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cyprus

nicenic

So much for ‘nice Nic’ — it’s not that he’s reverted back to ‘nasty Nic’ so much as ‘nonessential Nic.’European_Unioncyprus_world_flag

Fifteen days after his inauguration as Cyprus’s new president, Nicos Anastasiades (pictured above, bottom), was forced into what’s now become a growing domestic, eurozone and international crisis when European Union and International Monetary Fund leaders presented Anastasiades with a €10 billion bailout package.

The catch, of which you’re almost certainly aware at this point, is that an additional €5.8 billion of savings will come in the form of a one-time levy on all bank accounts in Cyprus — deposits of  €100,000 will pay a 9.9% levy and deposits of under €100,000 will pay a 6.75% levy, even those deposits are insured by a system similar to the FDIC guarantee in the United States.  Senior bondholders won’t take a haircut.

So if you’re a hedge fund, for now at least, you’ll receive fully 100% of the face value of any debt you hold in Cypriot banks.  If you’re, say, a widowed Cypriot pensioner with €30,000 saved in a Cypriot bank, you’ll wake up Tuesday morning to find that you now have just €27,975.

It’s impossible to overstate just how politically explosive the plan was — in one fell swoop, Europe’s leaders have single-handedly done all of the following:

  • undermined the Cypriot presidential administration just days after it was elected with the support of those same European leaders and a promise by Anastasiades that any bailout would not include deposit haircuts;
  • provided ammunition to every euroskeptic in Europe from Beppe Grillo in Italy to Nigel Farage in the United Kingdom by reinforcing the notion that European institutions suffer from a lack of democratic legitimacy and gratuitously trample national sovereignty;
  • pulled the rug out from under the financial industry in Cyprus, essentially the only growing sector in the Cypriot economy;
  • handed to Cyprus’s parliament — where Anastasiades’s center-right Democratic Rally (DISY, Δημοκρατικός Συναγερμός or Dimokratikós Sinayermós), controls just 20 out of 56 seats — a strong reason to vote against the deal, thereby exacerbating the uncertainty throughout the week;
  • undermined the concept of deposit insurance throughout the entire eurozone;
  • by Europeanizing — or even internationalizing — what should have been a small matter in a country with a GDP ten times smaller than Greece’s, potentially initiated bank runs in Italy, Spain, and who knows where else throughout Europe;
  • needlessly antagonized Russia in the process, and may have provoked Russia into making a politically explosive counter-offer to Cyprus; and
  • probably did nothing to help Cyprus’s long-term economic outlook, because if the levy weren’t enough to depress Cypriot growth and undermine its banking industry, further austerity designed to reduce Cyprus’s public debt is certain to send Cyprus’s GDP swooning for some time to come.

That’s right — the first major decision of the Eurogroup of eurozone finance ministers since choosing as its president Jeroen Dijsselbloem, a center-left finance minister newly elected in the Netherlands just last autumn, is to demand an increase in the Cypriot corporate tax rate from 10% to 12.5% and a further increase on Cyprus’s savings tax.

That’s in addition to the deposit haircut that everyone’s mostly focused upon.

Anastasiades seems to have had very little option but to accept the deal, despite the fact that European leaders, including German chancellor Angela Merkel, actively supported his presidential bid in last month’s election:

[Anastasiades] spoke on Saturday of a ready-made decision imposed on Nicosia in the form of a blackmail: Take it or have the eurozone crumble….

In a written statement he issued on Saturday afternoon, Anastasiades said “Cyprus came across a previously made decision, a fait accompli.” In his defense he said that the emergency situation “did not arise in the last 15 days that we have undertaken the country’s administration.”

In the February 24 presidential runoff, Anastasiades won a landslide victory, with 57.48% of the vote to just 42.52% for health minister Stavros Malas, the candidate of the socialist Progressive Party of Working People (AKEL, Aνορθωτικό Κόμμα Εργαζόμενου Λαού or Anorthotikó Kómma Ergazómenou Laoú).  

Anastasiades, in an address to the nation Sunday night, meekly argued that depositors would nonetheless receive bank shares in return for the one-time assessment and remained optimistic that recently discovered natural gas deposits in Cyprus might well boost Cyprus’s banks in the near future.

ATM Cyprus

The political fallout for Cyprus 

To the extent domestic politics is to blame for the current Cypriot crisis, AKEL is far from blameless — it’s unclear whether Cypriots will fault Anastasiades less than half a month into his administration more than his predecessor, Demetris Christofias, the country’s president from 2008 until last month.

