Nicos Anastasiades, Cyprus’ most pro-bailout presidential candidate. Photo: Reuters
The European Commission, ECB, IMF troika has been concocting a bailout package for Cyprus since the island-nation asked for assistance in June 2012. The €17.5 billion rescue plan, equal to Cyprus’s GDP, is expected to arrive after a presidential inauguration on March 1. The first round of the elections is due to be held on February 17. The likely new president, opposition center-right leader Nicos Anastasiades and the most pro-bailout candidate among the top three contenders, will have three days to accept harsh bailout terms if he is to get its approval from the Eurogroup of finance ministers meeting on March 4. It’s Cyprus’s only option to avoid insolvency. It has a €1.4 billion bond payment due on June 3. Without the bailout money it will default.
Disagreements within the troika about how the rescue fund should be structured are evident. The IMF is reluctant to participate at all. Its first condition for doing so is a debt restructuring, including forcing private bondholders to accept heavy write-downs, as it got with Greece (presented at the time as a one-time measure, let us not forget). That is at odds with the E.U.’s position that under the terms of any bailout, Cypriot government debt would not be restructured to impose losses on private creditors. Economic and Monetary Affairs Commissioner Olli Rehn repeated the point on Tuesday.
The Fund doubts that with such an unsustainable sovereign-debt level the island will ever be able to repay its bailout loan. Cypriot sovereign debt could grow to 140% of GDP by 2014 if the bailout were to be approved. The IMF is also demanding the implementation of the European Stability Mechanism (ESM), the euro zone’s €700 billion permanent backstop fund, to ensure repayment. However, the European Commission will not move forward with the ESM until a European banking regulatory agency is founded. Stalemate. None of the IMF, ECB and EC can make a next move.
Meanwhile, Cyprus’s financial sector teeters, making it one of the biggest risks to the island’s economy. Cyprus’s banks were hard hit by neighboring Greece’s problems, losing large amounts on Greek government bonds before and after that country’s sovereign debt restructuring. They face big losses on loans made to local businesses. They also hold most of the government’s debt. Banking sector assets, at €146.2 billion–or 820% of GDP. Only in Luxembourg among EU countries is the sector’s size in relation to GDP larger. If and when the bailout does arrive, the money will be divided: €10 billion to shore up the banks and a €7.5 billion for the government’s budget.
Another issue for the bailout is fueled by geo-economics and geo-politics –and emphasizes the singularity of this bailout. Cyprus’s banking system is widely seen as a tax haven for wealthy Russians. Germany, the biggest donor to the euro zone’s bailout fund and one of the most important voices in the ECB’s decisions, doubts the island’s commitment to fighting money laundering. Nor can it stand the idea that bailing out the country would help Russian oligarchs and other foreign depositors who use Cyprus to turn bad money good.
The disaffection towards Russia will have to be embraced in any final deal on the bailout. Moscow extended a €2.5 billion loan to Nicosia in December 2011, strategically strengthening its presence in the island. One solution: Moscow sends €5 billion to the IMF, which would then use the money to participate in the bailout, and Germany would hold its nose. At least that way Berlin wouldn’t have to negotiate directly with Moscow.
Early March or late March, April or May, euro crisis history has shown that bailouts do end up arriving. The troika has, so far, always come to the rescue. Problems have arisen with other European countries’ bailouts, but not to this extent. The amounts granted to other countries were much higher than what Cyprus seeks, but as a percentage of GDP, it would be the largest bailout yet of a euro-zone member state. The lack of urgency in coming to a decision underlines where the island stands in the EU’s pecking order of concerns.
In any event, precedents will be set. Once again talk will turn to the future of the single currency. Markets will become more volatile again, ending the recent degree of stabilization. And that is if the bailout is approved. If it’s not, and Cyprus defaults, the euro crisis will be back with a vengeance.
