Saturday, 23 March 2013

Cyprus, the next day

Yesterday, the Cypriot Parliament passed 9 bills in its intention to reduce the recapitalization funds the island needs as part of its restructuring process (for a review of the legislation this earlier post sums it up).

Two decisions have been the talk of the town (the Union is a better term): the imposition of capital controls (as Pawel Morksi commented, neither of us has ever seen such a thing in the Western World during our lifetime) and the decision to split Laiki bank into a good bank/bad bank scheme. As far as capital controls are concerned there is nothing to be critical about: had Cyprus not imposed these measures then we would have witnessed the first bank run in the 21st century; and either the ELA would have to pump 20bn in the system to save the country, or they would have to go bankrupt with both insured and uninsured depositors losing their money. It may not look good, but it is the only decision that will save the banks' deposit base.

With regards to the Laiki restructuring, there are some clear advantages and some issues which appear somewhat vague. As far as the advantages go, after this decision the Cypriot state will not be liable for the €1.8bn assistance which the bank "received" about a year ago. This amount is approximately 10% of the country's GDP. In addition, the recapitalization needs should be significantly reduced since the bad assets will not be counted as part of the whole procedure. Given this, some have stated that the whole assistance package has now been reduced to approximately half of what it originally was. This makes the Cypriot public debt sustainable and in addition no further austerity measures have to be taken in order to secure income.

In addition to these, there is also the huge advantage of having avoided the deposits haircut. Exotix’s Gabriel Sterne, presented the following graph on Twitter yesterday, shows that a haircut decision (as promoted by Troika last week) would mean a 20% contraction of GDP.

Yet, a haircut on uninsured deposits is not completely out of the table. It is very likely that uninsured depositors at the Bank of Cyprus will also receive a 20% haircut, for the bank's recapitalization needs. The drawback of such decisions is that they affect provident funds, pension funds, charities and other NGO's. The Cypriot Parliament committed yesterday to look into such issues, although given the island's financial position it would be difficult to compensate large depositors' losses in full. Some estimates place the final loss taken by uninsured depositors to about 20-40% of their funds (based on previous examples like this one). However, this avoids depositors in Coop's or other banks operating in Cyprus having to pay for the two banks' needs, safeguarding a significant amount of deposits. (latest developments indicate that a 4% tax on all uninsured deposits will be levied in order to cover the losses of provident funds, charities, etc from the separation of Laiki's operations)

On the bad side, what appears to be rather odd is the intention of merging the "good" bank with the Bank of Cyprus. This means that a huge bank will be created, one which will contain more than 50% of the island's deposits. Talk about too big to fail! Why the "good" Laiki bank does not continue with its operations independently is beyond my understanding. Adding to the stream of irrational decisions is the one to sell off the Cypriot banks Greek subsidiaries for approximately 1.5bn of which the Cypriot state will have to pay 0.5bn. I cannot help but wonder who was the genius behind this decision. This is not just inane is it exceedingly stupid. The Greek subsidiaries took all the damage from NPL's in the Greek economy over the past 3 years and just about when the potential for growth is at the door, they slam the door right at its face! In addition, this is exactly what made Cyprus systemic. Decreased recapitalization needs is what (in my opinion) caused this decision yet people should look just a few steps ahead when planning. It does not make sense to sell off your assets in a recession, when growth is to follow in the next couple of years.

An pertinent issue to affect the local economy is the shortage of liquidity. Imposing capital controls will mean that exchanges will be limited for an undefined amount of time, which will harm the already fragile local economy. As another article stated "For Cyprus, the single currency would be dead in all but name". Yet, as already mentioned, there is no option but imposing them. The drainage of capital due to Laiki's liquidation will also mean a shortage of funds in the economy, not the mention increased unemployment as an outcome of the Laiki merge. More than half of Laiki's employees or approximately 2,000 people will be jobless in the course of the next few years. This will inevitably push the island further into a recessionary cycle and destroy it's reputation as a financial center (what is left of that reputation anyhow).

Nevertheless, the most important aspect of last week's decision is that Cyprus did not set a precedent. They managed to stand up to what the inane decision of the Eurogroup had imposed on them and by protecting their insured deposits they have protected the whole of Europe's as well. The following years will not be easy on the island. Recession, thanks to the efforts of Germany and all those who did not oppose its politics and tactics, will reign over people who had no idea of what was going on in the political salons of Europe. The same people who will bear the burden of their leaders'  decisions, those who will be unemployed and hungry, those who will be homeless and even hopeless. People not just in Cyprus, but everywhere in a European Union tormented by austerity and unwilling to deviate from obsessions of a previous century.

P.S. Waiting for the Eurostat data on 2013's first quarter... Recession in Germany appears to be a good bet. We will wait and see.

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