Financial aid for Cyprus could push its debt to 140 percent of its national output unless the EU's permanent bailout mechanism assumes some of the burden, the island's central bank governor said on Wednesday.
Panicos Demetriades, also a member of the Governing Council of the ECB, said lowering the debt level was possible if the European Stability Mechanism took over some of the debt. That prospect, he said, was contingent on agreement on an EU banking union.
"Despite the difficulties, I am cautiously optimistic that a compromise on the banking union is in sight,» Demetriades told the Hellenic American Bankers Association in a closed session in New York on Tuesday evening.
The remarks were released on Wednesday. European Union finance ministers were scheduled to meet in Brussels later in the day to discuss the banking union, an issue now in deadlock.
Cyprus, one of the smallest economies in the 17-nation eurozone, sought aid in June to buffer banks substantially exposed to debt-crippled Greece. It says it has reached a preliminary aid deal with the EU and the International Monetary Fund, but approval and disbursement of aid is not seen until late January, at the earliest.
The cost of recapitalising the island's banking sector could be as high as 10 billion euros -- more than half Cyprus's annual output.
"As a proportion of GDP it is one of the largest bank bailouts ever, second only to the 1997 bank bail out in Indonesia,» Demetriades said.
The total cost of bailing Cyprus out is estimated at 17.5 billion euros -- including the cost of rescheduling 6.0 billion euros in maturing debt and 1.5 billion euros to cover deficit shortfalls until 2016.
But a net of 11.5 billion euros -- 10 billion euros for banks, and 1.5 billion euros for deficits -- would push debt levels to 140 percent of GDP. At that level, it is beyond the debt sustainability threshold of the IMF.
The level could be lowered to 100 percent, if 6.5 billion were directly injected to the island's banks from the ESM, Demetriades said. «This prospect is, however, dependent on progress with the establishment of a banking union in the euro area.»