16 January 2013

FT: Cyprus threatens to open a Pandora's box

This article suggests that a false step in Cyprus could knock the recent markets rally and undermine efforts by policy-makers and the ECB to remove the tail risk of a eurozone break-up and renew fears over bank solvency in the region.

The amount of debt held by foreign investors is relatively small. And the money needed to bail out Cyprus is small when compared with Greece, Portugal or Ireland. Initial estimates suggest a bank rescue may cost about €10 billion. But that is more than half the country’s annual output and overall the country is expected to require €17 billion-€17.5 billion.

Last week, Moody’s downgraded the country’s credit rating to Caa3 from B3 and later similarly marked down the country’s banks. The rating agency pointed to the heightened risk of sovereign default, which could jeopardise the effectiveness of bank recapitalisations, and the associated impact of increased sovereign credit risk on banks, given their sizeable portfolios of government securities.

There are other issues. Talks over the size of the bailout package have exposed divisions within the so-called troika of lenders – made up of the European Commission, the ECB and the International Monetary Fund – that will decide the size of the country’s bailout.

Meanwhile, politicians gearing up for this year’s German elections have questioned whether taxpayers would be willing to foot the bill for Cypriot banks, making political play out of Russian investment in Cyprus and making allegations related to money laundering.

Ultimately, any refusal by Germany to support a bailout of Cyprus could encourage investors to reassess the political will to keep the eurozone together.

Full article (FT subscription required)

© Financial Times