Cypriot Debt Will Not Be Sustainable in 2020

Cyprus Budget Deficits

Cypriots stunned by forced savings cuts | Reuters.

Savers bear brunt of unprecedented Cyprus bailout | Reuters.

Cyprus Bank Deposits to Be Taxed in $13 Billion Bailout – Bloomberg.

Factbox: Outlines of Cyprus’ bailout by the euro zone | Reuters.

The Cypriots and troika are calling the loss of depositors’ funds a tax, but this term is hiding what has happened in Cyprus.  For the first time in the euro crisis, banks have failed and depositors and junior bondholders are taking the hit.  Note that senior bondholders, mostly large European institutions, are exempt from these haircuts.

The tax has sparked a bank run in Cyprus, but it will not do the runners much good.  The tax has already been frozen in Cypriot bank accounts.  This was no accident.

The troika meeting where these issues were decided started one hour after American markets closed for the weekend.  In the wee hours of the morning, the troika moved like thieves in the night creating and implementing the bank levy so that the news would be fully digested by the time markets began opening again in Asia on Sunday night.

Despite taking this unprecedented step, the bailout is standard troika issue.  Privatizations, austerity and fantastic projections of future economic growth and herculean budgetary discipline form the core of the plan:

  1. Depositor Levy raises €5.8bn
  2. €10bn troika loan, equal to over 50%  of Cypriot GDP.
  3. Russia will extend the repayment of the €2.5bn loan for five years to 2021 and lower interest rate from 4.5%.
  4. Cyprus corporate tax rate raised 25% to 12.5%, which may raise €200mm per year.
  5. Privatize telecoms, electricity and ports.
  6. Downsize Cypriot banking sector by more than half.

The IMF has passed on the sustainability of the current bailout.  Under the old one being floated in the media for the last two months, depositors would have been made whole, but Cyprus would have taken on €17bn in new debt.

Determined not to allow Cyprus to become another Greece, the IMF insisted on a sustainable plan involving less debt.  This meant either more direct aid to replace loans, or finding another €7bn or so for the bailout.  With German elections approaching in the fall, direct aid was out of the question and the depositor tax became the answer.

This bailout raises two questions.  Will Cyprus’ bank run spread to the periphery? It should, but I believe that it will not.  Any depositor in the periphery must understand that if its country requires a bailout, not one euro in either country is safe.  However, time has shown that the periphery has a great deal of faith in the current system.  There may be some people withdrawing money Monday morning, but the run will quickly dissipate.  It will be back to business as usual fairly quickly.

The other question this bailout begs is whether or not Cyprus will have a sustainable debt load of 100% by 2020.  I delved into the numbers and can safely predict that it will not. Once again, the troika is making unrealistic projections of GDP growth  and budget savings.

Cyprus is in the midst of a Greek and Spanish style austerity depression and showing no signs that it will return to growth.  The island’s main industry is banking, and it is supposed to reduce its banking sector from 8 times GDP to 3.5 times GDP by 2018.  Cyprus will take a double hit on growth because the banks will be reducing both their employment and the loans originated to the rest of the economy.  During this massive deleveraging, the Cypriot economy will be lucky to remain stagnant let alone grow.

Despite this fact, I am using an average 2% annual growth rate for purposes of this analysis.  Cypriot GDP is currently €18bn with current government debt at €12.8bn (71.1% of GDP).  If the economy grows at an average rate of 2% per year starting today, the country will still have a debt to GDP ratio of 110% in 2020 assuming a balanced budget every year.  This means that the Cypriot government will need to run approximate annual budget surpluses of 1.5% a year until 2020 in order to have a debt load of 100% of GDP.

If growth is only 1% per year, then the ratio will be 118% in 2020 assuming a perfectly balanced budget for seven years.  Since the crisis began in 2009, show me one afflicted country that has been able to maintain both a balanced budget and a 1% growth rate.There isn’t one, and, more importantly, there will not be one because of the multiplier effect.

