03 March 2013

Simon Nixon: Cyprus needs to find a quick debt fix

Rather than pompously declaring what conditions he will or won't accept, Mr Anastasiades needs to come up fast with his own 'non-stupid' ideas to put the country's finances on a sustainable path, comments Nixon in his WSJ column.

Newly elected President Nicos Anastasiades wasted no time setting out his stall for negotiations on a possible €17 billion ($22.14 billion) bailout required before the country runs out of money in June: "I want to be absolutely clear. Absolutely no reference to a haircut on public debt or deposits will be tolerated. Such an issue isn't even up for discussion", he told Parliament on his first day in office.

The newly appointed finance minister, Michael Sarris, was even more emphatic in his opposition to imposing losses on depositors: "Really and categorically—and this doesn't only apply in the case of Cyprus but for the world over and the eurozone—there really couldn't be a more stupid idea".

The truth is that Cyprus is not in a position to rule out any ideas, even stupid ones. The facts of the situation are this: Cyprus is one of the most leveraged countries in the world, and its banking system has assets equivalent to eight times the country's gross domestic product, the result of Cyprus's attempt to turn itself into a major financial centre.

It did this by luring deposits with a favourable tax treatment and what many eurozone policymakers believe were exceptionally weak anti-money-laundering controls, turning Cyprus into a haven for tainted money, particularly from Russia. These deposits were then used to inflate a domestic property bubble, to fund Greek corporate loans and to buy large quantities of Greek government bonds. All three bets have since gone sour; last year's Greek debt haircut alone cost the banking system €4.5 billion...

Even if the eurozone were willing to take the hit to preserve financial stability, there is no legal mechanism for it to do so. The ESM is prohibited from making direct capital injections into banks and Germany has made clear there is no question of this changing until the eurozone banking union is up and running.

Nor is Germany prepared to repeat the mistakes made in Greece, Ireland and Spain, where the initial use of overoptimistic forecasts designed to minimise bailout bills contributed to an even worse economic outcome. No one wants to see Cyprus become a bottomless pit, with taxpayers dragged into debt forgivenesss by stealth. Meanwhile there's a serious risk of destabilising the wider eurozone banking system.

But some eurozone policymakers feel they have heard these financial stability warnings before, not least over the Greek debt write-down, and no longer find them persuasive. There is scepticism that an economy as small as Cyprus is systemic. Nor will the Italian elections have necessarily made policymakers more cautious: the corollary of austerity fatigue in the south could be bailout fatigue in the north. Certainly there is deep political hostility in Germany for using taxpayers' money to bail out wealthy Russians.

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