Blog Post

Options for Cyprus

Cypriot government official and parliamentary members face major choices in the next few hours: the European Central Bank (ECB) concluded that it will not be able to support Cypriot banks after Monday, the last day of the current bank holiday, if there will not be a proper agreement between the European lenders and Cyprus on a comprehensive adjustment programme that guarantees the viability of Cypriot banks and the sustainability of Cypriot public finances.

By: Date: March 22, 2013 Topic: European Macroeconomics & Governance

Cypriot government officials and members of parliament face major choices in the next few hours: the European Central Bank (ECB) has concluded that it will not be able to support Cypriot banks after Monday, the last day of the current bank holiday, if there is no proper agreement between European lenders and Cyprus on a comprehensive adjustment programme that guarantees the viability of Cypriot banks and the sustainability of Cypriot public finances.

The ECB has made the right call. It cannot support banks with such a major capital shortfall. Some observers satirically recalled the earlier speech of President Draghi in which he promised to save the euro, and accuse him now of doing the opposite. But this is incorrect. Mr Draghi said in July 2012 that "Within our mandate, the ECB is ready to do whatever it takes to preserve the euro." Supporting banks that have a capital shortfall of about 50 percent of the GDP of their country is not within the mandate of the ECB.

The Cypriot government is designing a new plan. The details are unclear at the moment, but most likely there will be a combination of a “small” levy on deposits above €100,000, and the creation of a holding company with state assets, including gas rights, central bank gold reserves and church properties. The holding company would borrow against these assets and may turn the bond into equity later. This is in fact privatisation, and it amounts to using the national wealth to bail out depositors who have benefited enormously from years of low Cypriot taxes and high deposit rates. This may be socially unfair, but it is up to the Cypriot parliament to decide.

There are also talks about quickly enacting a bank resolution framework, allowing a swift split of failed banks into “good” and “bad” banks, enabling the continued operation of “good” banks, probably in line with the Danish bank resolution regime, as I described here. This sounds like a good proposal, yet the devil is in the details.

So what are the options for Cyprus?

The first-best option is to get an agreement with euro-area partners. As I argued previously, for many reasons, euro-area partners cannot agree to significantly higher financing for Cyprus: that would endanger fiscal sustainability at the expense of European taxpayers. Also, that would be seen as a victory for blackmail. Greeks might wonder, for example, that if Cyprus can say no so easily to the conditions attached to financial assistance, why can’t they do the same? Backtracking by euro-area partners could wreck existing and future financial assistance programmes.

The question is if the current Cyprus proposal is sufficient to restore both fiscal sustainability and bank viability. Probably we will know the views of euro-area policymakers only by the weekend. If the proposal is not sufficient, the Cypriot parliament will have to agree to a revision of the plan. Yet even in this benign scenario, a massive bank-run is expected in Cyprus the first day the banks open. With the support of the ECB and euro-area partners, the situation may be manageable, though the prominent role of Cyprus’s financial services is probably over anyway.

The second option is to turn to Russia for help. Such help does not seem to be forthcoming, but Russian politics are not always predictable. One can never exclude a last-minute intervention.

The third is a chaos and possible euro exit (“Cyprexit”). If Cyprus does not reach an agreement with the euro-area partners and does not get help from Russia, then the ECB will turn off the tap for Cyprus’s banks. When there is no money, even ordinary transactions between businesses, or the purchase of food by people, cannot be done. Nobody would pay taxes and therefore the government would not be able to provide public services once the current cash reserves are gone. The use of euro cash will be limited further by the attempts to store the remaining euros under the pillows, so that they can be exchanged for an eventual new currency at a good price. Even though there is no formal process for leaving the euro, the lack of money in circulation would make it necessary to introduce a new currency.

The impact of an exit would be dramatic for the Cypriot people. The impact on the rest of the euro area would depend on expectations: would depositors consider the exit of Cyprus to be a precedent? If so, a massive deposit flight can start and then the ECB will need to lend a lot of money to banks in other euro-area countries. The ECB has the capacity to do so and will do this, in my view, but it would be a major period of turbulence with unpredictable consequences. If instead depositors consider the Cypriot case to be truly exceptional, then the situation would be manageable after initial turbulence.

People and politicians of other euro-area countries, seeing the dramatic impact of the Cyprexit on the Cypriot people, might conclude that it is better to do everything to keep all other countries in. It could therefore accelerate integration efforts, such as the banking union. Other issues, such as a euro-area fiscal capacity, could also be put back on the table. And perhaps the austerity debate would gain a new impetus. Indeed, irrespective of the Cyprus drama, the economic outlook of the euro-area is so weak, and is even desperate in southern member states, that a new direction is needed in euro-area macro policies. I hope that such a change will come, but it should come for reasons of economic principles, not because of a dramatic Cyprexit. The Cypriots have to make wise choices. After containing the first wave of shock, euro-area partners should also think more seriously about the future.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article
 

Blog Post

Will European Union recovery spending be enough to fill digital investment gaps?

