Big economic questions for Europe after Cyprus gets bailout

CALM of a sort has been restored in Cyprus with a last-minute 10 billion euros bailout resolving its immediate banking crisis. But it leaves huge question marks over the future of the Cypriot economy, the euro and the impact on other eurozone countries, with the likelihood that a bank bailout will be followed by bailing out the country’s government. It is clear that the Cypriot emergency took the euro-authorities by surprise, despite statements from Brussels over the past three years that they were monitoring banks and especially those vulnerable to problems in Greece. They said everything was under control and that deposits under 100,000 euros were guaranteed. Now we are not so sure. The origin of the crisis in Cyprus is clear enough: Its financial system has had a lack of transparency, sloppy monitoring and rather low taxation over the last ten years. Large sums of cash have been deposited by investors from outside the EU in search of friendly havens and light oversight. Bank deposits were substantial with 100 billion euros - half of it from Russia - being put into Cypriot banks. The Cypriot economy is small with a GDP of less than 18 billion euros. The main banks in Cyprus invested large sums in Greek bonds and lost huge amounts of money. At least two large banks are now bankrupt and unable to repay depositors. The euro-crisis has shown that governments are unwilling to let banks fail. The authorities have always claimed that the European banking sector was healthy and they know that a bank run would reveal that the deposit-insurance guarantee is a bluff. They fear the consequences of a systemic collapse. The Cypriot banks needed some 16 billion euros in order to remain solvent, and the troika of the European Commission, the International Monetary Fund and the European Central Bank, were asked for help in mid-March 2013. They proposed that the ECB would give Cyprus 10 billion euros but large deposits in the two largest Cypriot banks must take significant losses with some estimating that deposits of more than 100,000 euros would lose as much as 40 per cent of their capital. But this will not be the end of the story and new critical episodes will emerge. It appears that whatever the size or nature of the problem, the European authorities are willing to negotiate, even when negotiations cause further damage to the prestige of European institutions. In most countries, according to the law and commonsense, the burden falls on shareholders, and then on creditors, when a company goes bust. But this principle has been tested in Cyprus. Smaller depositors in Cyprus are escaping any penalty while large depositors pay for most of the losses. The strategy behind European bail-out programmes is far from transparent. This 10 billion euros package is probably adequate to stave off the Cyprus crisis in the short run, but it might create new problems. Depositors with assets in Cyprus are hardly likely to put more money into Cypriot banks over the next few weeks. They will do all they can to place their assets elsewhere. The EU has asked Cyprus to introduce stringent controls on capital movements for a ‘temporary’ period but what will happen when those restrictions are lifted? It is likely that credit will dry up, companies will go bankrupt and unemployment will soar. This grim picture will get worse as government spending increases and people rely on the welfare state while tax revenues drop. In short, after having bailed out a few Cypriot banks, the EU troika will have to meet again to bail out the Cypriot government - or accept that sooner or later troubled countries introduce capital controls and nullify 30 years of liberalisation. The future of the euro is likely to remain uncertain until the authorities clarify whether they want to print more money to bail out bad banks and irresponsible governments.

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