|SocialismToday Socialist Party magazine|
Issue 168 May 2013
Euro crisis engulfs Cyprus
The troika’s bail-out package is an economic and social disaster for the people of Cyprus. How was prosperity so suddenly transformed into penury? LYNN WALSH reports.
After joining the eurozone, the Cypriot capitalists adopted a financial, banking model for the development of the economy. The euro was a strong currency, backed by the major European powers, and Cyprus banks would provide a safe haven for international capital, especially cash from Russia (an estimated $350bn of Russian capital flowed out of Russia since 2008). Cyprus, moreover, unlike Russia, has a developed, stable legal system, which depositors considered would protect their funds.
However, when deposits grew to four or five times Cyprus’s GDP, there was no way that the government could underwrite the deposit insurance on funds up to €100,000. This would have required €30 billion.
One of the main triggers of the banking collapse was the crash in the value of Greek government bonds, which had been purchased on a big scale by Cypriot banks. This was a knock-on effect of the bail-out package imposed on Greece by the Troika – the European Commission, European Central Bank (ECB) and International Monetary Fund (IMF).
Earlier this year, two of the biggest banks, the Bank of Cyprus and Laiki, became insolvent and were refused emergency liquidity assistance by the ECB. This forced the government to go to the Troika for bail-out funds.
The Russian connection
Deposits in the banks in Cyprus were swollen to four or five times the size of the island’s GDP. It is estimated that about a third of these deposits originated in Russia. Perhaps two-thirds of it was dirty money, derived from the drugs trade, tax fraud, bribes, etc. Some of the Russian deposits, however, were ‘round-tripping’. In other words, the cash of the oligarchs was deposited in Cyprus and then invested back in Russia through Cyprus-based companies. This provided legal security for the oligarchs that they could not assume in Russia itself.
With the eruption of the Cypriot banking crisis, many hoped that Russia, because of the huge Russian stake, would intervene and rescue the island’s banking system. The previous Communist Party president, Demetris Christofias, had appealed to the Kremlin for a rescue. However, the eurozone powers warned Vladimir Putin off. At the same time, Putin drew back from the huge scale of the Cypriot banks’ liabilities. A bailout would cost at least €10 billion and, if the banks subsequently collapsed anyway, it might require €20 billion to €40 billion to salvage the system. Even though the big Russian depositors were ‘scalped’ under the Troika’s package, it was not worth the Kremlin’s while to underwrite the Cypriot banks’ liabilities.
Many of the oligarchs, who had clearly been warned in advance, withdrew their funds early in March before the crisis broke. No doubt the oligarchs will shift their money to new tax havens.
The botched deal
The first deal, proposed by the Troika in early March, was completely botched. Earlier, in the case of Ireland, where there was also a bank bubble (based on the speculative property boom), the government guaranteed all deposits – which they simply could not afford. They therefore had to go to the Troika for finance – on the basis of savage austerity measures. In the case of Cyprus, the Troika proposed that depositors should themselves bear the main cost of the bailout – a ‘bail-in’. No doubt the Cypriot government also wanted to appease the Russian depositors, and avoid putting the whole levy on the big savers.
However, this meant that the deposit insurance up to €100,000 was a worthless promise. This provoked fury among small savers, who would be facing a 3.5% tax on their savings.
But the proposal for a levy on all savers sent a shock-wave around Europe. Such a measure would mean that no deposits were safe; deposit insurance guarantees were effectively worthless. The situation was made worse by the statement of Jeroen Dijsselbloem, head of the eurozone finance ministers, who declared that the proposed deal for Cyprus would be a template for future bailouts. He was soon dubbed ‘Dimwit-bloem’! The Troika were quickly forced to withdraw this proposal and Mario Draghi, president of the ECB, admitted that it had been a mistake.
The second deal
The Troika came out with a new bail-out plan, announced on 25 March. This would involve no levy on insured deposits, but a higher levy on amounts over €100,000 (perhaps up to 40%). The Laiki bank would be wound up, with parts merged into the Bank of Cyprus. Thousands of bank workers lost their jobs. Other banks would receive additional funds to prop them up. For the first time in the history of the eurozone, capital controls were imposed, under emergency provisions of the EU/eurozone treaties.
But the €10 billion rescue (€9bn from the ECB, €1bn from the IMF) had a heavy price. As in Ireland, Portugal, etc, there would be savage austerity measures, with cuts in social spending, sweeping privatisations, mass sackings of public-sector workers, and sharp increases in taxation.