Since 100% is the number being bandied about, we know that wildly optimistic forecasts are being used to make it appear that this bailout will lead to sustainability.  This number is obviously a placeholder with the Cypriot can being kicked down the road.

This tactic is typical of German crisis fighting.  Do as little as possible to maintain the status quo while allowing the problem to continue to fester.

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4 thoughts on “Cypriot Debt Will Not Be Sustainable in 2020

  1. Pingback: The Cyprus Bailout Disaster | Floating Path

  2. There should be a bit of a run on most EU banks.

    As Mish reports, Spain is likely to be next.

    I do believe I reported a few times

    cyprus is key

    heres another article for ya

    http://www.nytimes.com/2013/03/17/business/global/facing-bailout-tax-cypriots-try-to-get-cash-out-of-banks.html?_r=2&

    I add on they did it “at the beginning of a three-day religious holiday on the island.”
    nice.

    and relating to greece

    http://www.ekathimerini.com/4dcgi/_w_articles_wsite2_1_16/03/2013_488205
    .

    • .

      http://www.ekathimerini.com/4dcgi/_w_articles_wsite1_1_17/03/2013_488241

      Here is Anastasiades’s statement in full:

      It is well known that the deep economic crisis and the state of emergency in which the country has found itself did not come about in the last fortnight since we have undertaken the administration of the country.

      The state of emergency and critical nature of the times do not allow me, as they do not allow anyone, to embark on a blame game.

      In the extraordinary meeting of the Eurogroup, we faced decisions that had already been taken and came across faits accomplis through which we were faced with the following dilemmas:

      On Tuesday, March 19 we would either choose the catastrophic scenario of disorderly bankruptcy or the scenario of a painful but controlled management of the crisis, which would put a definitive end to the uncertainty and restart our economy.

      A possible choice of the catastrophic scenario option would have the following consequences:

      1. On Tuesday, March 19, immediately after the holiday weekend, one of the two banks in crisis would cease to operate, since the European Central Bank, following the decision already taken, would terminate the provision of liquidity. The second bank would suspend its work, and neither could avoid collapse. Such a phenomenon would instantly lead 8.000 families to unemployment.

      2. The State would be obliged to compensate depositors in response to the obligation regarding guaranteed deposits. The capital required in such a case would amount to about 30 billion euros, which the State would be unable to pay.

      3. A proportionate amount corresponding to the deposits of thousands of depositors for deposits over 100.000 Euro, would be led to a vicious cycle of asset liquidation, and these depositors would suffer losses of over 60%.

      4. Such an uncontrolled situation would push the whole banking system into collapse with all the attendant consequences.

      5. Thousands of small and medium enterprises, and other businesses would be driven to bankruptcy due to their inability to trade.

      As a result of the above, the service sector would be led to a complete collapse with a possible exit from the euro. That, in addition to the national weakening of Cyprus, would lead to devaluation of the currency by at least 40%.

      The second choice was the controlled management of the crisis, through the decisions taken and which can be summarized as follows:

      1. Ensuring the liquidity of the banks and the rescue of the banking system through their recapitalization.

      2. Rescuing 8.000 jobs in the banking sector and thousands of others which would be lost as a corollary of not maintaining the operations of banks.

      3. Total rescuing of deposits, with just the exchange of a small percentage of savings with shares of the two banks. Currently, these shares do not have their full value, but with the economic recovery they will repay most it not all of the amount that will be cut.

      4. This option results in a drastic reduction of public debt, makes it manageable and sustainable and relieves future generations from the burden of repayment.

      5. It saves provident and pension funds and avoids taking other tough measures such as wage and pension cuts that were put on the negotiations table.

      6. It avoids further recession and the risk of the vicious circle of a second memorandum.

      We are not aiming to gloss over the situation. The solution chosen may be painful, but it was the only one that would allow us to continue our lives without adventures. It’s a decision that leads to the historic and permanent rescue our economy.

      In the next few hours we will all have to take responsibility. Tomorrow I will address the Cypriot people.

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