Submitted by: Donald Hank
CYPRUS IS IN DEEP TROUBLE
Cypriots like to think they are ever so slightly superior to their mainland cousins. More orderly, less prone to bending the rules, more financially sensible. But over the weekend, their shame reached a depth to rival that of their linguistic and cultural close relatives – whose country is firmly established as the global embodiment of fiscal folly.
Cyprus had already joined the bailout club. In December, it became the latest country in the eurozone to apply for a rescue programme, to the tune of 17.5 billion euros. The problem was that the money couldn’t be found from the international creditors and institutions that had propped up, by various methods, Greece, Ireland, Portugal and Spain.
So, for the first time since the debt crisis erupted, the Eurogroup – the finance ministers of the 17 states in the eurozone – decided that depositors in Cypriot banks should pay directly to keep those banks afloat. It called for a one-off tax to raise 5.8 billion euros towards saving the country. It was euphemistically called a “solidarity levy” – the price Cyprus had to pay for a 10 billion euro bailout from Euroland. Without it, the country risked defaulting on its bond repayments within weeks.
This momentus decision was reached late on Friday, ahead of a long weekend on the island, and when the banks would be closed for three days. As news filtered through on Saturday morning, queues formed at cash machines as anxious depositors tried to empty their accounts, or at least to extract their daily limit. One man tried literally to bulldoze his way in, and was arrested.
By yesterday morning, every cash-providing hole in the wall had either been turned off or shuttered. “I went out on a dawn patrol, but came back empty-handed,” says Colin Smith, a military historian who has lived on the island for years. Money transfers have been blocked, residents said.
So what went wrong? Not so long ago, Cyprus was being hailed as the home of a minor economic miracle. The International Monetary Fund described the country’s performance before 2008 as a “long period of high growth, low unemployment, and sound public finances”. It suffered a recession in 2009, but it was the mildest in the eurozone.
Tourism was booming, with British visitors still flocking to the former colony’s beaches and snapping up seaview properties, while the banking sector flourished. But as with the other troubled states of southern Europe, the success story hid grave ills and vulnerabilities.
Throughout the past decade, Cyprus gained a reputation as a centre for money-laundering. Among those booming numbers of foreign visitors were thousands of Russians, attracted by political connections with Moscow that went back decades, a shared Orthodox faith, and a banking sector that not only didn’t ask too many questions, but commonly pays interest rates of six per cent and upwards.
Over the past decade, many such Russians settled in Cyprus or bought second homes. The city of Limassol, the financial centre, became known as “Lima-grad”: it now boasts expensive boutiques for Muscovites, rental firms offering Porsches rather than Fiat Pandas, and three Russian-language newspapers.
Like Monaco, then, Cyprus has become something of a sunny place for shady people. “There are girls with legs that go on forever and men who insist on wearing sunglasses throughout the gloomy Cypriot winter,” says Smith. “They have vulgar villas, which cause a lot of consternation – blocking other people’s views and so on – but they tend to throw their money around and get their way.”
It is estimated that some 20 billion of the 70 billion euros on deposit in Cyprus – a country of only 800,000 people – belongs to Russians. Those deposits helped the banking sector grow beyond all reason, just like in Iceland. By 2011, the IMF reported that the assets of Cypriot banks were equivalent to 835 per cent of annual national income. Some of that was down to investment by foreign-owned banks, but most was Cypriot.
This imbalance might have been sustainable had the country’s two largest banks not made loans to the Greek government worth 160 per cent of Cypriot GDP. It has never been clear whether that risk was taken out of ethnic solidarity, or from a presumption that the Greeks knew what they were doing. But in any event, it was disastrous.
When the value of the debts owed by the Greek state was cut by 75 per cent, the Cypriot banks were hit hard. The island became stuck in a familiar negative cycle: already weak government finances were further ravaged by slow economic growth and the turmoil in the eurozone. The financial markets got edgy and became reluctant to lend. Property prices headed down sharply and construction ground to a halt, with the exception of those oversized Russian villas.
The government’s response made things worse. Former president Demetris Christofias, the Soviet-trained leader of the nominally Communist AKEL party, was unwilling to introduce austerity measures. On the contrary, at one point he declared that he could not see the point of governments having surpluses and continued to follow the Cypriot tradition of spending lavishly on welfare benefits and pensions.
The consequences of the crisis have been similar to those in Greece: closed shops, and an increase in crime. Colin Smith says his walk to buy a daily newspaper passes the bullet-holed glass of a betting shop whose proprietor was killed in a drive-by shooting.
For those paying attention to Eurogroup briefing papers and European Commission memos, the escalation of the situation – and especially this weekend’s “haircut” on the Cypriot banks – should not have been a surprise. The propensity of the country to turn a blind eye to the influx of Russian money angered Angela Merkel, the German Chancellor. During negotiations, as it became clear that Cyprus was struggling to reach its bailout target of 17 billion euros, Berlin came to the view that the levy on bank accounts would punish allegedly ill-gotten Russian gains – and the Cypriots for their laxity on the issue. After all, with a German election in September, rescuing high-rolling Russians would be a tough sell to taxpayers weary of saving those less responsible than themselves.
Many on the island thought that the levy on savers’ funds was not a serious proposal but a threat designed to force the government to raise corporate tax and boost privatisation. President Nicos Anastasiades declared in his inauguration speech in late February that “absolutely no reference to a haircut on public debt or deposits will be tolerated”.
Fiona Mullen, head of the consultancy Sapienta Economics and a resident of Cyprus for 20 years, says that “red line after red line has been crossed” by the European plan. “We knew there was a chance they would hit the deposits over 100,000 euros, which is the insured level, but nobody thought they would go for everybody. It looks like even people with 200 or 300 euros in the bank will have to pay.”
Under the plan, account holders in Cyprus with up to 100,000 euros in the bank will pay a one-off levy of 6.75 percent, and deposits over that will suffer a 9.9 per cent levy. It seems it will affect both deposit and current accounts, though the details are not yet entirely clear: a revised deal being negotiated last night would see larger accounts pay more and smaller less.
“We are stunned by this,” says Parker Williams, head of the Cyprus Expats website. “People are running out of cash for food.”
George Osborne has announced that British government staff, or those serving with the military, will be compensated. The only other people being spared are Greeks who hold accounts in Cyprus, as any move against them could lead to a run on the banks in Athens.
The levy has to be agreed by the Cypriot parliament today, and should pass, given the government’s reluctant support for it. European officials insist this will be a one-off. The last thing they want is queues at banks elsewhere in southern Europe. But as with every step taken during the eurozone crisis, it is a gamble whose consequences can never quite be predicted.
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