Cyprus, with friends like these…
It was just one week after the repeat Greek elections and a few days before Cyprus would assume the rotating presidency of the European Union that the island was forced to formally request a bailout after the government stepped in to strengthen the capital base of Cyprus Popular Bank and Bank of Cyprus in order to meet the end of June deadline of core Tier 1 requirement set by the European Banking Authority.
For a number of reasons, Cyprus’ formal request for a bank bailout went under the radar. Cyprus represents less than 0.2% of the eurozone’s GDP and the amounts in question were negligible (initial estimates were in the region of a total of 10 billion euros) when compared to other countries’ bailout programs. Also, all eyes at the time were on Greece and nobody wanted to spoil the celebratory mood in Cyprus as it prepared to assume the EU presidency by making the bank bailout an agenda-topping issue. Spain had also requested bailout funds and was going through the same process of assessing the capital requirements of its own banks. Bank bailout aside, there was a general expectation, after a 2.5-billion-euro loan the previous year, that Russia would step in and help cover the financing needs of Cyprus that would plug the holes of the state budget.
After months of haggling over details, Cyprus announced on Friday, November 23 that it reached a deal with the troika for a full bailout in the region of 17 billion euros, just below the overall annual output of the Cypriot economy.
The draft of the MoU agreed between Cyprus and troika was leaked to the press one week later. Cyprus had committed and identified measures that would lead the budget balance to a primary surplus of 4% of GDP in 2016 with the measures totalling 7.25% of GDP over the 2012-2016 period. Although the agreement was reached in the end of November, the draft included permanent measures for the remainder of 2012 equivalent to 0.25% of GDP that the Cypriot government implemented in the last six weeks of the year.
Following the Eurogroup of December 3, Jean-Claude Juncker welcomed the important first steps Cyprus had taken and left open for the next Eurogroup of December 13th the due diligence exercise on the capital needs of Cypriot banks that would finalise the program’s financing.
On the 4th of December, Cyprus president Dimitris Christofias spoke in his televised address of a “necessary evil”, closing with an observation that just as the Cypriot economy was re-built after the Turkish invasion there was hope today for a new “economic miracle”.
In the Eurogroup statement of December 13th, the finance ministers considered that progress had been made towards an assistance program for Cyprus. They welcomed again the commitment of the Cypriot authorities to implement such reforms and the fact that the local parliament had already passed the first set of agreed measures. The interim results of the due diligence of banks capital needs were broadly in line with the expectations underlying the program discussions.
And it is at this point that Europe, in its usual fashion, started messing this one up. Again, the main source of trouble was Germany.
As has occurred throughout the crisis, Angela Merkel has to find the right balance in her power-broker role, which stems from the dynamics within her own coalition and the need to win votes in the Bundestag for the various bailout packages, for which she needs the buy-in of the SPD.
Supposedly, a German secret intelligence report revealed strong ties between Russian money and the banking sector in Cyprus. The German media, led by Spiegel and Bild, which had extensive experience of defaming a nation from their attacks on Greece, started a campaign against Cyprus, presenting it as a paradise of money laundering and tax evasion.
Members of Angela Merkel’s coalition were quick to join in the campaign followed by the usual unnamed “EU officials” that kept spreading similar comments about Cyprus’s compliance with the legal framework for the prevention and suppression of money laundering. The fact that international organisations find Cyprus to be more compliant than Germany, let alone Luxembourg, has conveniently slipped their attention.
Other unnamed “EU officials” appeared in the press suggesting that depositors should get bailed in, despite the fact that this goes against the direction that Europe has been working towards over the last few months, which foresees a pan-European deposit guarantee. It also ignores the pattern of depositors being protected in the cases of Ireland, Spain and Greece, cases were the governments were saddled with billions of debt to save the banks and secure deposits. These are irresponsible comments that have the potential to shake the confidence in the already fragile Cypriot banking system and eventually increase the cost of the recapitalisation of the banks.
