Its bail-out may keep Cyprus in the single currency, but at a high cost
DREAD was mixed with anger. Cypriots feared that deposits in the two largest banks, Bank of Cyprus and Laiki Bank, might be taxed or converted into worthless equity—and worried about the economic effects. The glum mood in the shops and cafés of Nicosia was little improved when the terms of their country’s €10 billion ($13 billion) bail-out emerged on March 25th. The deal will close Laiki Bank, restructure Bank of Cyprus and impose big losses in both institutions on deposits above €100,000.
Many anxious Cypriots queued patiently to draw cash out of ATMs. Others protested angrily in the streets, waved Russian flags and talked about leaving the euro. They had hoped that joining the European Union (in 2004) and the euro (in 2008) meant solidarity from their fellows. The troubles of the two banks were caused, some believe, by a decision to buy Greek government bonds that were then restructured. They feel they are being punished by the EU for no fault of their own.
Victimhood is hardly new in Cyprus: the island’s troubles are routinely blamed on outsiders like Turkey, Greece, Britain or (now) Russia. What stuck in the craw was being told that the Cypriot business model had to change. Not all agree: speaking at a conference organised by The Economist in Nicosia on March 22nd, Chris Pissarides, a Nobel-prize-winning economist, argued that relying on business services and tourism in an economy with no manufacturing tradition was quite sensible.
The bail-out will inevitably force change. Capital controls may slow deposit flight, but after the threats of taxes, levies and now the conversion of large deposits into equity, foreign (especially Russian) money will very likely go elsewhere. Worse, the crash will shrink the economy. Fiona Mullen of Sapienta Economics, a local consultancy, notes that in 1974, when Turkey invaded the north after a Greek-Cypriot government tried to unite with Greece, GDP fell by 17% in that year and by 19% in 1975. Although the IMF talks optimistically of a fall of only 10% this time, she predicts falls of 15% this year and another 5% in 2014. This will have horrific effects. After the collapse of Laiki, unemployment is heading for 17% this year, says Ms Mullen; it could exceed 25% in 2014.
Cyprus cannot hope for more EU help. The past two weeks have annoyed creditors as much as Cypriots. Most Europeans were cross that the (Greek-Cypriot) republic happily joined the EU in May 2004 despite a week earlier voting down the United Nations’ Annan plan to reunify the island (the Turkish Cypriots voted in favour). Cyprus’s relations with Russia, the source of one-third of its bank deposits, have long irked many EU countries. So did the behaviour of Demetris Christofias, the president, a Communist who, despite asking for a bail-out last June, kept looking to Russia for help.
Cyprus’s creditors felt they had to wait for a new centre-right president, Nicos Anastasiades, before doing a deal. Now Mr Anastasiades is saddled with the blame and the task of revitalising a moribund economy. Yet a bold president, elected with a large majority last month, ought to have some leeway. The public sector needs reform and cutting back. As Phidias Pilides, president of the Cyprus chamber of commerce, pointed out, public spending gobbles up 46% of GDP and public-sector employment has almost doubled since 1990.
Much could be privatised, including Cyprus Airways, the electricity authority, the telecoms utility (one of only four in Europe still in public ownership) and ports. Competitiveness needs attention: Cyprus comes 36th in the World Bank “Doing Business” rankings and 58th in the World Economic Forum’s competitiveness table.
Cyprus has advantages. A well-educated workforce, lots of accountants and lawyers, a largely uncorrupt bureaucracy and the English legal system should help non-financial business services. Cyprus has bounced back before. For instance, in July 2011 an explosion destroyed the main Vasilikos power station, which was repaired faster and more cheaply than expected.
Above all, two prizes could be had. One is recent gas finds in the eastern Mediterranean. A resource bonanza is some way off as the cost of getting the gas out and exporting it would be huge. But what would make a huge difference is the second prize: a Cyprus settlement that reunified the island. Ms Mullen says that laying a gas pipeline from Cyprus to Turkey would be $15 billion cheaper than the $20 billion alternative of building a liquefied natural-gas plant. Reunification would also boost Cyprus’s GDP by some 3% a year, she reckons.
Could Mr Anastasiades do it after so many have failed? The political obstacles are large; Mr Christofias got nowhere. Yet unlike his predecessors Mr Anastasiades voted for the Annan plan in 2004. And a desire to exploit the Mediterranean gas, which is also claimed by the Turkish-Cypriots, makes a settlement far more pressing. Turkey has just mended its fences with Israel, which shares some of the gasfield. Relations with the EU are also improving.
Next year sees the 40th anniversary of the island’s division. Young people on either side of the “green line” have no memory of a united Cyprus, so a settlement is not getting any easier. Yet if Mr Anastasiades misses this opportunity, the island may be mired in economic gloom for decades to come. Inept handling of the EU bail-out may have weakened his chances. Even so, he needs to try.