Cyprus: The eurozone's omnishambles moment
By Nick Malkoutzis
At the beginning of last week, Cypriot politicians insisted they would not choose a “suicidal” option for their country. By the end of the week, they picked one that would inflict mortal wounds instead.
Nicosia’s handling of its unprecedented predicament has been cataclysmic. But the approach adopted by the European Union and International Monetary Fund to Cyprus’s problems has also been disastrous. The eurozone has been building up to an omnishambles moment throughout the debt crisis and it finally struck in a small island state in the Eastern Mediterranean.
The agreement arrived at in Brussels early Monday, following hours of talks involving Cypriot officials, eurozone finance ministers and EU and IMF chiefs, is being billed as the least worst option after all sides took successive wrong turns on the way. That may be the case but it will be little consolation to thousands of Cypriots who have lost a big chunk of their deposits and face uncertain times ahead.
For those looking at the longer-term picture, the island is in for years of extreme difficulties. Its banking system and concomitant services made up about half of the island’s economy. This has now been obliterated. Depositors are unlikely to trust Cypriot banks for some time to come and young Cypriots will have to choose to become something other than lawyers, financiers and accountants. Many will have to consider a future away from their homeland, which faces a double-digit recession in 2013 and more years of economic contraction ahead.
A large part of Cyprus’s downfall is of its own making. Having decided to make banking one of the main pillars of its economy, along with tourism and shipping, Cyprus should have done everything in its powers to protect its right to make a living from a much larger than average financial sector, just as Luxembourg and other countries do. Instead, it became acutely exposed to the failing Greek economy through nonperforming loans and Greek bonds shorn in last year’s PSI. It also allowed others to question the legitimacy of some of the money that was entering the island’s bank accounts.
The Cypriot political and banking leadership ignored for months the fact that the island’s second-largest lender, Cyprus Popular Bank (Laiki), was no longer a viable concern, especially after its suffered combined losses of about 4 billion euros with Bank of Cyprus when their Greek bond holdings were restructured in February 2012. An IMF country report in November 2011 outlined concerns about Cyprus’s banking system, particularly due to its exposure to the Greek economy, and recommended that “authorities should require banks to put in place robust plans to achieve higher capital ratios... and... move quickly to enhance their powers so that they can take prompt corrective action to recapitalize or resolve banks, if necessary.”
At that stage, there were examples from other countries with bank resolution processes in place that Nicosia could have turned to. It didn’t. In fact, former President Dimitris Christofias and his government appeared to become paralyzed after the fatal explosion at a naval base next to the Zygi power station in July 2011, which knocked another 2-billion-euro hole in the country’s economy. Christofias seemed satisfied with securing a 2.5-billion-euro loan from Russia in December 2011 and overlooked the pressing economic problems his country was facing.
It should be pointed out, though, that at that point there were few predictions of imminent economic disaster for Cyprus. In fact, the IMF was upbeat on the country’s prospects in November 2011, forecasting a balanced budget by 2014.
It would be wrong to give the impression, as some have tried to, that Cyprus was never willing to cooperate with the EU and IMF. Over the last few months, there was a growing realization among the island’s decision-makers that time for a solution was running out. In November last year, Anastasiades wrote to President Christofias to complain of delays in reaching an agreement with the troika and warned that one of Cyprus’s banks would need to be recapitalized by January or face losing access to ECB liquidity.
Before the end of November, though, Christofias had agreed a bailout with the troika four months after requesting assistance from the EU and IMF. Try as he might to hold out hope of more help from Russia and to avoid being the one who would invite the troika to Cyprus, Christofias acquiesced just a few months before his presidency came to an end. Anastasiades, the leading presidential candidate, was openly talking about agreeing a memorandum with the troika that would include a package of austerity measures. At that point, there was no official discussion of a deposit levy.
Where Anastasiades got it woefully wrong though was in being unprepared for what the troika might throw at him. His initial decision this month to accept a deposit tax for all bank customers in Cyprus was catastrophic. Having returned to Nicosia with the agreement, he realized his mistake and Cyprus embarked on a week of pointless domestic bargaining and futile overtures to Russia in a bid to raise revenues from alternative sources. Rejecting the deal on the table or not pulling out all the stops to design a better one only made sense if Cyprus had other, concrete options rather than nebulous ideas. The Europeans had done their homework and knew Russia would not come to the rescue; the Cypriots, though, were caught napping.
A series of mistakes, miscalculations and blinkeredness have cost Cyprus dearly but it was aided and abetted by lenders with a penchant for procrastination and internal disagreement. In this environment, both sides were lulled into ignoring imminent threats as they busily kicked the can down the road.
