Euro Crisis: Is There A Way Out For Cyprus?
WEDNESDAY APRIL 24, 2013
On April 12, Cyprus was at the top of the agenda for European Union finance ministers meeting in Dublin to discuss aid for struggling EU members. The EU finance ministers confirmed that 10 billion euros will be provided to Cyprus by the EU and the International Monetary Fund. The ministers also rejected reports that the country would be granted more financial assistance.
Cypriot presidential spokesman, Christos Stylianides said that the country was not seeking more aid under the bailout programme, but was instead seeking assistance through other European support mechanisms, as noted by the BBC. “What the president of the republic [of Cyprus] is discussing with European officials is the possibility of increasing European funds for growth and social cohesion,” he said.
Cypriot President Nicos Anastasiades said that he had spoken to the EU Economy and Euro Commissioner Olli Rehn, along with writing a letter to European Commission chief Jose Manuel Barroso and EU President Herman Van Rompuy, about extra assistance to Cyprus.
The cost of the bailout
The meeting came a day after the cost of the Cyprus bailout rose from 17.5 billion euros to 23 billion euros, according to a draft document prepared by Cyprus creditors. In order to secure 10 billion euros from the EU and the International Monetary Fund (IMF), Cyprus will need to contribute the remaining 13 billion euros. That is 7.5 billion euros more than previously thought.
As part of the bailout programme, Cyprus has agreed to a restructuring of its banking sector. Cyprus’s second largest bank, Laiki Bank, will close down and deposits of over 100,000 euros will move to a “bad bank,” according to a BBC report. Deposits below 100,000 euros will be moved into Bank of Cyprus, the country’s biggest bank and, in this case, the “good bank.” At both banks, deposits above 100,000 euros will be used by the Cypriot government to contribute towards the bailout deal.
However, as noted by another BBC report, analysts are now questioning if Cyprus is capable of raising the 13 billion euros sum. The Cypriot economy is worth 18 billion euros and accounts for less than 0.2% of the eurozone total. The winding up of one Cypriot bank, Popular, and the writing-off of a large portion of secured debt and uninsured deposits in the largest bank, Bank of Cyprus, should together contribute 10.6 billion euros of the 13 billion euros that Cyprus needs to raise.
The financial crisis arose due to Cypriot banks inflating seven times the size the of the Cypriot economy due to massive inflows of offshore money, mostly from Russians looking to dodge taxes in Russia. The situation became problematic because Cyprus invested in Greece, which itself came under financial turmoil and required EU/IMF bailout. The financial crisis in Greece left Cyprus undercapitalized and the Cyprus government was unable to address the financial problems resulting from investment in Greece.
Will Cyprus be able to meet its side of the bailout? Here are a few options put forward in the policy circles.
Selling gold bullion to raise money?
A European Commission assessment of what Cyprus needs to do to raise the remaining sum showed that the country is expected to sell gold reserves in excess in order to raise 400 million euros. While the sale of gold in itself is not the magic bullet, as a Reuters report notes, even a small gold sale can help address severe debt problems. The sale of gold would allow Cyprus to raise three percent of what it must contribute to the bailout.
However, there are limitations on the amount of gold a country can sell. The Central Bank Gold Agreement, originally signed in 1999 and currently in its third incarnation, caps gold sales at 400 metric tons a year. Cyprus’ total gold bullion reserves stood at 13.9 tonnes at the end of February 2013, according to data from the World Gold Council. A BBC report notes that at current prices, 400 million euros worth of gold amounts to 10.36 tonnes.
The Third Central Bank Gold Agreement (CBGA3), currently in force, covers gold sales of Eurosystem central banks, Sweden, and Switzerland. Like previous agreements, CBGA3 covers a five-year period between September 2009 to September 2014. The Cypriot national bank is a member of the CBGA3.