Christofias and European leaders opened talks in June 2012 to secure a bailout, and Christofias even began to implement some small reforms, including a 5% VAT on food and drugs and an increase in the bank levy and tobacco taxes, but fell far short of European demands to reform public employment, the public pension system, and privatization of state-run industries in a country where unemployment has now risen to 14.7%.

In addition, the bailout talks were particular complex for other factors, including the outsized amount of the Cypriot banking sector’s debt, tied in large part to the Greek debt crisis.  In addition, many Russian oligarchs have deposited money in Cyprus’s banks, and Cyprus has been scolded in the past for the facilitation of money laundering from less-than-pristine Russian sources.

With Merkel up for reelection in September, it would have hardly been palatable for her to push through a German-funded bailout of dodgy Russian depositors, which was apparent enough in the latest round:

Merkel’s Finance Minister Wolfgang Schäuble had gone to Brussels with a firm mandate from Berlin: “no bail-in, no bailout”, said a member of her government. That meant: unless depositors took a hit, there would be no agreement and Germany would not contribute towards a package for Cyprus.

So talks never quite progressed, and with Cyprus facing imminent sovereign default, Anastasiades came rather easily to office with a plan to renew those talks, though he repeatedly refused to accept a deposit haircut of the kind now being implemented.

Although today was a bank holiday in Cyprus, banks were initially set to close on Tuesday, but will now be closed until Thursday as well, as the Cypriot parliament has repeatedly delayed taking up debate on the Cypriot package.

Anastasiades’s DISY, as noted above, controls just 20 out of 56 elected seats in the Cypriot House of Representatives (Βουλή των Αντιπροσώπων) and AKEL controls 19.  The centrist Democratic Party (DIKO, Δημοκρατικό Κόμμα or Dimokratikó Kómma), which backed Anastasiades in the presidential race, controls another nine seats.  Three additional parties that largely supported the center-left, independent Giorgos Lillikas in the presidential election control an addition eight seats, including five by the Movement for Social Democracy (EDEK, Κίνημα Σοσιαλδημοκρατών or Kinima Sosialdimokraton).

That means that if AKEL, EDEK and other small parties oppose the deal, DISY and DIKO hold just of 29 votes, just enough to pass the Cypriot package without any defections.

Moreover, DIKO’s leader has already called for changes to the bailout legislation, and it looks increasingly like Anastasiades lacks the support to win a vote in parliament, which means that European leaders will have to renegotiate the previous deal.  It’s not clear how much time Cyprus has before its banks (or its government) become insolvent.

Cold War redux?

Meanwhile, Russian president Vladimir Putin denounced the decision as ‘unfair, unprofessional and dangerous.’

Russia hasn’t indicated whether it will extend or otherwise change the terms of an existing €2.5 billion loan to Cyprus — if Russia refuses to extend the loan for another five years, the Cypriot bailout will need to be even larger.  So there’s that.

I wouldn’t be surprised if Anastasiades and members of the Russian government are discussing an alternative to the current European-IMF plan — the Republic of Cyprus, which occupies the southern half of the island of Cyprus, is not a member of the North Atlantic Treaty Organization, and a €17 billion bailout would be a small price for Russia to pay in exchange for closer military ties or a Russian naval base on the island.

Perhaps even more tantalizing for Russia, and its state-owned natural gas company Gazprom, are newly discovered natural gas deposits that Cyprus hopes will fuel future economic growth.  Indeed, there are already vague reports of a Russian counteroffer — the official Russian news agency seems to indicate that emergency talks have now been initiated:

Russia’s Gazprom has not offered the Republic of Cyprus financial assistance in restructuring the country’s banks in exchange for the right to gas production in the exclusive economic zone of Cyprus. Gazprombank initiated this offer, a spokesman for the gas giant told Tass.

That result would cause dismay among the United States and its European and NATO allies which, by the way, includes Turkey.  Turkey has occupied the northern half of the island of Cyprus since the 1970s — the Turkish Republic of Northern Cyprus declared its independence from the Greek Cypriot republic to the south in 1983, and the two have remained divided ever since.  So what’s an economic crisis and a domestic political crisis could also become a geopolitical security crisis soon enough.