It is only in the last few months that any great urgency was injected into proceedings and it had only been two weeks since Anastasiades was made president when he was confronted by the “deposit tax or euro exit” choice at the Eurogroup. Decision makers within the eurozone will liken the way they confronted Cyprus to an intervention for an alcoholic refusing to accept to his addiction. Anastasiades, however, had already shown a willingness to cooperate and won an election saying he would do so – not a popular policy platform in a Southern European country. The March 15 Eurogroup should be called what it was: an ambush.
It went beyond steering a eurozone partner toward a particular path. Cyprus was given no other option than to accept a solution that would decimate its economy and supposedly reduce its banking sector to the EU average of 3.5 times GDP. The idea itself that Cyprus’s financial sector had to be equal to the EU average betrayed something more than just an attempt to tidy up its economy. Why the EU average and not four or five times GDP? The target smacks of an attempt to put Cyprus in its place, just as the persistent talk of Russian money being laundered in the Cypriot banking system – as if it was not being used for anything else – also appeared a choreographed attempt to undermine Cyprus, which had joined the euro in 2008 with pretty much the same banking system and no complaints.
Over the past few weeks, Cyprus found itself negotiating with the same eurozone whose leaders nine months earlier had affirmed “that it is imperative to break the vicious circle between banks and sovereigns” and who had drawn up plans for euro-area banks to be recapitalized via the European Stability Mechanism (ESM). It was also the same eurozone that just three months earlier had agreed to plans to create a Single Supervisory Mechanism, which would pave the way for ESM recaps. And to think that Cyprus was the one being criticized for its inconsistency.
More damaging than this, though, is the manner in which the Cypriot problem was tackled over the past few days. It showed complete ignorance or indifference regarding the vulnerable position in which a euro member state found itself. Cyprus has borne the cost of having enemies for many years, so being ambushed by its friends can only be distressing.
The eurozone had no qualms about pushing to the edge its only member to be involved in a war in the last 50 years, to have part of its territory occupied by a foreign army, to be still suffering the effect of an intercommunal divide and to have a capital in which passports must be shown to pass from one side to the other.
It is in this environment that Cyprus, a semi-arid island that is surrounded by competing states, must survive. It has taken years for Nicosia to negotiate agreements that would allow it access to the island’s natural resources, but even now Turkey is threatening a “new crisis” if Cyprus seeks to collateralize future gas revenues before there is a settlement on the island.
It is these challenges and the hope of being able to gain a security and stability dividend that brought Cyprus to the eurozone. For all its failings, it did not deserve the treatment it got. With some horror, Cyprus has now realized that the euro area’s interpretation of its central tenet of convergence has become warped. It is not the compact structure many had envisioned. The fissures are now clear.
Ignoring the failure of banks all over Europe over the past few years and the fact that finance was one of the few activities Cyprus could turn to after the Turkish invasion in 1974, French Finance Minister Pierre Moscovici refers to the country’s “casino” banking system.
These double standards are not confined to the eurozone.
"In principle they have only the finance sector and beaches to offer and now the banks are on their way to closure,” said Swedish Finance Minister Anders Borg of Cyprus last week.
Apart from the prejudice implied in Borg’s comment, there is also a failure to recognize history and the strict limits within which Cyprus can operate as a euro member. Sweden went through its own banking crisis triggered by a property bubble in 1991 and 1992 but recovered from it due to a multi-pronged approach that included a state guarantee for all deposits, the government assuming banks’ toxic assets and the nationalization of two key lenders. These options were not available to Cyprus because of single currency regulations and the narrow remit within which the European Central Bank operates.
An EU and a eurozone that forget or ignore even their recent history are becoming a less inviting place to be. The part of Europe that is in a relatively healthy state at the moment seems keen to set aside the past now that another part of the continent is being severely tested. German Finance Minister Wolfgang Schaeuble says the problem lies with the laggards. They are like jealous schoolchildren, he says. However, the immaturity, complete with playground bullying, seems to lie elsewhere.
The tremulous description of the March 15-16 Eurogroup meeting provided by Maltese Finance Minister Edward Scicluna underlined that Europe’s weaker or more vulnerable states feel powerless next to their more successful partners. Hopes of fairness, understanding and solidarity are evaporating.
"Cyprus, more than all the others, holds a special place not so much with regard to the unique factors which brought about the financial crisis... but as a case study of how an EU micro-Mediterranean island member state is expected to be treated if ever its unfortunate turn would come to seek aid from its fellow member states,” wrote Scicluna in an op-ed after the meeting of eurozone finance ministers.
While the last few days have uncovered an alarming propensity for Cyprus to shoot itself in the foot, they have also revealed that the EU, and the eurozone in particular, seems bent on self-destruction. There can be little doubt that the last week will have planted the idea in many minds across Europe, including Cyprus, that going it alone is a better option than being a second-class member of an exclusive club. This may end up being the most damaging wound inflicted during the eurozone’s omnishambles moment.
[Kathimerini English Edition]