Since the original bail-out package was agreed on 25 March, the total ‘savings’ the Cyprus government will have to come up with has doubled to €13 billion. Gouging this amount out of the economy will push the island into a prolonged slump. Moreover, a collapse of the banking system still cannot be ruled out. On the basis of capitalist ‘solutions’, worse is yet to come.
A way out?
In contrast to Greece, the outbreak of the crisis in Cyprus brought widespread demands for a break from the euro and a return to the Cyprus pound. This would allow a devaluation of the Cyprus currency and, the familiar argument goes, this would boost exports. Cyprus, however, is not Argentina: it does not have massive reserves of raw materials to export. The gas reserves found around Cyprus may, in time, provide support to the economy. But it would take time to develop these reserves, and will mean dependency on the big oil and gas companies for exploration and development. Moreover, there are disputes over territorial claims between Cyprus and Turkey which may not be easily resolved.
Given that a large part of Cyprus’s requirements are imported (fuel, clothing, most manufacturing goods), a devaluation would mean a rise in the cost of living. The current account deficit is currently around 5% of GDP and, with very limited foreign currency reserves, this would quickly become unsustainable. The government, moreover, would no doubt resort to the printing press to pay its debts. This, together with imported inflation (via devaluation) would further devalue people’s savings.
On a capitalist basis, there is no easy way out. Within the eurozone, Cyprus faces extreme austerity, with the possibility of a 20% fall in output over the next two years – a major slump by any measure. On the other hand, breaking from the euro would not mean escape from austerity and stagnation.
Cyprus is a small, fragile element in the slow-motion chain-reaction taking place within the eurozone, a process that will sooner or later lead to the break-up of the single currency. The latest bailout for Cyprus will not stabilise the situation there. Economically, the austerity measures and burden of debt will prove unsustainable. Politically, the situation will become more and more intolerable and provoke mass rebellion against the savage package imposed by the Troika.
But Cyprus is only one component of the eurozone crisis, though it could still trigger a wider crisis. Ireland and Portugal have now been given another seven years to repay the bail-out loans from the Troika. But these packages will still be unsustainable. Relentless austerity will inevitably lead to ever-deeper recession.
Christine Lagarde, wearing her IMF hat, frequently calls on the stronger eurozone economies, particularly Germany, to implement policies to stimulate growth. Wearing her Troika hat, however, she supports the austerity measures that are strangling the European economy, and acting as a drag on the world economy.
The Spanish economy is also locked into a slump, with a devastating 26% unemployment rate, and 50% youth unemployment. Prime minister, Mariano Rajoy, has been calling for a direct injection of credit by the ECB into the Spanish economy, on the lines of the Federal Reserve’s intervention in the US. There is no assurance that this would work: there has been no real recovery in Britain, despite the Bank of England’s massive quantitative easing policy. In any case, this kind of monetary stimulus by the ECB is firmly opposed by Germany, which regards it as creating the danger of inflation (though there is, in general, a deflationary situation in the advanced capitalist countries).
Despite the intervention of the Troika in Cyprus, its banks remain shaky. No doubt many wealthy ‘savers’ will remove their cash deposits from Cyprus as soon as the relaxation of capital controls allows. The money will go to other tax havens, which may include Luxembourg and Malta, which have bank deposits far bigger than their GDP (Luxembourg six times, Malta three times).
The proposal for a eurozone banking union has been on the agenda for several years. In theory, the union would introduce a single banking authority for the eurozone, which would regulate the banks and (in theory) rule out the kind of crises that have occurred in the last few years. This, however, is little more than a grandiose plan. France and several other eurozone countries consider that a banking union could be introduced within the existing treaty structures. Germany is now insisting that a banking union would require treaty changes. Politically, this amounts to an insuperable political barrier. Treaty changes would require approval in the eurozone countries, either in their parliaments or through referendums – at a time when popular hostility to the eurozone and the EU is strengthening.
The eurozone crisis is a special crisis within the world economy. According to the Financial Times (15 April), the US Brookings Institution recently concluded: "The global economy is stuck in a rut, unable to sustain a decent recovery and susceptible to a sudden stall". The eurozone has not fostered the stability and prosperity promised by European leaders. On the contrary, it has exacerbated the crisis in Europe and, at the same time, has the potential to trigger a new downturn in the world economy.