But gold sale has its own repercussions; mainly that selling such a large amount of gold will push down the price of the commodity. Spot gold posted its biggest one-day drop in nearly two months on April 10 after reports speculating gold sale began circulating. “Cyprus may be a one-off, [but] the market’s concern will be that it isn’t, and that other countries will be invited to sell their gold,” one senior gold trader said, as quoted by Reuters. “It’s a potential game-changer for the market," he added. "Given we know that Portugal rejected the most recent austerity plan, and they have over 90 percent of the country’s foreign exchange reserves in gold, does this mean that Portugal perhaps will be asked to sell some of its gold?”
However, the Central Bank of Cyprus has denied that it will sell 400 million euros worth of gold to alleviate Cyprus’ financial woes. Aliki Stylianou, a spokesperson for the central bank, told CNBC: “The decision to sell the gold is a decision to be taken by the board of the Central Bank of Cyprus (CBC). No such thing has been discussed or is in the process of being discussed. There are so many rumors flying about and this is just one of them.”
Julian Jessop, head of commodities research at Capital Economics says, “At most, gold might be used as collateral for some government debt (an idea being promoted by the World Gold Council). However, the chances of large outright sales are very slim,” quoted CNBC.
Turkey: Off-shore natural gas reserves
Cyprus is under pressure from the troika — organizations like the EU, the European Central Bank and the IMF monitoring Greece’s progress in carrying out austerity measures as a condition of bailout loans — to speed the development of off-shores natural gas reserves. The troika hopes that the proceeds from natural gas exploration will allow Cyprus to keep its debt under control. However, according to a New York Times report, this move could create geopolitical tension. Last month, Turkey challenged any move by Cyprus to speed its exploration.
Turkey, a regional energy hub, could help alleviate the financial turmoil in Cyprus. However, before providing assistance to Cyprus, Turkey would like to see progress towards a resolution of decades-long conflict between Greek and Turkish Cypriots that has divided the country into two.
However, Eurasianet states that progress towards a resolution is impossible in the immediate future, and if Cyprus can alleviate its financial troubles by offshore natural gas exploration, it must do so promptly. According to the adviser to the Cypriot President, Makarios Droushiotis, “there is room for negotiating soon. I mean in the coming months.” Further, he added, cooperation with Turkey might be “an alternative” in the future, but at least until “the autumn,” the financial crisis will take priority over negotiations.
A major area of possible cooperation between Turkey and Cyprus is over hydrocarbon deposits in the waters of Cyprus. These resources are possibly worth a hundred billion dollars. Greek Cypriots have granted exploration licenses to international energy companies without consultation with northern Cyprus. According to Eurasianet, Turkish officials have said that profits from these resources should be shared by the entire island and that any international company collaborating with Cyprus on energy exploration will face repercussions from Turkey. The suspension of Turkish projects with Italian energy giant Eni on March 27 appeared to signal that Turkey was serious.
Leaving the euro behind
Several analysts have argued that Cyprus must leave the euro. One report in the Atlantic argues that the bailout programme “will save the Cypriot financial system by destroying it, along with the rest of their economy.” Therefore, the sooner Cyprus abandons the euro, the better. Paul Krugman, columnist at The New York Times, also argues that Cyprus needs to leave the euro. Krugman writes that staying in the euro means “incredibly severe depression, which will last for many years while Cyprus tries to build a new export sector. Leaving the euro, and letting the new currency fall sharply, would greatly accelerate that rebuilding.” Cyprus has two major exports, banking services and tourism. Krugman notes that the exports from banking services “just disappeared,” referring to the closure of the second largest Cypriot bank (Laiki Bank), the freezing of deposits of over 100,000 euros, and capital controls limiting withdrawals to 300 euros a day.
Whichever route to recovery Cyprus chooses- whether it be through the sale of gold, a shift from the euro to another currency, and/or offshore natural gas exploration-the solution won’t be perfect and the country’s economy will continue to experience a decline for an uncertain period of time. It is also uncertain whether any measures taken by the Cypriot government will save the economy from another crisis.