The recovery facility will boost digital transformation, but questions remain whether it will be sufficient to achieve Europe’s digital ambitions.

By: Zsolt Darvas, J. Scott Marcus and Alkiviadis Tzaras Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: July 20, 2021
Read about event More on this topic
 

Upcoming Event

Sep
1
12:30

The EU recovery fund - state of play and outlook

Bruegel Annual Meetings, Day 1- In this session we will discuss the EU recovery fund, its state of play and outlook.

Speakers: Nadia Calviño, Karolina Ekholm and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic
 

Upcoming Event

Sep
2
10:00

Conversation on the recovery programmes

Bruegel Annual Meetings, Day 2- In this session, we discuss the recovery programmes.

Speakers: Maria Demertzis, Mehreen Khan and Tadeusz Kościński Topic: European Macroeconomics & Governance Location: Palais des Academies, Rue Ducale 1
Read about event
 

Upcoming Event

Sep
2
13:00

European banks: under global competitive pressure?

Bruegel Annual Meetings, Day 2 - European banks have lost stature and remain generally low-profitability, low-valuation in comparison to their global peers. Is that a problem? If so, what can EU policymakers do to address it?

Speakers: José Antonio Álvarez Álvarez, Mairead McGuinness and Nicolas Véron Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Palais des Academies, Rue Ducale 1
Read about event More on this topic
 

Upcoming Event

Sep
2
15:45

Blending physical and virtual: shaping the new workplace

Bruegel Annual Meetings, Day 2 - This panel will cover the changes the COVID-19 pandemic made to our workplaces, and what to expect in the near future.

Speakers: Nicholas Bloom, Michael Froman, Mario Mariniello, Sara Matthieu and Luca Visentini Topic: European Macroeconomics & Governance Location: Academy Palace
Read about event More on this topic
 

Upcoming Event

Sep
3
09:00

The role of the EU's trade strategy for an inclusive and sustainable recovery

Bruegel Annual Meetings, Day 3 - We are delighted to welcome Valdis Dombrovskis, Executive Vice President of the European Commission for An Economy that Works for People to talk about Europe's trade strategy.

Speakers: Valdis Dombrovskis, Alicia García-Herrero and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Palais des Academies, Rue Ducale 1
Read about event More on this topic
 

Upcoming Event

Sep
3
10:15

Conference on the Future of Europe: envisioning EU citizens engagement

Bruegel Annual Meetings, Day 3 - Panellists will discuss different options and what they may entail while revisiting the debates on the future of Europe at national and EU-level that have been conducted thus far.

Speakers: Caroline de Gruyter, Kalypso Nicolaïdis, Niclas Poitiers and György Szapáry Topic: European Macroeconomics & Governance Location: Palais des Academies, Rue Ducale 1
Read article Download PDF
 

Policy Contribution

A new direction for the European Union’s half-hearted semiconductor strategy

The EU needs a more targeted strategy to increase its presence in this strategic and thriving sector, building on its existing strengths, while accommodating its relatively low domestic needs.

By: Niclas Poitiers and Pauline Weil Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: July 15, 2021
Read article More by this author
 

Blog Post

Fit for 55 marks Europe’s climate moment of truth

With Fit for 55, Europe is the global first mover in turning a long-term net-zero goal into real-world policies, marking the entry of climate policy into the daily life of all citizens and businesses.

By: Simone Tagliapietra Topic: Energy & Climate, European Macroeconomics & Governance Date: July 14, 2021
Read article More on this topic
 

Blog Post

Fair vaccine access is a goal Europe cannot afford to miss – July update

European countries must do more to tackle the vaccine uptake gap. Vaccination data should be published at the maximum granularity level so researchers and local decision-makers can monitor progress.

By: Lionel Guetta-Jeanrenaud and Mario Mariniello Topic: European Macroeconomics & Governance Date: July 14, 2021
Read article More by this author
 

Blog Post

SPACs in the gap

Special-purpose acquisition vehicles could fill a gap in European equity markets and lure risk-averse investors off the sidelines.

By: Rebecca Christie Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: July 13, 2021
Read article More on this topic
 

Blog Post

A breakdown of EU countries’ post-pandemic green spending plans

An analysis of European Union countries’ recovery plans shows widely differing green spending priorities.

By: Klaas Lenaerts and Simone Tagliapietra Topic: European Macroeconomics & Governance Date: July 8, 2021
Load more posts