The Cypriots have an expression, “eninboro allo.” It means: I cannot take any more of it.
There was jubilation last night outside the small Mediterranean island’s parliament when every single member of parliament either voted against a plan to tax depositors or abstained. The message was that people of Cyprus had enough and weren’t going to let the big bullies, led by Germany, boss them around.
The plan to tax insured deposits was a dreadful mistake — I have described it as legalized bank robbery. But the deposit tax was part of an unpalatable but available 10 billion euro bailout, agreed with the euro zone. That Plan A is now at risk. As Cypriots contemplate possible Plan B’s, their jubilation may start to fade: all of them are also dreadful.
Some observers, including my colleague Anatole Kaletsky, believe that Germany will now blink. With an election looming there in the autumn, that seems most unlikely. Berlin has said it is unwilling to back any loan bigger than 10 billion euros, already 60 percent of Cyprus’ gross domestic product. The problem is that Nicosia needs 17 billion euros to recapitalize its banks and cover the government’s own expenses, leaving a 7 billion euro hole.
Berlin is right to refuse to lend more. Even with 10 billion euros, Cyprus’ debt will rise to around 130 percent of G.D.P. At 17 billion euros, it would shoot up to around 160 percent of G.D.P. Under the original plan, debt was supposed to fall to 100 percent by 2020. But after the events of recent days, confidence will be so crushed and the island’s offshore finance business model so broken that this forecast now looks like pie in the sky.
So what are Cyprus’s options? There are broadly three: sell its soul to Russia, default and possibly quit the euro or patch together a new deal with the euro zone. They are all bad, but the last one is the least bad, for both Cyprus and the rest of Europe.
Cyprus’s finance minister is in Russia on Tuesday. Moscow is furious because many of its citizens, who have channeled money to Cyprus, would pay the deposit tax. It may seem odd that the Kremlin is so keen to protect citizens who make use of an offshore financial center. Many are trying to reduce Russian tax payments and some may be money launderers. But that shows where President Vladimir V. Putin’s priorities lie.
Russia has nonfinancial interests in Cyprus. The island has potentially rich offshore gas deposits and its position in the eastern Mediterranean has long been strategic. It was colonized by Christian crusaders, the Ottomans and then Britain, which still has two military bases there. Could Moscow, whose only naval base on the Mediterranean is in strife-ridden Syria, somehow wangle some military advantage out of this crisis?
Some in Cyprus won’t care. They’ll say it is better to be colonized by Russia, which at least is also predominantly Orthodox in its Christianity, than to be Germany’s whipping boy. But such a pact would amount to turning its back on modernity.
The second main option for Nicosia is to default — or more precisely for its big banks to go bust. If Cyprus can’t get a bailout from the euro zone, it won’t be able to recapitalize its banks. The European Central Bank has said it is willing to supply them with liquidity, but only under its rules. That is far from offering an open spigot.
The country’s second largest bank, Laiki, already seems to have run out of suitable collateral to receive even emergency loans. At some point, the government is going to have to reopen the banks. If it doesn’t then have a deal, everybody will rush to take their money out. The whole financial system will collapse.
It is hard to see this situation ending with anything other than the imposition of capital controls and Cyprus quitting the euro. Some sort of equilibrium would eventually be established, but depositors would lose much more than Plan A’s 6.75 to 9.9 percent. The country might also be forced out of the European Union. That would weaken its strategic position vis-a-vis Turkey, which has occupied around a third of the island since 1974.
The remaining option is to recut the deal with the euro zone. The good news is that Cyprus’s partners are not fixated on a deposit tax, especially hitting those with less than 100,000 euros. The bad news is that there is still a 5.8 billion euro hole to fill. That’s about a third of G.D.P.
Nicosia may be able to scrabble around for some alternative ways of finding cash. One unattractive idea is to raid pension funds. Another is to find some way of cashing in on the potential future value of the offshore gas deposits. Yet another is to get the Cypriot church to chip in; its archbishop has offered to help. Maybe there is also a way of fast-tracking privatizations. Conceivably the state itself could default on its debts — although that wouldn’t help a lot because half of them are held by the country’s banks.
That said, a combination of such measures, plus a smaller tax focused only on the uninsured depositors, might do the trick. It won’t be easy to sell this politically in Cyprus. But every day that the banks stay shut, the people may begin to appreciate the advantages of doing a deal with the euro zone.
“Eninboro allo” may then be replaced by “ne boro” — “yes I can”.
Hugo Dixon is co-founder of Breakingviews and editor-at-large at Reuters News. For more independent commentary and analysis, visit breakingviews.com.