Overnight, the Eurozone and Cyprus took the unprecedented step of announcing a tax on depositors in order to raise the necessary funds to recapitalise Cypriot banks and reduce the cost of a bailout. Have no doubt, this is a very radical measure and one that, admittedly, we did not believe would happen for just that reason.
Here are the details of the plan:
One-time 9.9% levy on deposits over €100,000
6.75% levy on deposits below that level
Cypriots hit by the deposit levy will be given bank shares of equal value
Increase in corporate tax rate to 12.5% (from 10%)
€1.4bn in privatisations
€10bn bailout loan (likely including the IMF)
Cypriot debt to GDP to be at 100% in 2020
The seizure of deposits will happen over the weekend, while there is conveniently a bank holiday on Monday in Cyprus. Depositors will be unable to move funds, even electronically, before the move is complete on Tuesday (more on this further down). As we said, this is clearly an unprecedented move and the fallout will be interesting, below we list the key points to watch as this progresses.
This will hit normal Cypriot taxpayers hard: Perhaps the most surprising (and worrying) point of the deal is that even those with deposits below €100,000 will be hit. Cypriots will receive bank shares in return but surely after this move they will decline in value quickly and are no comparison to a deposit in terms of risk and liquidity.
Banks and funds have escaped somewhat: With all the focus being on ‘illicit’ Russian deposits it seems that the usual steps of bailing in bank creditors and sovereign creditors have been skipped, this will make the point above even more painful. As we noted in our analysis yesterday, writing down bank creditors or sovereign creditors would be tricky and yield little monetary benefit. However, it is still strange that when taking a step as radical as this the Eurozone did not force some losses on banks and those holding sovereign debt, even as a gesture to the taxpayers who are now footing the bill. The fallout of this politically could be serious (see next point).
The Cypriot government position looks almost untenable: During the recent election campaign and the start of the negotiations the new Cypriot government flat out rejected a deposit tax, even just on foreign depositors. It has now rolled over and accepted one on domestic depositors as well. Surely, it cannot last out its 5 year term. It is not yet clear whether new elections could be on the cards, but the potential for civil unrest is significant – not only is the Cypriot population footing much of the bill but since there is still a Eurozone loan they will also likely face austerity conditions.
Germany put its foot down: By many accounts, Germany entered the negotiations with a radical stance, arguing from the start for a large hit to depositors. It is clear that, with elections looming, the German government is no longer willing to simply foot the bill to avoid contagion. This could be a very important turning point for the Eurozone crisis.
Does this move break EU rules on capital controls and/or deposit guarantees? As noted above, it seems that depositors will be blocked from withdrawing their funds from banks. For other EU depositors this surely amounts to a form of capital control – strictly forbidden under the EU Treaty. Furthermore, as Sharon Bowles MEP has been tweeting, this move makes a mockery of the current EU rules on deposit guarantees below €100,000. The Eurozone may protest that the bank shares given in exchange are of the same value, but this is a very thin argument. Either of these issues could be challenged at the European Court of Justice.
It seems some lessons of Greece et al. have been learnt: As our flash analysis yesterday showed, our main concern with Cyprus was that the Eurozone has failed to learn lessons from its experience in Greece et al. Clearly, the need to put debt back on a sustainable footing has been realised – although 100% debt to GDP in 2020 is still not entirely sustainable, we will wait for more details before passing final judgement on this.
Contagion could be significant: The Eurozone is arguing that Cyprus is a one-off – sound familiar? This is unlikely to hold. The on-going backstop of the ECB OMT will help, as will the fact that the bailout countries already have funding secured. That said, with many of their debt levels still do looking unsustainable ,it is very possible that depositors could become increasingly skittish.
Such a radical move was necessary because the Eurozone lacked more precise tools: Cyprus is a cut and dried case of where a bank resolution fund would have solved most of the problems. The fund could have bailed out the banks directly and restructured the financial sector without burdening the state or depositors. The state’s funding gap could have been covered by privatisations and tax increases, and possibly a very small international loan. It should not be lost on the Eurozone or anyone else, that this situation partly arose due to complacency and a failure on the part of Eurozone leaders to move swiftly to correct the structural flaws in the Eurozone.
This decision is ultimately a very mixed bag. On the one hand the Eurozone has taken a radical step to try and put debt on sustainable footing rather than just proceeding with a massive taxpayer funded bailout (although it must be remembered Cyprus is still getting a bailout worth almost 60% of GDP). That said, the decision to force the losses on all depositors is a radical and politically explosive one. The fact that losses were not enforced all round, on banks and funds, leaves a bad taste in the mouth. On a wider scale, the fact that Germany is no longer willing to provide bailouts at any cost must mark a big change in the crisis. With Italy and Spain still mired in political and economic problems this point will surely be in the back of their minds from now on. Can German approval of access to the ESM and OMT be taken for granted anymore? It may be that Cyprus is small enough to be a special case, but that cannot be a given.
In terms of forcing a change in the Eurozone crisis it seems that Cyprus may be the straw that broke the camel’s back.