Russian Roulette

Cyprus, the third largest island in the Mediterranean Sea, attained independence from the British in August 1960, but inter-communal violence between Greek and Turkish Cypriots escalated and by 1974 the island was partitioned, since when Turkey has controlled about 35% of it in the North, with the residue controlled by the Greeks. This week Cyprus was back in the news, creating divisions not just within its own citizens, whether Creek, Turkish or other, but within the Euro-Zone, the wider EU and with Russia

The problem, as the wider world is now aware, is that the country’s banking system is bust. It’s so leveraged that it represents 800% of GDP, whilst the country itself has a DEBT/GDP level of 90%, which will jump to 140% after the proposed Euro 17 BN loan from the Euro-Zone ( 10BN to recapitalise the banks and 7BN to assist the government), a level, like Greece which is patently unsustainable. Ironically, the Cypriot banks took a massive hit on their Greek Sovereign debt holdings, which is when the scale of the problem jumped.

The banking problem isn’t new, as Cyprus officially requested help from the Euro-Zone back in June 2012. The ECB stepped in with “emergency liquidity assistance” to the island’s central bank, but the policymakers have been hesitant with this bailout request, possibly awaiting the new President, Nicos Anastasiades, elected last month, whom European leaders regard as someone they can do business with, unlike his communist predecessor. More likely is that Russian interests have massive deposits in Cyprus, to the tune of 125% of the Cyprus economy according to a recent Bloomberg / Moody’s report. Furthermore, Russian banks have an additional Euro 29BN of loans outstanding to Cypriot companies of Russian origin, not to forget the Euro 2.5BN loan to Cyprus made by Russia whilst Europe debated.

weekly_blog_130322_1

This has widened the growing North/South divide within the euro-zone, as many within the northern countries, already annoyed at their forced commitment to their southern “colleagues,” now suspect that much of the Russian deposits and Cypriot business interests are derived from either laundered activities and/or  are mob controlled.

weekly_blog_130322_2

Incidentally, a socionomist would have suspected a major problem building up for Cyprus, just by observing its stock market, as the stock

index is perhaps the best barometer on collective social mood. Having patently been too exuberant over the period 2004 through 2007, it hardly got off of the mat, post 2009, when most of the planet’s stock-indices benefited from the anticipated results of QE, LTRO and the rafter of other stimulus activities. But I digress.

The dilemma that has hit the news-wires and the markets, are the conditions suggested for Cyprus to be provided with E-Z assistance, which are that E10BN will be forthcoming from the Zone, but Cyprus must contribute the other E7BN requested. The initial suggestion was that retail deposits should suffer a tax or levy, amounting to 6.75 percent on deposits under EURO100, 000 and 9.9 percent on those above, which has not only angered the population as a whole, but divided it further as the less well off feel that the wealthy should shoulder the burden, an opinion not necessarily shared by the better off, whilst the Russians are not happy at all. One can partially understand why the authorities have tried this route, it’s fairer to the non-Cypriot E-Z contributors plus Cypriot banks are overwhelmingly funded by deposits, not bondholders, so it wouldn’t have been very fruitful to go after bondholders in this case.

However, aside of deducting these amounts at source, whilst the banks are kept shut, thereby negating access to accounts by clients’, itself questionable in legality and which blows a hole in so called “property rights,” this move places a very large question mark over “unintended consequences.” First of all, savers across the rest of Europe, and in particularly the more venerable and far larger indebted counties such as Greece, Italy, Spain and Portugal, will look at what’s happened and start to withdraw their accounts en-masse, better known as a run on the banking system, which would be far more problematic to policymakers. Secondly, it places doubt in respect of the Europe’s Deposit Guarantee System, which provides a guarantee of up to €100,000, with payment within 7 days, but is only triggered in respect of a failed bank, not when deposits are frozen, potentially for up to a week with levies imposed to preempt the failure of a bank. As such the guarantee appears worthless to many. If confidence is undermined, the mattress becomes an option.

Aside of the banking problem, Cyprus also has the burden of private non-financial debt (i.e., of households and non-financial firms) which is the third-highest in the euro area as can in the following chart, courtesy of The Economist.

weekly_blog_130322_3

There is a wild card for Cyprus, which is the recent discovery of a big offshore gas field in its sector of the Mediterranean, albeit that its value is unknown and turning it into hard cash will take some time. Russia’s largest gas producer, Gazprom, has already expressed an interest and any further aid from Russia,  a country which runs a balanced budget and has one of the

lowest debt-to-GDP ratios, at 12 percent, will surely be conditional on first rights to this asset.

Geo-politically, the EU would prefer to see Cyprus remain within the fold, hence the game of Russian-Roulette continues and dangerous it certainly is, in more ways than one.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: