With its bank spending and Greek links it was inevitable Cyprus would need help, but this package may be a game-changer
It was always a case of when, not if, Cyprus would join the list of eurozone countries requiring a bailout to rescue them from financial crisis. But the peculiarities of the support package coupled with the economic weakness across the rest of the 17-nation single currency area suggest that this could be a game-changing moment.
Cyprus has faced two big problems. The first is that its banks went on a lending spree during the good times – by 2011, they had made loans worth more than eight times the country's national output. Even Britain, the most spectacular example of a big developed country that allowed an overblown banking sector to threaten the entire economy, did not go quite that far.
The second problem was the close links between Cyprus and Greece, a country gripped by a brutal slump that has seen the size of the economy shrink by 20% in four years. Cypriot banks had made loans to Greece worth 160% of GDP and the losses on that high level of exposure have been rising rapidly.
Greece is also a key trading partner for Cyprus, so there has also been a direct impact on the Cypriot economy from the austerity imposed on Athens.
But while there was never a doubt that Cyprus would need help from the so-called troika of the International Monetary Fund, the European Union and the European Central Bank, the dealannounced at the weekend differed in one significant way from the ones that have gone before it: bank deposit holders in Cyprus will have to foot part of the bill themselves.
The reason for this is simple. There is a lot of Russian money in Cyprus, much of it from somewhat dubious sources. With the richer countries of the eurozone suffering from bail-out fatigue, there was resistance – particularly in Germany – to the idea that ordinary European taxpayers should be writing blank cheques to Russian oligarchs who might have been using Cyprus as a money laundering destination.
As a result, there will be a "stability levy" of 6.75% on all bank deposits of less than €100,000 (£87,000) and 9.9% for those above €100,000. In addition, there will be the now familiar strings attached to the financial help: austerity and structural reform.
By the standards of previous rescues, the €10bn handed to Cyprus is chickenfeed. But even before the ink was dry on the agreement, financial markets were fearing that the deal could have wider ramifications than the troika expects.
One issue is whether the "stability levy" is unique to Cyprus or will be applied to other – much bigger – eurozone countries that might require help. Telling Spanish bank depositors, for example, that they would have to follow the Cypriot precedent would risk inflaming a country already experiencing widespread social unrest.
The assumption in Brussels, Frankfurt and Washington seems to be that Cyprus is the coda to the eurozone crisis – a last echo of problems that are now all but resolved. Yet that view may not be shared in the markets, where many analysts have seen the calm that has descended on the single currency since last summer as a phoney peace.
Ever since Greece precipitated the crisis in late 2010, events in the eurozone have been marked by periods of extreme tension punctuated by periods of stability. The one since last July when Mario Draghi, the president of the ECB, said he would do "whatever it takes" to safeguard the euro has been the longest so far.
Yet, the economic news from the eurozone has remained grim. In 2012, there was not a single quarter of positive growth and activity is still weakening. Italy's political impasse has added to fears that it may just take the disturbance of one small rock to set off another avalanche of selling in the bond markets. Cyprus could be it.
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