Cyprus is still recovering from its banking crisis 100 days ago. Harsh capital controls at the banks are holding back spending which is hurting the economy. This year the Cyprus economy is expected to shrink by more than 9 percent while unemployment is expected to soar.
July 3, 2013
NICOSIA, Cyprus (AP) — It's been just over 100 days since its financial rescue and Cyprus is struggling to cope with life under the terms of its international bailout.
The country's shell-shocked banking system is still reeling from a punishing restructuring while harsh capital controls at the banks are holding back spending. All of which is hitting Cyprus' fragile economy, which is projected to shrink by more than 9 percent this year while unemployment is expected to soar. At the same time, international ratings agencies are warning that the country has defaulted on its debts.
To keep its government going and the country's financial sector from imploding, Cyprus in March negotiated a 23 billion euro ($30 billion) financial rescue package with its euro partners and the International Monetary Fund. In order to receive a 10 billion euro ($13 billion) bailout loan, Cyprus had to raise the remaining 13 billion euros ($17 billion). To do that, it had break up its second-largest bank, Laiki, and impose heavy losses on depositors with over 100,000 euros sitting in it and the largest lender, the Bank of Cyprus.
Further sapping trust in Cyprus' banking system are the strict restrictions on money withdrawals and transfers that were imposed to prevent a run.
Cyprus' president, finance minister and central bank governor met with European Central Bank President Mario Draghi Wednesday with the aim getting the country's banking system moving again.
Analysts warn an economic rebound won't happen until the country has a healthy banking sector doing what it's supposed to be doing — loaning people money to start businesses, buy homes and invest.
Here is a look at how Cyprus is trying to deal with its biggest problems:
BANKING AND CAPITAL CONTROLS
On top the agenda at the meeting with Draghi were the problems at the country's largest lender, the Bank of Cyprus. The country's president, Nicos Anastasiades, last month warned the country's international creditors that bank's cash reserves were running dangerously low.
This cash crunch arose because, under the terms of the country's bailout, Bank of Cyprus was forced to shoulder billions in debt when it merged with parts of the now defunct Laiki, the country's second largest lender. The debt, amounting to €9 billion ($12 billion) euro, is ECB emergency funding that Laiki had racked up.
Anastasiades has warned that Bank of Cyprus' debt burden is hampering the bank from bolstering its coffers, which in turn is stopping it from obtaining its own emergency cash from the ECB — a problem that could undermine the country's rescue package.
An ECB statement issued after the Cypriot delegation's meeting with Draghi said that both sides agreed that a priority is to wrap up Bank of Cyprus' restructuring soon. The statement said that talks would continue once an assessment of the bank's good and bad assets is completed sometime in the second half of July.
To prevent a run on the country's banks after the terms of the bailout were revealed, Cyprus authorities imposed in March a series of harsh capital controls, such as a daily cash withdrawal limit of 300 euros and a ban on opening new accounts. There is no end in sight for these controls. The authorities say they will remain in place until trust is restored in the banking sector and the risk of a mass deposit flight has sufficiently subsided.
But even with capital controls in place, banks have lost some 7.8 billion euros in deposits since the March bailout agreement, according to Cyprus Central Bank figures. These outflows are mainly due to ordinary business activity — the rules do allow payments abroad, while foreign banks doing business in Cyprus are control-free. While money is going out of the country, not much is coming back in. Deposits stood at 55.9 billion euros at the end of May, a far cry from the 72.4 billion — much of it from Russian and other foreign investors — in May of last year.
The controls are a key obstacle to stimulating a moribund economy, analysts say. Property sales have slumped precipitously because banks aren't loaning money, while the cash crunch has seen the country's small and medium-sized business sector shrink by about 30 percent, says Cyprus Chamber of Commerce and Industry General Secretary Marios Tsiakkis.
Economist Theodore Panayotou, director of the Cyprus International Institute of Management (CIIM) and a former Harvard professor, argues that lifting the controls as soon as possible is the best option in order get money injected back into the economy again.
"There's no good time to remove restrictions," says Panayotou.
Cyprus on Monday announced that it successfully completed a swap of 1 billion euros worth of government bonds held by local investors with longer-term ones. The swap allowed the government to avoid paying what it owes on the bonds that mature over the next three years.
A Cyprus finance ministry statement said the deal, which it agreed with its international rescue creditors, won't add to the country's overall debt burden. The European Commission and the IMF welcomed the move.
However, international credit agencies said the move meant the country had defaulted on part of its debt. Standard & Poor's downgraded Cyprus to "selective default" — short of a straight default which would mean that the country was not meeting any of its obligations. Moody's — which doesn't use either a "default" of "selective default" — said that it considered the country to have defaulted.
Cyprus government spokesman Christos Stylianides played down the S&P downgrade as a "technical matter."
Panayotou said that the downgrades and warnings have no real bearing on the Cypriot economy, since the country — already rated in the lowest levels of "junk" status — is unable to borrow from the international markets. The only tangible effect is that the ECB has stopped accepting Cypriot bonds as collateral for loans to banks. But that is only seen as a temporary as credit ratings agencies are expected to lift Cyprus out of default in due course.
Panayotou said the real impact of the downgrades is its psychological effect, indicating that the country has hit "near bottom" in financial terms.
With the banking sector still in flux, the country's economy remains in a virtual limbo.
Foreign investors are holding back from putting their money in Cyprus while Cypriots have steeply curtailed their spending amid the uncertainty over the banks. This has piled even more pressure on already hard-hit retailers. Property sales reportedly dropped by more than 50 percent in June over a year ago, compounding a 75 percent year-on-year plunge in May.
Finance Minister Georgiades has warned that the country's gross domestic product could shrink deeper than the forecast 8.7 percent this year. Meanwhile, the country's unemployment rate is 16.3 percent and expected to head higher.
However, officials from Anastasiades on down have repeatedly stressed the government's commitment to sticking to the bailout's terms, saying it's the only way out of the country's dire financial straits. Further cuts to the public sector payroll haven't been ruled out.
However, Marios Tsiakkis, the Cyprus Chamber Commerce and Industry general secretary says it's not all gloom for the economy. Tsiakkis says the tourism and shipping sectors remain strong, while the economy remains competitive on in the services sector with high-quality legal, accounting and banking services that could still attract foreign business.
The country is also pinning hopes on its recently discovered offshore natural gas reserves. However, these won't generate any income for at least several more years.
Association of Cyprus Banks Director Michael Kammas said: "The uncertainty must end and for that to happen, things have to move much faster than before."
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