EU turns a blind eye to Cypriot bailout bid

By:
Matthew Turner
Published on:

An ESM bailout for Cyprus could lead to fears among investors of contagion in Spain and Italy.

GDP figures released this week painted a gloomier outlook for euroland this quarter. The eurozone’s largest economies – Germany and France – are wavering amid lower growth and output in Q4 2012. Meanwhile, Spain’s political and economic turmoil continues after forecasts revealed the government would miss its deficit reduction targets by a significant amount. And then there is the issue of bailing out Cyprus. Cypriot debt to GDP reached a peak of 84% of real GDP in 2012, up from 71.6% in 2011.

So why are policy makers talking about Cyprus? First, debt restructuring and a downsizing of the banking sector is planned through "bailing in" of uninsured bank depositors. This would mean "more foreign investors would be involved, especially from Russia," the Financial Times reported. Such an arrangement would be a side-step from a full-blown EU-IMF bailout package.

Therefore, the terms of a Cypriot bailout agreement do have implications for the rest of the eurozone. But is this new arrangement a sign that Germany, France and the other core eurozone economies no longer have the muscle to pick up the eurozone debt baton?

German politicians are reluctant to anger voters with taxpayer-funded support for other euro members, reckons the Economist Intelligence Unit’s chief economist, Robin Bew. Cyprus asked for a bailout back in June 2012, but senior EU policy officials have so far hummed and hawed.

Michalis Vassiliadis, economist at the Foundation for Economic and Industrial Research (IOBE) and one of ECR’s experts, says policy priorities were more to blame for the delay in granting Cyprus a fully packaged deal.

“The Cypriot economy is not in as difficult a position as some of the periphery economies were in 2010, so they have tried to take measures by themselves before asking for help from the EU for bailout assistance,” Vassiliadis says. “When there is not such an urgent need for financial assistance, there’s an attempt to define the crisis through national polices and measures.”

But according to Bew, from a realpolitik standpoint, German political interests outweigh Cypriot needs for the time being.

“Despite the relatively small financial commitment to save Cyprus — in contrast to the sums pledged in previous eurozone bailouts — and Russia’s expected participation in a deal, which will reduce the financial burden placed on eurozone taxpayers, Germany is in no rush to secure a rescue deal,” he is quoted as saying by The Economist.

Contagion fears have also delayed bailout talks from materializing, as debt restructuring for Cyprus could lead to concerns among investors that Spain and Italy may follow. Such an occurrence could lead to a rallying in bond yields and turn a relatively small financial commitment into a full-blown eurozone crisis.

As the Economist Intelligence Unit point out, “Not addressing the problems facing the Cypriot banks risks triggering an intensification of the eurozone crisis, as long as the threat of a disorderly default and exit from the currency union persists.”

Cypriots go the polls on Sunday (February 17), which should clear the decks for bailout terms to be negotiated and agreed. But the “new government will need to make decisive moves to signal its willingness to seriously tackle the many structural issues that need urgent attention,” says Bernard Musyck, associate professor at Frederick University and one of ECR’s expert contributors.

“We have seen enough ill conceived ‘worker-friendly’ measures, and time has come to engage in a meaningful strategy of growth by doing more and better with less,” he adds. 

This article was originally published by Euromoney Country Risk.