What Does A 'No' Vote Mean For Cyprus And The Eurozone?
19
March, 2013
All at sea – what does the 'No' vote mean for Cyprus and the eurozone?
The
Cypriot parliament tonight voted against a bill to introduce a tax on
bank deposits, in return for a €10bn bailout offered to the country
by Germany and other eurozone governments. Not a single Cypriot MP
voted for the deal. The structure of the tax in the bill is shown in
the table below. The vote leaves Cyprus’ place in the eurozone
hanging in the balance and threatens the escalation of the crisis to
a new level, though the most likely outcome is that the Cypriot
parliament votes a second time, on a revised deal.
Results
of the vote
The
governing party (DISY) abstained (with one member absent), while the
junior coalition partner (DIKO) voted against – this signifies the
huge political divisions at work in Cyprus. Even if a bailout deal is
eventually approved the government’s position continues to look
untenable.
What
does the vote against the deposit levy mean?
As
we have noted before,
this has the potential to be a very serious twist in the eurozone
crisis. Previously, Germany and the eurozone have stressed that
Cyprus has no alternatives to the deposit levy. Now, all eurozone
partners are forced back into difficult negotiations.
What
timeline are Cyprus and the eurozone working on?
Cyprus
will run out of cash on 3 June, when it has to repay a €1.4bn
international bond. However, the decision will need to be taken long
before that. Cypriot banks cannot stay closed for long but they
cannot be reopened until a decision is taken, otherwise there will
almost certainly be a deposit run. While people can reportedly
withdraw up to €700 per day from ATMs, businesses, large and small,
cannot function without banks being open. We would expect some
decision would need to be taken by early next week before the lack of
liquidity and lack of economic activity begins to severely harm the
Cypriot economy.
What
are the possible outcomes?
Both
sides have some serious decisions to make. Below we outline the
potential scenarios (as
highlighted here):
1.
Cyprus votes again and approves a revised tax: The
governing party pushed for the vote to be delayed and hence
abstained. This may be seen as delegitimising the result, not least
because they hold 36% of the seats in the Cypriot parliament. The
deal could see a few small tweaks along with some additional cash
(either from the eurozone or Russia – see below), which would then
be put to another vote in parliament – after all, being asked to
vote twice is a common practice in the EU. But such a decision and
vote must come quickly. In addition to running out of government
cash, banks would have to remain closed during the interim period,
meaning businesses and the wider economy could not practically
function. The vote would therefore have to take place by the start of
next week to avoid another escalation of the crisis. In our view,
this remains the most likely option (possibly in combination with
part of option 2).
2.
The eurozone blinks: With
the possibility of a country exiting the eurozone becoming very real
and the “irreversibility” of the single currency coming under
direct threat the eurozone may present Cyprus with a more palatable
deal. After all the cash in question – €5.8bn – is only 0.06%
of eurozone GDP. The real issue will be how to provide this cash
while keeping Cypriot debt sustainable.
Options
include:
- providing the full €17bn loan but with very long maturity and low rates;
- linking the repayment of the loan to future gas revenues;
- using the ESM or another vehicle to recapitalise banks directly;
- restructuring domestic bonds to extend maturity;
- accepting losses on some of the official loans.
None
of these is perfect but if push came to shove, one or several could
be moulded to make the deal look viable – at least on paper.
The
main issue here remains political. It would be very tricky to push
any increased bailout / relaxed conditions through the German,
Finnish and Dutch parliaments, who don’t want to be seen to prop up
a bloated Cypriot financial sector dominated by Russian interests.
After all that is partly why we got here in the first place. Such a
deal would be also reliant on the ECB agreeing to continue providing
liquidity to Cypriot banks.
3.
Cyprus looks to ‘other plans’ (i.e. Russia):
Cypriot President Nicos Anastasiades suggested that Cyprus is
considering “other plans” in case the parliament voted down the
deposit levy and no new bailout deal was forthcoming.
As of now, it
is not clear exactly what these plans are, however, it is a decent
bet that many, if not all, involve Russia in some way.
Cypriot
Finance Minister Michalis Sarris will be in Moscow tomorrow to
discuss the situation with his Russian counterpart. As we have argued
before, Russia has significant self interest in helping Cyprus out –
it could reduce the losses for the reported €20bn in Russian
deposits held in Cyprus, it could gain favourable terms for future
contracts on gas exploration in Cyprus (and therefore the future
revenues) and it could also improve its geopolitical foothold in the
region (as
we have highlighted before,
there is speculation that Russia has previously sought to move its
naval base from Tartus, Syria to Cyprus).
Russia
may therefore step up and provide additional financing, potentially
to cover the circa €2bn which may have come from Russian depositors
under the tax. Reports
have also suggested that
Sarris may propose a 20% tax on Russian deposits in Cyprus in
exchange for a stake in a future Cypriot national gas company and
board positions at Cypriot banks.
However,
the EU will not want to see one of its members become so closely
intertwined with Russia, so could actually strengthen Cyprus
bargaining chip.
4.
Cyprus exits the eurozone: No
compromise can be found under any of the scenarios above (at least
not within the necessary timeline – see above). With the largest
Cypriot banks going without a recapitalisation, the ECB could be
forced to follow through on its threat to withdraw liquidity from
Cypriot banks – not just to reduce its risk exposure but also to
ensure its threat of action remains credible to the rest of the
eurozone and financial markets. If so, the ECB Governing Council
would also probably promptly vote (a 2/3 majority is needed) to turn
off the Emergency Liquidity Assistance to Cyprus leaving the banks
illiquid and insolvent.
This
combined with the previous threat of a deposit tax would likely lead
to a deposit run on the banks and their likely collapse. In the face
of all this, without an ECB or eurozone backstop, Cyprus would find
it impossible to bail out its banks or support the guarantee of
deposits – it would be forced to exit the eurozone and print its
own currency.
The
logistics are messy, but as
we suggested with
respect to Greece, some use of Article 50 in the EU Treaty to exit
the EU would be the most likely option.
The
new Cypriot currency would have little international trust,
particularly in financial markets – not least because it would have
just defaulted on a significant amount of its debt, particularly
foreign-held debt. This would be worsened by the Cypriot Central Bank
having to print massive amounts of liquidity to keep the banks afloat
and backstop deposits. It would likely also have to monetise the
government deficit, which is due to be 4.5% of GDP this year, or
Cyprus would have to enforce massive austerity. In any case, this
scenario has all the hallmarks of an inflation spiral and collapsing
GDP.
This
could be combined with option 3 to some extent. Russia could offer
Cyprus a significant bailout, particularly of the banking sector.
Alternatively some currency link could be envisaged. In either case
this would help increase trust in the new currency and the Cypriot
economy.
Would
the ECB really pull the plug on liquidity to Cypriot banks?
The
key turning point here will be whether the ECB cuts off Cypriot
banks. It is to some extent the vital difference between option 2 and
4, while keeping liquidity on could help facilitate option 1. To pull
the plug on ELA the ECB needs a 2/3 majority (15 out of 23 votes) at
the ECB Governing Council. Although the Bundesbank and maybe the
Dutch and Finnish central banks might vote to turn off the ELA a 2/3
majority is not certain. In fact since Mario Draghi took over the ECB
it has not been particularly hawkish. Bloomberg
reports that
the ECB said after the vote: “The ECB reaffirms its commitment to
provide liquidity as needed within the existing rules”. The crisis
has shown so far that the rules of the ECB are incredibly malleable,
so what exactly that statement means is unclear, but the vote could
certainly go either way.
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