Beware of German Gifts Near Their Elections: How Cyprus Got Here and Why it is Currently More Out than in the Eurozone

Abstract

Key points:

• The situation in Cyprus arose due to banking overreach, insufficient regulation, excessive government deficits, poor debt management and collateral damage from previous Eurogroup bailouts.

• The amount needed is small in absolute values, but large relative to the size of the economy. The Troika was unwilling to fund more than 10bn Euros.

• Extreme delay from the departing Christofias government and persistence from the Troika led to the bailing-in depositors to cover the gap. An attempt to spread the pain by suggesting a “shares-for-deposits swap” for all Cypriot depositors, (bailing-in even insured depositors) was defeated in the Cypriot parliament.

• In subsequent negotiations, insured depositors were unharmed: uninsured depositors in the largest two Systemically Important Financial Institutions, Laiki Bank and Bank of Cyprus were affected.

• Local debt default and forced rollover are part of the bailout, but as it currently stands, holders of external debt are to be paid in full. The exception is the Russian Federal Republic: the Troika has demanded that Cyprus negotiate a restructuring of that direct government loan.

• As a result of the above actions, Cyprus is left facing an unprecedented economic depression; the link between weak financial institutions and a weak state has not been broken, making a second bailout very likely.

• Cyprus has capital controls, deteriorating financial situation and needs to defend itself against local and domestic lawsuits that might overturn decisions. Cyprus is still dangling precariously from the Euro exit cliff.

Keywords: Cyprus, Eurozone, Debt Crisis, Eurogroup, Bank of Cyprus, Laiki Bank

JEL Classification: P52, P17, O52