(The author is a Reuters Breakingviews columnist. The
opinions expressed are his own)
By George Hay
LONDON, May 27 (Reuters Breakingviews) - Cyprus has a
liquidity problem. It has been barely two months since
depositors of the two largest lenders of this small island
state, Bank of Cyprus and Laiki, learned they were to face
losses of 60 to 100 percent on the part of their deposits
exceeding 100,000 euros ($129,278). Yet Nicosia’s streets
haven’t been savaged by furious rioting, nor have the banks
fallen victim to visible panic. The harm is more pernicious:
capital controls are slowly smothering a domestic economy
already hit by a heavy dose of austerity.
It doesn’t look obvious at first. Controls have been relaxed
in stages since March. Businesses can now make cashless payments
of up to 300,000 euros without supplying documentation, while
permitted cashless transactions from one bank to another have
been increased to 15,000 euros and 75,000 euros for households
and businesses, respectively.
Yet a major problem lies beneath the surface. Imagine a
fictional Cypriot business manufacturing car parts, Aphrodite
Autos. And imagine that in mid-March, just before the bail-in,
it had 1.1 million euros on deposit at the Bank of Cyprus, to
provide a decent buffer against uncertainties such as a price
hike of raw materials, which, in Cyprus, are mostly imported.
After the bail-in, Aphrodite Autos is in a tight spot. It
still has the 100,000 euros of deposits that were insured. But
the million euros that were uninsured are now down to 100,000
euros. 375,000 euros are definitely being turned into Bank of
Cyprus shares of as yet uncertain value. Another 225,000 euros
are also at risk of being bailed in. Finally, the remaining
300,000 euros have been summarily frozen too.
That’s bad enough. But Aphrodite Autos can’t even get its
hands on all of the 200,000 euros of deposits it can
theoretically access. Imagine that half of this is in the form
of a one-year, fixed-term deposit maturing in June. When it
does, the current capital controls mean that the firm is only
allowed to turn 20,000 euros into ready cash. The other 80,000
has to be rolled over.
This is a big problem, because many of the importers
Aphrodite Autos deals with now don’t trust the banking system
and insist on being paid in newly-scarce cash. Payments by
cheque take five days to settle if they involve two different
banks. Meanwhile, companies and individuals alike are forbidden
to manage this by opening new accounts in other banks.
Quantifying the effect of all this is tough without hard
data, but it’s clear that many healthy firms could end up going
bust. The longer capital controls endure, the more liquidity
crises will hit businesses, according to OEB, a Cypriot
employers and industrialists’ federation. Jittery consumers
prefer to wait and demand has fallen off a cliff, according to a
senior Cypriot businessman.
The Cypriot central bank could try to take one step out of
the morass by taking Bank of Cyprus out of resolution. There are
signs of progress: the Cypriot ministry of finance is planning
to appoint a new management team and reconnect BoC to cheaper
conventional eurosystem funding within days, according to a
person familiar with the situation. And central bank data imply
that the new BoC could end up with a core Tier 1 ratio of well
over 15 percent if 60 percent of its uninsured deposits are
bailed in. If that is deemed sufficient to withstand future
losses, BoC can unfreeze the other 30 percent of uninsured BoC
That probably won’t happen. The central bank is reluctant to
take BoC out of resolution until an independent third party
values its assets – which could take months. And if capital
controls are relaxed, resentful BoC depositors will withdraw
their funds, and BoC could collapse.
Economists like Marios Zachariadis suggest that Cyprus could
discourage mass withdrawals by slapping a punitive tax on BoC
money leaving the country. The idea is that a one-off charge of,
say, 25 percent could discourage a Cypriot stampede. Rates could
be reduced for those who keep their money in Cyprus longer, or
who bring it back within a predetermined timeframe.
But that looks like replacing one set of capital controls
with another. And deposits might just drain out of BoC into
fellow Cypriot banks. The ECB might agree to supply emergency
liquidity assistance, and the Cypriot central bank could lean on
other domestic banks to lend the money back to BoC on the
interbank market. But both carry big legal or practical risks.
The most likely scenario is that BoC’s uninsured deposits
remain frozen while capital controls are slowly relaxed. Then
Cypriot GDP, which fell over 4 percent year-on-year in the first
quarter, will plummet further. Unless the Troika helps solve
Cyprus’s credit crunch, the 8.7 percent drop in GDP it had
forecast for 2013 will prove far too rosy.
SIGN UP FOR BREAKINGVIEWS EMAIL ALERTS:
- For previous columns by the author, Reuters customers can
click on [HAY/]
(Editing by Pierre Briançon and Katrina Hamlin)
Keywords: BREAKINGVIEWS CYPRUS ECONOMY
(C) Reuters 2012. All rights reserved. Republication or redistribution of
Reuters content, including by caching, framing, or similar means, is
expressly prohibited without the prior written consent of Reuters. Reuters
and the Reuters sphere logo are registered trademarks and trademarks of
the Reuters group of companies around the world.