The problem:
- Cyprus debt to GDP ratio increased to 127% (Forbes) in the third quarter of 2012
- Cyprus GDP growth in 2012 is estimated to be between -2 and -4% (estimate)
- The Cyprus economy has been hard hit by the slump in Greece – a major trading partner of Greece
- Cyprus made significant loans to Greece during the boom years. Cyprus loans to Greece were worth 160% of GDP (Guardian)
- Cyprus two main banks have come close to default.
- With both financial debt and government debt increasing beyond their capacity to repay, the Cyprus government sought an EU bailout.
As part of the EU bailout agreement, the EU have requested a one off tax of”
- 9.9% levy will be imposed on all deposits over the insurance threshold of €100,000
- 6.75% levy on savers with deposits in Cypriot banks below the insurance ceiling
The logic for this one-off levy on bank deposits is that:
- Cyprus has a very large banking sector with bank deposits far greater than GDP (By 2011, they had made loans eight times GDP)
- Cyprus banks have attracted significant deposits from foreigners, such as the super-rich Russians. (50% of savers are thought to be non-resident Russians) The EU didn’t want to bailout the whole banking sector, why should EU taxpayers bailout wealthy (and non-EU) savers. This is an attempt to share the cost of debt restructuring amongst all those with a stake in the economy.
- If Cyprus doesn’t get a bailout and is forced to default and leave the Euro – the overall cost to the economy and savers could be even greater.
The problem of this one of tax on savings.
- The tax on small scale savers was unexpected and arguably controversial because whilst the package places tax on small scale savers, it leaves the (wealthier) bank bondholders unaffected.
- Cypriot savers may feel aggrieved that no levy was placed on Greek savers in the Greek bailout.
- Risks creating financial uncertainty across Europe. The levy on savers risks undermining confidence in European wide deposits. Savers in Spain, Italy and Portugal may not take seriously EU reassurances that their savings are safe. After all, the Cypriot President only two weeks ago said bank deposits were safe. No-one really expected this one off tax for Cyprus. If no one saw it coming, it will make people think why take the risk? Even a partial run on EU bank deposits could upset the fragile banking sector. Why take risk for a paltry few billion in Cyprus saving accounts?
- Unsurprisingly, news of the Cyprus deal has pushed the Euro lower, and put up Eurozone bond yields.
- The other problem is that countries may become more reluctant to enter into a deal with the EU for future bailouts. Even talk of investigating a bailout with the EU could lead to a bank run as people try to withdraw savings.
- Potential fall in money supply as Cyprus savers withdraw money from bank. This will add to the already damaging economic contraction.
- An estimated €2bn of British deposits are held in Cyprus. The chancellor G.Osborne stated that people serving the military and government in Cyprus would have their savings protected.
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