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.


Warning: Invalid argument supplied for foreach() in /home/bruegelo/public_html/wp-content/themes/bruegel/content.php on line 449
View comments
Read about event More on this topic

Upcoming Event

Jun
17
12:30

Role of national structural reforms in enhancing resilience in the Euro Area

At this event Gita Gopinath, Chief Economist at the IMF will discuss the role of national structural reforms in enhancing resilience in the Euro Area.

Speakers: Shekhar Aiyar, Maria Demertzis, Romain Duval, Gita Gopinath 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

Jun
19
12:30

What reforms for Europe's Monetary Union: a view from Spain

How is a successful European Monetary Union still possible in today's ever-shifting political landscape? What reforms need to occur in order to guarantee success of cohesive policies?

Speakers: Fernando Fernández, José Carlos García de Quevedo, Gabriele Giudice, Inês Goncalves Raposo, Javier Méndez Llera and Isabel Riaño Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Upcoming Event

Jun
25
08:30

How comprehensive is the EU political realignment?

Has the left-right divide become obsolete in EU politics?

Speakers: David Amiel, Otilia Dhand, Nicolas Véron and Silke Wettach Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF More on this topic

Policy Brief

A strategic agenda for the new EU leadership

Memo to the presidents of the European Commission, Council and Parliament. 'A strategic agenda for the new EU leadership' by Maria Demertzis, André Sapir and Guntram Wolff is the first of our 2019 Bruegel memos to the new presidents of the European Commission, Council and Parliament. Focusing on the most important economic questions at EU level, these Bruegel memos are intended to be a strategic to-do list, outlining the state of affairs that will greet the new Commission.

By: Maria Demertzis, André Sapir and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: June 13, 2019
Read about event More on this topic

Past Event

Past Event

Past, present, and future EU trade policy: a conversation with Commissioner Malmström

What was trade policy during the last European Commission? What will be the future of European trade under the next Commission?

Speakers: Cecilia Malmström, André Sapir and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 13, 2019
Read article More on this topic More by this author

Podcast

Podcast

Director’s Cut: A strategic agenda for the incoming EU presidents

In this Director’s Cut of ‘The Sound of Economics’, Bruegel’s Guntram Wolff and Maria Demertzis talk through their memo to the new presidents of the European Commission, Council and Parliament, outlining the specific measures that should be implemented in order to tackle the most formidable challenges arising in the next five years.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: June 12, 2019
Read article Download PDF More on this topic

External Publication

Effectiveness of cohesion policy: learning from the project characteristics that produce the best results

This study by Zsolt Darvas, Antoine Mathieu Collin, Jan Mazza, and Catarina Midões analyses the characteristics of cohesion policy projects that can contribute to successful outcomes. Their analysis is based on a literature survey, an econometric analysis and interviews with stakeholders. About two dozen project characteristics are considered, and their association with economic growth is studied using a novel methodology. Based on the findings, the study concludes with recommendations for cohesion policy reform.

By: Zsolt Darvas, Antoine Mathieu Collin, Jan Mazza and Catarina Midoes Topic: European Macroeconomics & Governance Date: June 11, 2019
Read article More on this topic More by this author

Opinion

Europe’s citizens say they want a more political EU

The recent European Parliament election suggests that a growing share of European voters sees things differently from national governments. Whereas citizens clearly used their votes to express policy preferences, very few governments are ready for a more political EU leadership.

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance Date: June 4, 2019
Read article More on this topic More by this author

Podcast

Podcast

Deep Focus: Striving for research excellence with Horizon Europe

In this episode of 'The Sound of Economics', Reinhilde Veugelers speaks about her recent Bruegel paper, requested by the European Parliament, on using public resources to improve the EU's potential to be a global centre of excellence for research in the next decade.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: June 4, 2019
Read article More on this topic

Blog Post

A European atlas of economic success and failure

Economic growth was diverse across EU regions, yet it is crucial to control for region-specific factors in assessing growth performance. We find that there are rather successful regions in many EU countries, suggesting that the EU can provide a good framework for growth. Yet the worst performers are more concentrated in some countries, suggesting that country-specific factors can play a major role in regional development.

By: Zsolt Darvas, Jan Mazza and Catarina Midoes Topic: European Macroeconomics & Governance Date: June 3, 2019
Read article More on this topic More by this author

Blog Post

European Parliament election results: The long view

Following the latest European elections, the author updates his previous analysis of trends in the share of European Parliament seats among ‘mainstream’ and ‘non-mainstream’ parties.

By: Nicolas Véron Topic: European Macroeconomics & Governance Date: May 29, 2019
Read article More on this topic More by this author

Podcast

Podcast

Director's Cut: Reflections on the European elections

Bruegel director Guntram Wolff hosts Ferdinando Giugliano, columnist for Bloomberg and La Repubblica, and Krzysztof Blusz, political analyst and senior fellow at WiseEuropa – Centre for European Strategy, for a discussion about the results of the European elections, both across Europe and within the states of Italy and Poland.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: May 29, 2019
Load more posts