22 Mar 2013

Cyprus bailout – the key questions

As the banking crisis in Cyprus continues, what comes next? And what has happened to other EU countries that have been bailed out?

As the crisis in Cyprus continues, what comes next and what has happened to other EU countries that have been bailed out? (Getty)

Cyprus is under pressure from the European Union (EU) and International Monetary Fund (IMF) to come up with a plan to raise almost 6bn euros as the price of a 10bn euro bailout to prop up its banking sector.

After the Cypriot parliament ditched proposals for a levy on people’s bank deposits, the European Central Bank (ECB) has given the island nation until Monday to put together a convincing financial package – or risk having its emergency funding cut off.

This could lead to default, the collapse of the country’s banking sector and ultimately its exit from the euro, a fate neighbouring Greece has so far avoided.

How could Cyprus raise the money?

Cypriot politicians are considering a range of options. The bank levy idea is still alive, as part of a solution, but would now only apply to deposits of over 100,000 euros.

Cyprus has also turned to Russia for help, with Moscow concerned that its citizens living on the island would be hit by a bank levy.

Nicosia has dangled its offshore gas reserves in front of the Russians, despite Turkish concern, but they have not responded with any enthusiasm.

Cyprus is drawing up plans for a “solidarity fund”, which would raise cash by issuing bonds – in other words, borrowing money.

Help would come from privatising the state pension fund, an idea rejected by Germany, restructuring the banks, and accepting money from the Orthodox church.

The Cypriot parliament has the final say in a vote.

What if Cyprus does not find a solution?

The ECB has said emergency funding can only continue “if an EU/IMF programme is in place that would ensure the solvency of the concerned banks”. It has given Cyprus until Monday to find a solution.

Without this, it is not inevitable that the ECB would throw Cyprus to the wolves. There has to be a two-thirds majority at the ECB’s governing council before such drastic action is taken – and it is not clear if hawkish eurozone members would get their way.

The eurozone has pulled back from the brink. But there’s still a long-term economic malaise and it’s not clear where growth will come from. Raoul Ruparel, open europe

But assuming the ECB carried out its threat, Cyprus banks would become insolvent. Cyprus could remain in the euro, but without help from the EU and IMF, an exit from the single currency could become a reality.

How serious would a euro exit be for other EU countries?

A Cypriot exit from the euro should be containable because of its small size. Fears of “contagion” are not causing alarm on the international markets.

But Cyprus would become the first EU country to leave the euro, a scenario no-one imagined when the single currency was created.

As such, there is no mechanism for an exit to take place. A Cypriot exit would create a mechanism, setting a precedent for other EU countries struggling to keep up with the eurozone’s strongest economies.

How many other countries have received bailouts?

Stung by borrowing costs it could not afford, Ireland was the first country to be bailed out by the EU and IMF. Portugal, Greece and Spain followed suit.

In Spain, it was the banking sector that received support, which is what is being proposed for Cyprus.

How have these countries fared economically?

Ireland is generally thought to have coped well since it received its bailout. There is growth and labour costs are down, but unemployment is high.

Raoul Ruparel, head of economic research at the open europe think tank, told Channel 4 News: “It has definitely fared better than the other countries.”

In contrast, Greece and Portugal are “stagnant economies”, with the former struggling to cope with a deep recession and youth unemployment of 60 per cent.

“There is only so long you can have a large proportion of your workforce unemployed before it starts to impact on the long-term performance of the economy,” said Mr Ruparel.

Portugal is mired in low growth and also has an unemployment problem, but is proving successful at rebalancing its economy in favour of exports.

Spain’s bailout was designed to release funds to strengthen the country’s banks. It is in the midst of this recapitalisation at the moment, but “there has been a huge increase in unemployment and economic growrh isn’t good”.

Looking at the eurozone as a whole, Mr Ruparel said it had “moved from an acute crisis to a chronic one”.

He added: “The eurozone has pulled back from the brink and an exit is not on the cards like it used to be. But there’s still a long-term economic malaise and it’s not clear where growth will come from in the near future.”

How is this crisis likely to end?

The word crisis should not be over-used, but there is no doubt that this is the right way to describe what has happened to the eurozone in recent years.

The financial difficulties experienced by Greece, Spain and Italy were – and are – deadly serious, for these countries and the eurozone as a whole.

It is not fanciful to imagine a single currency without these nations, or the end of the single currency. But so far Greece, with help from its friends, has managed to pull itself bank from the brink.

In an election in May 2012, voters rejected austerity, threatening the country’s bailout deal with its lenders. The following month, they went back to the polls and gave their support to parties committed to this bailout deal.

In Italy in 2011, with the country’s borrowing costs soaring, Silvio Berlusconi resigned and was replaced by the technocratic “‘safe pair of hands”, Mario Monti.

Crisis over or simply postponed? In February, Italian voters gave their verdict on the financially orthodox policies pursued by Mr Monti by failing to elect a majority government while rewarding the anti-austerity Five Star Movement leader Beppe Grillo.

One month on and a new government has still not been formed.

At the eleventh hour, whenever that time comes, recent history suggests Cyprus is likely to come up with a solution that satisfies its lenders and keeps the wolves at bay.

How long this calm lasts is impossible to predict. The fact that Greece is still in the euro, despite predictions that it was destined to leave many months ago, does not mean this scenario will never come to pass.

The doomsayers could be proved right in the end. But so could the optimists.