The leadership change at the Central Bank of Cyprus after President Dimitris Christofias decided not to reappoint Athanasios Orphanides, replacing him instead with University of Leicester finance professor Panicos Demetriades, has stirred up a political storm against the backdrop of the country?s fiscal problems and the predicament of Cypriot banks resulting from their exposure to Greek debt.
Following the announcement of his departure, the former governor accused the Christofias government of pursuing economic policies that led in the 2007-09 period to a fiscal shortfall of around 1.6 billion euros (in 2007 Cyprus had a surplus of 554 million euros, or 3.5 percent of gross domestic product), while public debt increased by 4.3 billion euros from 2008 to 2011. The end result of this fiscal imbalance, according to Orphanides, was that Cyprus was shut out of the markets in May 2011.
?Our economy is going through a crucial period,? Orphanides told Parliament?s finance committee.
?We must deal with this in the correct manner. It?s not just the Cyprus economy and the well-being of our citizens that is at stake, but our international standing as well.?
In response to the aforementioned accusations, Christofias went on the counteroffensive, blaming Orphanides for allowing Cypriot banks to be exposed to Greek bonds.
?Orphanides is trying to acquit himself and to shake off his responsibility for today?s predicament,? Christofias said. Government spokesman Stefanos Stefanou added that the only problem mentioned by rating agencies in their downgrades of Cyprus was the exposure of domestic banks to Greek debt, citing a recent report by Moody?s as an example.
Cyprus?s banks sustained huge losses as a result of the Greek debt write-down, with the two biggest, Bank of Cyprus and Laiki -- which is active in Greece through Marfin -- now being called upon to proceed with significant recapitalization measures.
Bank of Cyprus is already close to its goal (it is seeking another 237 million euros after already having buttressed its main assets by 592 million), though Laiki is still quite far off the mark, as it needs 1.8 billion euros in fresh capital.
The state?s stepping in to help is not out of the question -- especially for Laiki Bank group -- but it will only be able to do so at a time when its own finances are not so precarious.
A 2.5-billion-euro loan from Russia has largely covered Cyprus?s financial needs for 2012, but this money is insufficient to bolster the banking system as well if the need arises.
Newly appointed Finance Minister Vassos Shiarly has already announced new fiscal measures to keep the deficit below 2.5 percent, though so far there is a divergence of 1 percent from that target equaling 150 million euros. As far as the banks are concerned, Shiarly said that the government is ready to discuss ways in which it could contribute, if the need arises.
Given these developments, the likelihood of Cyprus having to resort to a support mechanism to ensure the domestic banking system has the necessary capital is no longer just theoretical.