The economic and political fallout for the eurozone

Reaction from economic commentators has been essentially universally negative since news broke early last weekend. Continue reading What comes next for Cyprus and the EU following Friday’s haircut ‘bail-in’? →

Cyprus

Anastasiades, Malas head to Cypriot presidential runoff next Sunday

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nikos

Center-right presidential candidate Nicos Anastasiades (pictured above) overwhelmingly triumphed in Sunday’s presidential election in Cyprus, outpacing his nearest rivals by nearly 20%.  Nonetheless, he fell about 4.5% short of the 50% absolutely majority he would have needed to win the election outright and avoiding a runoff that will now take place next Sunday on February 24, despite early exit polls that showed he might win up to 52% of the first-round vote. cyprus_world_flag

Anastasiades, the candidate of the center-right Democratic Rally (DISY, Δημοκρατικός Συναγερμός or Dimokratikós Sinayermós), will face health minister Stavros Malas, the candidate of the governing, leftist Progressive Party of Working People (AKEL, Aνορθωτικό Κόμμα Εργαζόμενου Λαού or Anorthotikó Kómma Ergazómenou Laoú), who edged out alternative leftist candidate Giorgos Lillikas:

cyrpus 1st roundSo the question now is whether Lillikas’s voters will move en masse to Malas in the runoff or, alternatively, they will split between Anastasiades and Malas, thereby giving the center-right candidate sufficient support to win the presidency next week.

Anastasiades has pledged to move forward as quickly as possible to secure a €17 billion bailout that Cyprus needs to avoid sovereign default in a country that’s seen its public debt rise to 140% of GDP.  Although talks have been ongoing for over a year with the far leftist administration of outgoing president Demetris Christofias, the current administration has not been willing to implement the privatization of state industries that European leaders would require, though it has implemented tax increases and budget cuts over the past year.  Those austerity measures have worn down the popularity of Christofias and of his party’s presidential candidate, Malas.

At first glance, an alliance between Lillikas and Malas makes sense — both are generally to the left of Anastasiades, and Lillikas has campaigned on a platform of refusing to lead Cyprus into a bailout with tough conditions, arguing instead that Cyprus should rely on recently discovered offshore natural gas deposits to boost its public finances.  Lillikas, a businessman and an independent candidate, was supported by several small centrist and leftist parties, including the center-left Movement for Social Democracy (EDEK, Κινήμα Σοσιαλδημοκρατών or Kinima Sosialdimokraton).

Taken together, Lillikas and Malas polled nearly 6% more than Anastasiades in the first round, meaning that a majority of Cypriots appear to oppose the more austerity-focused bailout approach Anastasiades is very likely to pursue if elected.  But in order to upset Anastasiades in the runoff, Malas would have to sweep up over 93% of Lillikas’s first-round voters.  That seems unlikely, especially given that supporters of many of Cyprus’s political parties were split in the first round between Lillikas and Anastasiades, including the smaller Evroko (European Party) and Cyprus’s Ecological and Environmental Movement, both of which ultimately deadlocked over the issue of endorsing either Lillikas or Anastasiades.

But that’s especially true of Cyprus’s Democratic Party (DIKO, Δημοκρατικό Κόμμα or Dimokratikó Kómma), a centrist party that most recently held the presidency under Tassos Papadopoulos from 2003 to 2008, under whom Lillikas served as foreign minister from 2006 to 2007.

Although DIKO ultimately endorsed Anastasiades in the first round, many rank-and-file DIKO voters supported Lillikas, and that means it’s likely those voters will turn to Anastasiades in the runoff or, at least, abstain entirely from voting or protest-vote for neither Anastasiades nor Malas.

Once derided as ‘Nasty Nic’ for his reputation as a mean-streaked and hot-tempered politician, Anastasiades’s victory today marks a remarkable comeback since he fell from favor nearly a decade ago after supporting the ‘Annan Plan’ that would have reunited the Greek and Turkish sides of the divided island of Cyprus — over 76% of Greek Cypriot voters opposed the plan in a 2004 referendum, despite Turkish Cypriot backing for the plan.  The island remains split between the (largely Greek Cypriot) Republic of Cyprus and the (largely Turkish Cypriot) Turkish Republic of Northern Cyprus, following a 1974 Cypriot coup that led to an attempt by Greece to annex the entire island and a subsequent Turkish invasion of the north.

Although the Turkish/Greek issue has not been a significant issue during the campaign, if he’s elected as president next Sunday, Anastasiades may well find himself on the wrong end of Cypriot public opinion once again, given that he’s indicated he’s willing to make tough sacrifices in order to secure a bailout for Cyprus.  European leaders, including German chancellor Angela Merkel, have expressed support for Anastasiades, and it seems much likelier that Anastasiades could achieve a bailout deal for Cyprus.

