Republic
of Cyprus is an island (or rather half an island) country in the
Eastern Mediterranean Sea, east of Greece and south of Turkey. It is
the third largest island in the Mediterranean Sea, and a member state
of the European Union. Half of the island of Cyprus is controlled by
Turkey. Until now, Cyprus was considered an affluent
country with its per capita GDP (adjusted for purchasing power) at
$28,381, just above the average of the European Union. Cyprus was
found to be an attractive base for several offshore businesses for
its highly developed infrastructure. It's 14 Billion Euro economy
depends upon tourism, financial services, and shipping. On 1st
of January 2008, Cyprus adopted the euro as the national currency. In
recent years significant quantities of offshore natural gas have been
discovered in the area known as Aphrodite in Cyprus' exclusive
economic zone.
Since
1974 invasion by Turkish forces, which split the island in two,
Cyprus is facing its worst crisis today. It all started when Cyprus
joined the European union in 2008. Wealthy Russians and Britons found
Cyprus' business model as an offshore financial centre extremely
attractive and huge sums were deposited in bank accounts from abroad.
Russian citizens and companies have billions of euros at stake in
Cypriot banks. Cyprus's banking sector, now has assets eight times
the size of its economy.
The
Cyprus banks hold 68 billion euros in deposits, including 38 billion
in accounts of more than 100,000 euros, astronomical amount of money
for an island of 1.1 million people, which could never sustain such a
big financial system on its own. Flush with funds, Cyprus banks
invested the money in Greek bonds, where the return expected was
good. However, when Greek economy collapsed last year, a bailout
package given by European central banks stipulated a 75 percent
"haircut" (or just give up the money) for the private bond
holders. The money invested by Cyprus banks and in particular by the
Popular Bank of Cyprus CPBC.CY, also known as Laiki, just
evaporated.
French
Finance Minister Pierre Moscovici says that the island's offshore
business model has failed and adds; "To all those who say
that we are strangling an entire people ... Cyprus is a casino
economy that was on the brink of bankruptcy."
The
situation has become so grave now that the cash-strapped island
nation with a total debt or 5.8 Billion Euros to be paid this week,
needs a 10 billion euro bailout ($13 billion) to recapitalize its
ailing banks and keep the government afloat. On March 16, 2013, a
deal was struck under which depositors in Cypriot banks were to be
levied with a one-off tax on their savings to raise the amount of 5.8
Billion Euros. The deal however came off after the Cypriot
parliament rejected the deal struck.
On
25th
March, after a tough round of negotiations, a deal has been struck.
Under the new agreement, deposits below the EU deposit-guarantee
ceiling of 100,000 euros will be all protected, but all deposits
above that amount will have to take losses. Deposits above 100,000
euros, which under EU law are not guaranteed, will be frozen and
would be used to resolve debts, and Laiki Bank will effectively be
shuttered, with thousands of job losses. It is expected that the two
most problematic banks would be restructured and uninsured creditors
(having deposits above 100000 Euros) take a 40% hair cut or watch
their money going up in smoke.
It was
widely expected that there would be run on the banks on 25th
March, as many Russian depositors had threatened to remove their
spoils if they were subjected to any kind of a haircuts. Central
Bank of Cyprus imposed a 100-euros per day limit on withdrawals from
cash machines at the two biggest banks to avert a run.The new capital
controls would make it impossible to move Euros out of Cyprus now.
The
Cyprus collapse is a great lesson for all developing countries
including India. One of the most important lessons is to never let
foreign investments in bank accounts as deposits, where interest
liability immediately starts accruing. Foreign investments must come
into equity markets only. The other important lesson is about the
ratio of foreign investments to the size of the economy. If bank
deposits grow to eight times the size of economy, it is an invitation
for trouble.
Repercussions
and effects of last year's Greek meltdown, it seems, are still
continuing. We need to watch, who is going to be the next?
26th
March 2013
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