Island faces deep recession, Europe faces fresh instability, says Ian Taylor
The immediate crisis in Cyprus ended this morning with smaller banks on the island re-opening. The extent of the wider fall-out remains to be seen.
On the island, banks were closed yesterday and all last week. The two largest, Bank of Cyprus and Laiki Bank, remain shut.
Tourists and locals have been able to obtain cash from ATMs. However, cash withdrawals have been limited to €100-€120, less than half the usual limit.
The BBC reported “many businesses only taking payment in cash”. The Foreign Office advised UK visitors to carry cash and take precautions against crime. It was a small taste of what was in store without a deal.
Bank of Cyprus should re-open on Thursday and will be restructured. Laiki Bank will fold.
The fact that Laiki Bank deposits below €100,000 will eventually transfer to the Bank of Cyprus while larger deposits will forfeit as-yet-unspecified amounts will not worry many UK tourists.
However, the howls of investors, particularly wealthy Russians, may be heard all over the eurozone.
The deal removed the immediate risk of Cyprus going bust and falling out of the eurozone, with all the uncertainty that would mean for Cypriots and tourists alike. But it is not good news.
First, it will hammer the Cypriot economy. The chair of the finance committee of the Cyprus parliament, Nicholas Papadopolous, put it this way: “We are heading for a deep recession, high unemployment.
“They have destroyed our banking sector.” Indeed, they have.
One forecast put the likely fall in GDP – the contraction in size of the economy – at 20%.
The bail-out will be accompanied by a brutal austerity programme, putting the island on a par with Greece.
EU commissioner for economic affairs Olli Rehn warned: “The near future will be difficult for the country and its people.”
Cyprus will suffer what Guardian economic editor Larry Elliot described as “a ferocious credit crunch” as surviving banks protect their balance sheets.
Obviously, Russian investment will be a thing of the past – because the deal will hammer Russian investors in Cyprus.
Those with more than €100,000 in a deposit account could lose 30%-40% of their money, when Russians account for about one-third of deposits on the island. Inevitably they will withdraw whatever money they can.
The island is finished as a financial centre and it is this finance which has largely underwritten investment in the tourism sector.
What hope is there the fall-out will remain confined to Russia? As travel finance specialist Graham Pickett of Deloitte told Travel Weekly last week: “It will scare everyone with funds in Europe. Who will be next – Spain? Portugal?”
According to Elliott: “Any depositor with more than €100,000 in an Italian or Spanish bank will wonder whether to move it.”
The EU has made this explicit. Jeroen Dijsselbloem, the Dutch finance minister who is now president of the eurogroup of finance ministers, suggested the rescue represents a template for future bailouts.
“If there is a risk in a bank, our first question should be ‘OK what are you in the bank going to do about that?'” he said.
The Financial Times (FT) reported the rescue marks “a watershed in how the eurozone deals with failing banks”.
Until now the lesson from the post-2008 bank bailouts has been that investors and depositors don’t get burned, that taxpayers foot the bill for central bank rescues.
We must see what happens when the penny drops, but seven months of relative calm in the eurozone appear at an end.
One FT columnist (Neil Collins) suggested yesterday: “Could it happen here? You bet. We may already have passed the point where the state’s debt can be brought under control by conventional means. In that event, there are only three ways out: inflation, taxation or confiscation.”
That is an extreme view, but Cyprus marks a sea change. As the same writer insisted: “Nothing the European Central Bank, the International Monetary Fund or the EU promise can push the toothpaste back in the tube.”
It is astonishing how it has come to this. Cyprus is small. The €10-billion cost of the bailout is minimal in EU terms.
In the words of one investment analyst: “The US will create the GDP of Cyprus by lunchtime.”
The markets’ reaction to the crisis last week was fairly sanguine. However, a former governor of Cyprus’s central bank, Athanasios Orphanides, told the FT: “I don’t think the full extent of the shattering of trust – in the safety of retail bank deposits – has been seen yet.”
The settlement cannot fail to have undermined the proposed EU banking union which is supposed to entrench financial stability.
It has even weakened the group behind the bailouts – the ‘troika’: the coalition of EC, European Central Bank and IMF.
The FT quoted a senior EU official saying: “The troika model has become dysfunctional. A centre piece to the eurozone’s crisis response may have been impaired.”
Leave aside the lack of a democratic mandate for the bail-out – the fact that the Cyprus parliament rejected a bail-out last week only to see the government and troika impose one this week.
The crisis has revealed what analysts such as Pickett have maintained throughout the past year or more: that the contradictions in the eurozone are intractable.
The UK has done well to be outside the euro, but cannot escape the consequences.
Tomorrow we will learn the latest official estimate of UK GDP in the last full quarter, along with details of household disposable income. None of the subsequent figures will have been improved by events of the past week.
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