What if Cyprus said no?
What if the small island-nation decided to repudiate the terms of the 10 billion-euro ($12.8 billion) bailout handed down by European leaders on Monday, bid “auf Wiedersehen” to the euro and the 16 other countries that share it, and become a free agent? What if, as British member of the European Parliament Daniel Hannan wrote in the Telegraph this week, “Cyprus were to default, decouple, devalue — and then prosper? What effect would a successful return to the Cyprus Pound have on the rest of the euro zone?”
Little, if any, in the short run. Cyprus accounts for less than 0.2 percent of euro-zone gross domestic product. It could be cut loose without any macroeconomic impact. European savers were unfazed by the initial rescue package’s proposed tax on insured bank deposits: Bank runs in other countries never materialized. Even the financial-market reaction to the Cypriot parliament’s March 19 rejection of that plan turned out to be a non-event. Perhaps officials in Brussels saw the response as a sign that Cyprus could be treated differently without any adverse consequences.
Over the longer term, an escape by Cyprus would signal the beginning of the end of a dream that was decades in the making: a United States of Europe. Other uncompetitive countries would see exiting as a viable option, a way of unshackling their economies from the chains of a single currency and policies more suited to, and determined by, the northern countries. (Although the Maastricht Treaty provides no mechanism for leaving the euro, a country’s refusal to comply with bailout terms would probably be a de facto deal-breaker.)
The effect on Cyprus would be just the opposite: a disaster in the short run, as Cypriot banks collapsed, taking the economy down with them. In the long run, Cyprus would become more competitive through a devalued currency rather than by a decline in wages. So who could blame Cypriots for wanting their freedom?
The rescue package agreed to early this week in Brussels is certainly better than the first go-round. In fact, it’s in line with normal resolution procedures for insolvent institutions. Cyprus Popular Bank Pcl, the country’s second-largest bank, will be liquidated, with shareholders and bondholders taking the hit. Uninsured depositors could suffer a loss of up to 40 percent. Bank of Cyprus Pcl, the largest financial institution, will be recapitalized by converting uninsured deposits to equity shares to achieve a capital ratio of 9 percent, according to a Eurogroup statement. Insured depositors at both banks will be fully protected.
So a better plan, yes, despite the haphazard execution and perilous message it sends to European bank creditors and depositors, including small savers supposedly covered by deposit insurance. It’s also unique in the context of earlier euro-zone bailouts, the cost of which was largely borne by taxpayers.
Consider, for example, the decision to spare depositors in Greek branches of Cyprus Popular, whose troubles started with the 50 percent “haircut” it was forced to take on its large portfolio of Greek government debt, a condition of that country’s bailout. Piraeus Bank SA agreed to buy Cyprus Popular’s Greek branches, with half of the financing provided by the Cyprus bailout.
The goal is to shield the Greek banking system from Cyprus’s crisis and prevent a mass deposit exodus. (Contagion would only create additional problems for German Chancellor Angela Merkel in advance of September’s parliamentary election.) Cypriot banks are to remain shut at least until today and will be subject to capital controls once they open.