Cyprus collapse 'may trigger landslide'

By Catherine Field

Worries grow as nation runs out of money and calls for a bailout.

Analysts are worried that if Cyprus goes bankrupt it will set off a chain reaction in other EU countries. Photo / AP
Analysts are worried that if Cyprus goes bankrupt it will set off a chain reaction in other EU countries. Photo / AP

Europeans are well versed in the debt crisis that has overwhelmed Greece, Ireland and Portugal and threatened Spain and Italy and even France.

Few, though, have spared much thought for Cyprus, which accounts for just 0.2 per cent of the European Union's gross domestic product (GDP).

But some experts are sounding the alarm, saying the debt-crippled Mediterranean island could be the molehill whose collapse triggers a landslide.

"Cyprus is a small economy, but the systemic risk may not be small," European Central Bank (ECB) chief Mario Draghi has warned.

"If Cyprus goes bankrupt, it would not only raise the risk for a euro-area exit, but it could have more of a domino effect," David Song of Daily FX currency analysis in New York told the Herald.

Divided into ethnic Greek and Turkish parts since Turkey invaded in 1974, the island has a reputation for glorious sunshine and dodgy banking.

The Greek Cypriot republic is in a mess, battered by lending to Greece and a hyper-inflated property market.

The country has run through emergency loans provided by Russia, its ally, and negotiated by former president Demetris Christofias, a Communist.

By June, the Government will run out of cash. Unemployment which during the boom years was negligible now affects one worker in seven.

President Nicos Anastasiades, elected last month, heads to his first European Union summit in Brussels today and tomorrow as the country grapples for a bailout from the "troika" - the European Commission, ECB and International Monetary Fund (IMF).

Cyprus is seeking €17 billion ($26.8 billion) - a tiny sum compared with the hundreds of billions pumped into EU economies over the past four years.

But this equals a year of the nation's economic output. Around €10 billion of it would be used to buttress its banking system, which has assets eight times the size of the country's GDP. The two largest banks are on life support after losing €4.5 billion in Greece.

Troika negotiators flew to Nicosia last week for the first haggle while their accountants pored over the books, evaluating state assets for possible privatisation.

Archbishop Christostomos II, the head of Cyprus's orthodox church and a firebrand nationalist, urged the Government to stand firm.

"If they want to destroy us, then we say goodbye to the euro. We can survive with the Cyprus pound," he said referring to the currency that prevailed before Cyprus joined the euro in 2008.

The bailiffs are taking a tough line, firstly demanding independent vetting of Cyprus's reputation as a centre for laundered money. They want corporate gains tax to rise from 10 per cent to 12.5 per cent for three years, according to the Cyprus Mail. And they want a financial transactions tax, of 0.01 per cent of the value of trades for derivatives and 0.1 per cent for stocks and bonds.

The tax is to be introduced by 11 eurozone countries from next year, but was fiercely opposed by Cyprus, which like Britain argued the levy would hit its vital financial industry.

Tougher still, though, is how to make the loan manageable.

Cyprus's debt, already 93.1 per cent of GDP, would rocket to 146 per cent under the new borrowings, according to investment bank Morgan Stanley.

As Greece showed last year, such levels send an economy into a death spiral: to make repayments, governments have increasingly to slash welfare or hike taxes, which crushes growth.

One idea is to set a debt target of 100 per cent of GDP, say EU sources.

One option is a "haircut"- a loss or cut in the expected return - on deposits and investments in local banks, much of which are held by Greeks and Russians.

Doing so would be politically acceptable in Germany, for it would prove that pain is being shared among taxpayers and investors alike.

But Cyprus has ruled this out. Nearly a third of its bank deposits are held on an overnight basis. A "haircut" would trigger an instant pullout, unleashing a local banking collapse that would hit Greece followed by other debt-burdened countries, it argues.

Equally, confidence would slump if the troika demanded a "haircut" on government bonds.

One idea would be to offset debt against a prospective windfall from receipts in natural gas, found off Cyprus's eastern coast. But "gas revenues will not solve today's liquidity problems as the possibilities of profitable commercial exploitation are not yet fully clear", said Nicolaus Heinen at Deutsche Bank in Frankfurt.

- NZ Herald

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