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Eninboro allo economics

20 March 2013 By Hugo Dixon

The Cypriots have an expression: eninboro allo. It means: I cannot take any more of it.

There was jubilation last night outside the small Mediterranean island’s parliament when every single MP either voted against a plan to tax depositors or abstained. The message was that people of Cyprus had had enough and weren’t going to let the big bullies, led by Germany, boss them around.

The plan to tax insured deposits was a dreadful mistake – I have described it as legalised bank robbery. But the deposit tax was part of an unpalatable but available 10 billion euro bailout, agreed with the euro zone. That plan A is now at risk. As Cypriots contemplate possible plan Bs, their jubilation may start to fade: all of them are also dreadful.

Some observers, including my colleague Anatole Kaletsky, believe that Germany will now blink. With an election looming there in the autumn, that seems most unlikely. Berlin has said it is unwilling to back any loan bigger than 10 billion euros, already a non-trivial 60 percent of Cyprus’ GDP. The problem is that Nicosia needs 17 billion euros to recapitalise its banks and cover the government’s own expenses, leaving a 7 billion euro hole.

Berlin is right to refuse to lend more. Even with 10 billion euros, Cyprus’ debt will rise to around 130 percent of GDP. At 17 billion euros it would shoot up to around 160 percent of GDP. Under the original plan, debt was supposed to fall to 100 percent by 2020. But after the events of recent days, confidence will be so crushed and the island’s offshore finance business model so broken that this forecast now looks pie in the sky.

So what are Cyprus’ options? There are broadly three: sell its soul to Russia; default and possibly quit the euro; or patch together a new deal with the euro zone. They are all bad, but the last one is the least bad, for both Cyprus and the rest of Europe.

Cyprus’ finance minister is in Russia today. Moscow is furious because many of its citizens, who have channelled money to Cyprus, would pay the deposit tax. It may seem odd that the Kremlin is so keen to protect citizens who make use of an off-shore financial centre. Many are trying to reduce Russian tax payments and some may be money launderers. But that shows where President Vladimir Putin’s priorities lie.

Russia has non-financial interests in Cyprus. The island has potentially rich offshore gas deposits and its position in the eastern Mediterranean has long been strategic. It was colonised by Christian crusaders, the Ottomans and then the UK, which still has two military bases there. Could Moscow, whose only naval base on the Mediterranean is in strife-ridden Syria, somehow wangle some military advantage out of this crisis?

Some in Cyprus won’t care. They’ll say it is better to be colonised by Russia, which at least is also predominantly Orthodox in its Christianity, than to be Germany’s whipping boy. But such a pact would amount to turning its back on modernity.

The second main option for Nicosia is to default – or more precisely for its big banks to go bust. If Cyprus can’t get a bailout from the euro zone, it won’t be able to recapitalise its banks. The European Central Bank has said it is willing to supply them with liquidity, but only under its rules. That is far from offering an open spigot.

The country’s second largest bank, Laiki, already seems to have run out of suitable collateral to receive even emergency loans. At some point, the government is going to have to re-open the banks. If it doesn’t then have a deal, everybody will rush to take their money out. The whole financial system will collapse.

It is hard to see this scenario ending with anything other than the imposition of capital controls and Cyprus quitting the euro. Some sort of equilibrium would eventually be established, but depositors would lose much more than plan A’s 6.75-9.9 percent. The country might also be forced out of the European Union. That would massively weaken its strategic position vis-a-vis Turkey, which has occupied around a third of the island since 1974.

The remaining option is to recut the deal with the euro zone. The good news is that Cyprus’ partners are not fixated on a deposit tax, especially hitting those with less than 100,000 euros. The bad news is that there is still a 5.8 billion euro hole to fill. That’s about a third of GDP.

Nicosia may be able to scrabble around for some alternative ways of finding cash. One unattractive idea is to raid pension funds. Another is to find some way of cashing in on the potential future value of the offshore gas deposits. Yet another is to get the Cypriot church to chip in; its archbishop has offered to help. Maybe there is also a way of fast-tracking privatisations. Conceivably the state itself could default on its debts – although that wouldn’t help a lot since half of them are held by the country’s banks.

That said, a combination of such measures, plus a smaller tax focussed only on the uninsured depositors, might do the trick. It won’t be easy to sell this politically in Cyprus. But every day that the banks stay shut, the people may begin to appreciate the advantages of doing a deal with the euro zone. “Eninboro allo” may then be replaced by “ne boro” – “yes I can”.

 

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