Merkel and other European leaders would be likely to demand extremely onerous concessions though, certainly no less than the concessions imposed on Greece.  In light of the Cypriot banking sector’s less-than-pristine reputation on money laundering, it’s expected that a bailout would benefit dodgy Russian financiers and oligarchs whose money is currently deposited in Cyprus’s banks — a proposition that Merkel will likely find politically difficult with seven months to go until her own reelection campaign in Germany.

Cyprus, European Union, Greece

Europe concedes Cyprus default less than a month before presidential election

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bankofcyprus

Felix Salmon has a tantalizing tidbit about Olli Rehn, European commissioner for economic and monetary affairs, apparently conceding that a Cypriot default is now virtually inevitable, less than a month before the Cypriot presidential election:European_UnionGreece Flag Iconcyprus_world_flag

EU economics commissioner Olli Rehn went on the record telling him that Cyprus is going to have to restructure its debt — just two weeks after ruling such a thing out.

That might come as little surprise, given that Cypriot banks were loaded up to the gills with Greek debt, and Greek debt suffered a 70% haircut. Cyprus is tiny, and could never afford the €17 billion needed to bail out the banks and the government — especially since that would bring the country’s debt load up to more than 140% of GDP.

Salmon cites a report from The Wall Street Journal‘s Stephen Fidler reporting from Davos.

The Republic of Cyprus, with just over 800,000 people, is the third-smallest member of the eurozone (after Malta and Luxembourg), and it’s a relative newcomer to the single currency, having replaced the Cypriot pound for the euro only in January 2008, although the Turkish-controlled northern part of the island still uses the Turkish lira.

The country accounts for just 0.2% of the eurozone economy, though its GDP per capita is a relatively wealthy $29,000, and it’s been in negotiations for a bailout for some time now.  That hasn’t yet been successful, in part because of the unique legal, political and financial complexity of the negotiations.

Rehn’s statement, if true, is essentially a declaration that time has run out — Moody’s downgraded Cypriot debt in July 2011 to junk status.

Nonetheless, a €17 billion bailout would be dwarfed by the Greek bailout (€245.6 billion), the Spanish bailout in July 2012 to provide liquidity to Bankia (€41 billion), and even the bailout provided by the ‘troika’ of the European Commission, the European Central Bank and the International Monetary Fund of Romania that began in 2009 (around €20 billion).

In many ways, a Cypriot default will be a key test for the European Union, given that it would be the first default since the treaty establishing the European Stability Mechanism formally came into effect at the end of September 2012.

Unlike in Greece, where much of its debt is governed by Greek law, much of Cypriot debt is governed under various international law, which will make it a messier restructuring.

Keep in mind, also, that the island of Cyprus remains split between the Republic of Cyprus (largely populated by Greek Cypriots) and the Turkish-occupied northern half of the island, the Turkish Republic of Northern Cyprus (largely populated by Turkish Cypriots).  The island has been divided since a 1974 coup, Greece’s attempt to annex the entire island, and Turkey’s subsequent invasion, and the formal declaration of Northern Cyprus’s independence in 1983.

Add to that the fact that Cyprus is seen as a hub for worldwide money laundering, especially with respect to illicit funds from Russia, despite the protestations of Panicos Demetriades, president of the Central Bank of Cyprus, earlier this week.

That means bailout proceeds could go directly into the pockets of some of Russia’s wealthiest oligarchs, a position that’s unlikely to go down well politically throughout the rest of the eurozone, especially as Germany gears up for federal elections later this year — German officials have even demanded that Russia contribute to any Cypriot bailout.

Meanwhile, Cyprus will go to the polls in less than a month to replace Demetris Christofias, the country’s left-wing president since 2008.  Unlike in many European countries with parliamentary systems, Cyprus’s president is both head of state and head of government.

With a default (orderly or otherwise) on the horizon, Cyprus now faces a presidential election on February 17 — with a runoff, if necessary, a week later on February 24 — in the midst of a financial crisis and perhaps in the midst of bank runs.

Christofias, who has presided over economic turmoil and an unemployment rate that’s now at 14%, has so far refused to engage in massive privatizations of state-run industries as a condition for a potential bailout.

Add all of those factors together — the size of the Cypriot banking sector’s debt, the legal complexity of the debt, the Russian laundering issue, the complexity of the Turkish political reality with Northern Cyprus, and the leftism of the Christofias administration — and you start to understand why Cyprus is now allegedly headed to a default.

Continue reading Europe concedes Cyprus default less than a month before presidential election →