Politically and technically, Cyprus's request for aid could be a very tough nut to crack, writes Barley in his WSJ article. That makes it a source of risk.
While Cyprus's bailout needs may be small in absolute terms, it will push up the sovereign's debt from 83.3 per cent of GDP as of June 2012 to 150 per cent in 2013, Moody's says. That raises doubts about debt sustainability, potentially preventing some eurozone nations from agreeing to lend to Cyprus.
But restructuring existing Cypriot debt may be tricky. It will render false the eurozone's pledge that Greece is a unique case. Around half the debt is in loans from official creditors, notably a €2.5 billion loan from Russia, and international-law bonds that may prove tricky to restructure. Domestic-law bonds are largely held within Cyprus, meaning a restructuring would likely boost bank recapitalisation needs.
Restructuring the banks is also troublesome, as they are predominantly deposit-funded. That raises a political problem: deposits worth 130 per cent of GDP are from non-residents, mainly Russia and Eastern Europe, S&P notes. Germany and other eurozone nations aren't keen to bail out rich Russian depositors. But if it proved impossible to burn senior bondholders in Ireland because of European Central Bank opposition, it is hard to imagine a plan that involves haircutting depositors—not least because of the chilling effect that might have on banks and depositors elsewhere in the eurozone.
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