The situation in Cyprus is moving from bad to worse, with experts noting the island's future as a financial center is already over. As capital controls and a eurozone exit become increasingly likely, businesses using the island as a transaction hub are left in search of a new operating model.
The idea of involving depositors in the $13
billion bailout of the nation shocked the world on March 16.
Depositors riled against a proposed 10 percent tax on deposits above 100,000
euros ($130,000), and 6.7 percent for those below the threshold, leading
parliament to reject the deal on March 18.
Harsh measures were not entirely unexpected:
frustrated Germans had complained for months about having to bailout yet
another southern European country, particularly one seen as a tax evasion and
money-laundering center for dogdy post-communist groups.
But violating the supposedly sacrosant
principle of guaranteed bank deposits, critics say, could do lasting damage to
banking systems across the world. Deposits throughout the European Union are
guaranteed up to 100,000 euros, one reason why citizens feel comfortable
keeping their savings in banks – not under mattresses.
“The really worrisome scenario is that
the Cypriot bailout becomes euro-systemic,” Charles Wyplosz, a professor
of economics at the Graduate Institute in Geneva, wrote in a March 18 article.
If depositors in Italy and Spain start
suspecting the same could happen to them, Wyplosz argued, it could lead to a
run on banks, which “would probably be the end of the euro.”
“Even if the stability levy is dropped
the proposal sets a precedent that
depositor bail-in mechanisms are now an acceptable policy tool,” Fitch
ratings warned in a statement.
For now, however, Europeans appear convinced
the Cyprus plan is unique. Some even challenge the European deposit insurance
scheme, which leads to moral hazard as countries like Cyprus, Iceland or
Ireland use tax legislation and other incentives to build up banking systems
far beyond the size of their economies, betting neighbors will come to the
rescue. (In 2010, a World Bank report found that Cypriot bank debt was worth
nine times the nation’s gross domestic product.)
“Unless a country has strong banking
regulation, a strict failed bank resolution regime, carefully designed deposit
insurance with safeguards against risk, healthy private monitoring, and, most
of all, strong institutions, explicit deposit insurance will only be a recipe
for future bank crises,” a study by the International Monetary Fund found.
With Cyprus in search of a plan B, the
currently most likely scenario involves a combination of looting the country’s
pension system, privatizing banking assets, and issuing bonds linked to future
gas revenues. Higher corporate taxes and a new levy on bank deposits – a
necessary condition according to the ECB – also look probable.
But the damage has already been done, experts
note. If bank accounts are opened on March 26, the current plan, both
businesses and individuals will likely pull out as much as possible.
As a result, capital controls are viewed as
part of the solution, with severe limits on what can be moved out of the country.
While this could prevent a massive outflow of money if the floodgates are
opened next Tuesday, it will further damage Cyprus’ already tattered image as a
financial center.
“No, Cyprus The Financial Centre is not
resting, it’s shuffled off this mortal coil, run down the curtain and joined
the bleeding choir invisible,” respected financial blogger Pawel Morski
wrote, adding that traders in London are already putting quitely putting Cyprus
on no-trading lists.
Meanwhile, continued delays are moving Cyprus
ever closer to bankruptcy, and thus exit from the eurozone. At present, the
country is kept afloat owing to an emergency lending scheme propping up the two
largest banks, which the European Central Bank has extended until Monday
pending a deal.
Cypriots, who overwhelmingly opposed the
intial bailout plan, might just acquiesce. A March 21 poll by Prime Consulting
found that two-thirds of Cypriots would happily quit the euro and forge better
relations with Russia, which some view as a brotherly Orthodox nation.
The Cypriot finance minister Michael Starris
is currently in Moscow seeking to obtain $5 billion in exchange for a stake in
the country’s natural gas reserves, among others. Speaking to Cypriot news
channel CNA, the finance minister said he would not leave until a deal was
made.
Russia has a lot at stake in a Cyprus bailout,
starting from the geopolitical value of Cypriot gas reserves and a friendly
government – leading to quips about the island being Russia’s “Trojan
donkey” in the EU among the union’s senior officials, according to online
news site EUobserver.
More directly, though, Cyprus is a major
banking center for Russians, who are estimated to hold some $30 billion there,
according to research outfit Capital Economics, which estimated Russia could
lose a manageable 0.4 percent of its total deposits under the initial plan.
But Cyprus is also Russia’s biggest source of
foreign investment, accounting for close to 30 percent of total inflows. This
is due to a Soviet-era tax treaty that absolves dividends, royalties and
interest payments from any fees, making Cyprus a top location for
post-communist countries.
With a much lower $1-3 billion estimated in
Cypriot deposits, Ukrainians are less directly exposed. But the model of using
Cyprus-based holding structures could be irreperably damaged.
While emphasizing there has been no impact so
far on shares or assets of Cyprus-based structures, Oksana Kneychuk, a partner
at AstapovLawyers, said bank levy would “affect any deposit account kept
by any person (physical and legal, Cypriot and foreign) with any bank operating
in Cyprus, including trading accounts, escrow accounts, term deposits and
credit current accounts.”
Igor Davydenko, a partner and head of tax
practice at Salans law firm, added that while holding structures in Cyprus keep
limited amounts in deposits, they could suffer from an increase of the
corporate tax.
“The problem here is the reduction of
financial reliability in Cyprus financial system, economical and political
trustworthiness of the country,” Davydenko added.
“We believe that in order to avoid any
further risks the foreign investors will move their holdings and other
corporate entities to other jurisdictions where their assets will be duly
protected,” Kneychuk said.
Kyiv Post editor Jakub Parusinski can be
reached at [email protected]
