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Cyprus gets bailout deal, but at what cost?

March 25, 2013

Published in ‘New Europe’, online edition

ScheubleAfter long discussions and an initial negative vote by the Cypriot Parliament, an agreement was finally reached reached last night in Brussels between Cyprus and the Eurogroup. Thus, Cyprus, after Greece, Portugal, and Ireland, becomes the fourth Eurozone country to be bailed out in order to face a dire financial situation, both in its banking system and its public finances.

The Agreement provides a total financial aid package of €10 bn, while another €6 bn will be saved from a bank deposits’ haircut and used for the recapitalization of the banking system. The initial proposal (that was rejected by the Parliament) demanded a 6.6% haircut in deposits below €100,000 and a 9.9% haircut for deposits above that amount. That proposal had sparked a wave of protests throughout Europe as it violated the prevailing bank deposits guarantee in the Euroland for all deposits up to €100,000. This problem was addressed in the final Agreement, whereby a 20% levy was adopted, but only applying to deposits above €100,000 of the ailing Bank of Cyprus.

Another point of the agreement concerns ‘Laiki’ Bank, which has suffered heavy losses both from investing in Greek government bonds, and from bad corporate loans. Laiki will be separated into a ‘good’ and a ‘bad’ bank, and the latter will be put into liquidation.

The Agreement also provides for a downsizing of the banking sector ‘reaching the EU average by 2018.’ Practically speaking though, the shock on Cypriot banks from the current situation will most probably lead to an abrupt downsizing in the immediate future, much in advance of the target date. Clearly, the Eurogroup is asking Cyprus to abandon its ‘tax haven’ status and to become a ‘normal’ Eurozone country. Thus, Cyprus is required to adopt ‘further measures’ such as the increase of the withholding tax on capital income and of the statutory corporate income tax rate. The latter, at 10 percent, was to date one of the lowest in Europe.

Finally, there will be an‘independent evaluation’ of the anti-money laundering framework of Cyprus’ financial institutions, involving Moneyval alongside a private international audit firm. Just to remind that Moneyval is Council of Europe’s institution that has already audited Cyprus several times (the last was in September 2011) and has always given it high marks. Obviously, the Eurogroup (that is: Germany) does not trust Moneyval’s reports and thus requires an additional evaluation from an international audit firm.

In sum, Cyprus will cease to be a preferred place for international banking and tax planning. Its relations with Russia, whose banks and businessmen have contributed a large part of corporate business and deposits to Cyprus, will be strained. But, above all, the business model of Cypriot economy will have to change. Problem is that financial services and related activities (law firms, accounting offices etc) account for around 42% of Cyprus’ GDP, and it will be quite difficult to find quickly alternative activities to make good for their loss.

The strange thing is that Mrs. Merkel and Mr. Schäuble just discovered that Cyprus was a low tax jurisdiction – only nine years after its EU entry and five years after joining the Euro. By deciding to put an end to its status, they are sending another Southern European country into deep recession, further enlarging the gap between North and South, and adding one more destabilizing element in the battered Euroland economy.


From → Views & Opinions

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