Cypriot bailout praise masks spat over central bank

As Cyprus’s bailout masters review the country’s finances, the six-month-old feud between the heads of its government and central bank is taking another twist.

President Nicos Anastasiades’s attorney general asked police on Oct. 24 to look into a contract between the central bank and an adviser on the depositor losses that were a condition for the rescue agreement in March. Governor Panicos Demetriades, also a member of the European Central Bank’s governing council, said the false allegations of wrongdoing were part of orchestrated efforts to pressure him into resigning.

The one thing that unites the men is that both insist the country must adhere to the conditions of the aid program. While yields on Cypriot bonds have dropped to the lowest since the bailout, the concern is that the arguments in the background might delay or derail efforts to do so.

“The spat is not going away,” Michael Michaelides, a rates strategist at Royal Bank of Scotland Group Plc in London, said Wednesday. “This certainly carries risks of upsetting the ECB, which does have significant power.”

Making progress

Inspectors from the ECB, European Commission and International Monetary Fund, the troika who monitor rescued euro members, lauded Cyprus after their first review in July, saying the Mediterranean island was on track to meet targets.

Demetriades sat alongside government officials and the troika on Oct. 29 in Nicosia to sketch out the next stage of talks on a recovery program that will focus on asset sales, public services and rebuilding the financial industry.

So far, that progress has been reflected in the bond market more than the duel between Anastasiades, 67, and Demetriades, 54. The yield on Cypriots bonds maturing in February 2020 dropped 5.5 percentage points to 9.87 percent from a March 28 peak as the country avoided economic meltdown.

“I don’t think this is relevant to what will happen in Cyprus,” said Lefteris Farmakis, an analyst at Nomura International in London. “There will be screaming and shouting on both sides. It’s a sideshow.”

Escalating dispute

The spat first escalated in April as Cyprus’s economy lurched following the closure of one of its two biggest banks and losses imposed on depositors.

The main complaint against Demetriades was described in a letter dated April 15 from President Anastasiades to ECB President Mario Draghi. In it, the central bank chief was blamed for keeping the now-defunct Laiki Bank artificially afloat throughout the second half of 2012 to enable the country to reach elections in February 2013 without needing a bailout.

Anastasiades said last month he was building a case against Demetriades for poor performance, which he may refer to the Supreme Court. Draghi then said on Oct. 12 that he takes a “dim view” on any attempt to put pressure on the governor.

The latest round was triggered by press reports in Cyprus last week that an adviser had sought a “success fee” from the recapitalization of the country’s banks. The attorney general then asked police to investigate.

“I don’t think that Demetriades is going to be ousted,” said Farmakis at Nomura. “The ECB is going to make it clear that they cannot touch him, and the Cypriots domestically will keep threatening.”

Staying put

Demetriades, a former university professor in England who was appointed by the previous government in May 2012, told state broadcaster RIK on Oct. 25 he’s staying put.

“If the president of the central bank resigns under conditions of heightened political pressure, then that will create problems for the country,” he said.

The animosity toward Demetriades may stem from a belief that he abetted former President Demetris Christofias with the central bank’s Emergency Liquidity Assistance program, according to Gabriel Sterne, an economist at Exotix Ltd. in London.

That wound up increasing the bill for rescuing Cyprus’s lenders and resulted in the euro-area finance ministers forcing the government to accept the depositor losses, less than a month after Anastasiades’s election, in exchange for a 10 billion-euro loan accord at a meeting in Brussels.

“The ELA was a shambles,” Sterne said. Regardless of “whether they’re shooting the right guy, it’s astonishing the way the ECB works is to keep a bankrupt bank afloat.”

Shrinking economy

The result is a shrinking economy as the island reduces the size of its banking industry and cuts spending. Capital controls aimed at limiting deposit flight are still in place. The troika forecast that Cyprus’s gross domestic product would contract 8.7 percent this year and another 3.9 percent in 2014.

Demetriades and Finance Minister Haris Georgiades said on Oct. 21 they expect the economy to contract less than that as they answered lawmakers’ questions on the 2014 budget.

That will come as little consolation to many Cypriots who are angry at what they see as a blame game overshadowing a collapse in their standard of living.

“We’re going hungry and they’re at each other’s throats,” said Maritsa Louka, 85, who relies on help from her children to cover her living expenses and an increase in property tax as part of austerity measures. “I don’t care who is right.” [Bloomberg]