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The proposal for a “bail-in” of investors and depositors, and drastic shrinking of the Cypriot banking sector, is one of three options put forward as alternatives to a full-scale bailout. The Eurogroup ministers are trying to agree a rescue plan by March, to follow the presidential elections in Cyprus later this month.
The new plan has not been endorsed by its authors in the European Commission or by individual eurozone members. The memo warns that “the risks associated with this option are significant”, including a renewed danger of contagion in eurozone financial markets, and premature collapse in the Cypriot banking sector. The radical proposal is intended to produce a more sustainable debt solution for the country, cutting the size of Cyprus’s bailout by two-thirds – from €16.7 billion to only €5.5 billion – by involving more foreign depositors and bond holders. It would reduce Cyprus’s outstanding debt to just 77 per cent of economic output, compared with 140 per cent in the current full bailout plan.
One more moderate “bail-in” option would involve junior debt holders, but not bank depositors, and would aim to shrink the size of the banking sector by half over 10 years. It would seek to raise corporate income tax to 12.5 per cent (from the current 10 per cent), and increase withholding tax on capital income to 28 per cent. It would also seek to extend the maturities on the €2.5 billion loan that Cyprus received from Russia last year.
A third option would allow Cyprus to sell the shares it acquires in its ailing banks to the European Stability Mechanism, once that eurozone rescue fund is allowed to provide direct recapitalisation for banks. Cyprus’s bailout, while small compared to Ireland, Portugal and Greece, has proven unexpectedly difficult because its size relative to the country’s gross domestic product would increase debt to levels considered unsustainable both by the International Monetary Fund and the German government.
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