Other “EU officials” recently cited privatizations as a prerequisite for the program to be agreed upon although there is already an agreement at staff level between Cyprus and the troika without the inclusion of any hard conditions for sell-offs, other than an inventory of state-owned enterprises and assets for possible divestments or restructurings. Also, the amounts of money required for the Cypriot bailout were of no surprise to any of the players as clearly stated in the conclusions of the December 13 Eurogroup.
In a recent interview, German Finance Minister Wolfgang Schaeuble even went as far as commenting that the EU has to assess how much of a systemic risk Cyprus is for the euro so it could be included as a condition for a bailout program. Schaeuble was not asked if he would be willing to let Cyprus default and the country’s banking system and economy collapse in the case that an assessment showed Cyprus is not a systemic risk.
All these are just signs that in spite of the fact that the eurozone has three years of crisis management under its belt, it remains as inefficient at handling crises as it was back in October 2009 when Greece opened the floodgates.
During the happy and carefree days of the first decade of the euro, the rhetoric was all about European solidarity, a concept easily referred to when one’s resolve is not put to the test. Once the crisis struck, the ideology of solidarity was quickly replaced by national interests, domestic political dynamics and agendas.
There is no more characteristic example than the absence of any attempt to deflect the universally known fact that a decisive solution to Greece’s debt overhang will not happen before the federal elections in September. An economy, that has shrunk by 20% since the crisis started and has an unemployment rate close to 27%, is left with a major growth impediment, something that is blatantly and repeatedly stated in IMF’s recent review for the country.
The public debate around Cyprus is missing the key point that the main driver behind the deterioration of the local banking system is first and foremost the exposure that it has to Greece, a natural exposure given the historical ties between the two countries. The EU and the same officials that now berate Cyprus were instrumental in orchestrating the PSI and the economic policies in Greece that have damaged the balance sheets of all banks exposed to the Greek economy.
Many now criticise and question Cyprus’s economic model. While there is no doubt that Cyprus has fallen in the same trap as Iceland and Ireland before it and fell victim to a banking sector that became too big for the state and the economy, there is also a serious question to be asked to regulators and officials in Frankfurt and Brussels that did not raise caution for this overexposure. More questions need to be asked about their negligence or intentional omission of factoring in the impact that the Greek PSI decision in 2011 would have on the Cypriot banks when Cyprus’s two systemic banks combined balance sheets in the end of 2010 were five times the size of the economy and Cyprus had already lost access to international markets and had turned to Russia for a loan.
Some even go as far as saying that Cyprus justifiably gets this criticism because it is asking for a bailout. As much as without a doubt Cyprus should not just dismiss the allegations against it and prove that not only it complies but also enforces the necessary regulations primarily to safeguard its place and reputation as an international finance centre, is this really the modus operandi of the European Union? We turn a blind eye as long as it does not reach our pocket while at the same time making statements about the need of a fiscal and political integration in order to make the union stronger? We accept the business model of one nation simply because it does not require financial assistance while chastening the exact same model of another simply because it is in financial need?
European leadership with a vision, instead of defaming a country, could see Cyprus as an opportunity. A small banking system, consisting of just two systemic banks, only one of which is in serious trouble, and a small amount – by EU standards – of 10 billion euros needed for recapitalisation could be used as the test for the efficiency, the overall conditionality and the supervisory procedures for the eventual use of the European Stability Mechanism for the direct recapitalization of banks including “legacy assets”. Given that banks in Spain, Ireland and Greece are crippled, the ESM will eventually have to step in “to break the vicious cycle between banks and sovereigns”, despite the objections of the AAA-rated block. Cyprus makes the ideal test case.
The bottom line is that even if the concerns of the German clock over transparency are justified, there is nothing related to the Cypriot bailout that could not have been addressed behind closed doors, without public defamation. Holding the purse strings, the EU has the leverage and persuasive powers to eventually achieve the conditions that it wants. Instead, we are seeing a repeat of the play performed n the run up to the Greek bailout.
With friends like these…