No, it wasn’t just a bad dream. The tiny island tax haven of Cyprus is still in a crisis that could upset the fabric of the euro zone, and everyone’s still having trouble figuring out what to do about it.
For better or worse, we now have a time frame for resolving this crisis. In a statement released today, the European Central Bank (ECB) said it would continue providing emergency funds to Cyprus’s banks until this upcoming Monday, March 25. “Thereafter, Emergency Liquidity Assistance (ELA) could only be considered if an EU/IMF programme is in place that would ensure the solvency of the concerned banks,” it said.
ELA has been functioning as life support for the Cypriot financial system. This program allows the Central Bank of Cyprus to extend emergency loans to commercial banks that might not be able to remain solvent otherwise. However, this money more or less comes from thin air, and the ECB will only approve of this monetary policy action for so long. So by Monday, Cyprus must figure out how to raise €5.8 billion ($7.5 billion) in order to win a €10 billion bailout from the European Union, the IMF, and the ECB—the so-called “troika”—or else face an uncertain future.
The initial plan that the troika advocated wasn’t a great deal. It would have imposed a one-time bank levy on anyone who had an account in Cyprus—6.75% on the first €100,000 and then 9.9% on every dollar past that amount. Cyprus’s government rejected that.
Today, the speaker of the Cypriot parliament, Yiannakis Omirou, also made clear that a plan to increase the levy on deposits exceeding €100,000—many of them held by Russians—was off the table. The government said it was considering some kind of bundling of government assets in a “solidarity fund” in order to issue emergency bonds. The details on this remain fuzzy.
That’s leading many to believe Cyprus’s best bet may be relying on Russia. Since close to 29% of deposits in the Cypriot banking system probably come from Russians and Eastern Europeans, and since the €5.8 billion Cyprus needs to raise would be a drop in the bucket for the northern giant, many are becoming hopeful that Vladimir Putin and his government will come to Cyprus’s aid.
Morgan Stanley economists Jacob Nell and Alina Slyusarchuk suggest that Russia could once again provide Cyprus with a special loan: “It might be possible for part of this loan to be convertible over time to equity in Cypriot assets, such as privatised state assets and hydrocarbon rights. There are precedents in Belarus and Ukraine for similar deals involving Russia.”
The worst case scenario remains that Cyprus will not be able to raise the funds, and so default and leave the euro. Reuters reports that a Cyprus exit is actively being considered by euro area finance ministers and US Treasury officials.
Whatever happens, euro zone policymakers haven’t exactly done a good job at figuring this out. Morgan Stanley analyst Paolo Batori writes:
European officials have repeatedly declared that the Greek PSI was ‘unique’. The same actors have proposed another ‘unique’ solution for Cyprus: a levy on deposits. Our question is: Why should the Troika be concerned about another debt restructuring in Europe, when it has already decided to touch a much more sensitive nerve of the financial system (i.e., deposits)?