Cyprus Bailout Process Moves Forward Despite Risks

Cyprus Bailout Process Moves Forward Despite Risks

Monitors from the International Monetary Fund (IMF), the European Commission and the European Central Bank, collectively called the troika, visited Cyprus from July 17 until July 31 to assess the island nation’s progress on its bailout plan.

The €10 billion relief package, approved March 25 2013, will be rolled out in a series of tranches, with each subsequent dispersion of funds depending upon compliance with certain stipulations. The first round of bailout money, amounting to €3 billion, was released in June. The next tranche hinges on the outcome of the July check-up.

In the course of this monitoring visit, troika officials set out to look at progress on several of the plan’s key provisions. According to the terms of the bailout, Laiki Bank is being dismantled, while the Bank of Cyprus is undergoing recapitalization. One of the goals of this review mission was determining the equity to be given in exchange for deposits as part of a “bail-in” arrangement. Meanwhile, the Cypriot government must continuously implement austerity measures to reign in its debt-to-GDP ratio. It also must prepare for a privatization program (meant to take place later in the process) aimed at jump starting the economy.

Report from the check-up

According to a joint statement by the troika, Cyprus has met its fiscal targets and is on track. It is also taking appropriate steps to rehabilitate the financial sector, gently easing capital controls and restrictions on deposits.

Significantly, the recapitalization of the Bank of Cyprus was finalized. The central bank and finance ministry announced that 47.5 percent of deposits greater than €100,000 will be converted into equity. This step clears up uncertainty for depositors, who had a part of their assets frozen and were unsure about the size of the levies they would face. Cypriots hope that resolving this issue will accelerate the lifting of capital controls, which can have a suffocating effect on the economy.

In light of this good report card, Cyprus will likely receive €1.5 billion from the European Stability Mechanism and €86 million from the IMF in September, pending approval by Eurozone finance ministers and the IMF executive board.

The road ahead

Despite these seemingly positive steps, Cyprus still faces a long uphill climb. There remains considerable uncertainty in the short-term. Unemployment hit 17.3 percent in June, representing the largest annual increase in the Eurozone. Meanwhile, the economy is expected to decline by 13 percent in 2013 and 2014 and not experience growth again until 2015 at the earliest. The troubled economy will pose a challenge to privatization efforts down the line. Although capital controls are being eased, they will likely remain in place to some degree for at least two more years. This will hurt any chances Cyprus might have of remaining an attractive business hub.

To add to the hardship, the tourism industry, an otherwise reliable boon to the Cypriot economy, is also on the decline. One potential ray of hope, however, is the Aphrodite gas field recently discovered off the island’s southern coast. This discovery, along with the state of the tourism industry, brings to the surface a political issue. If Cyprus were to unify, it would be better able to take full advantage of this newfound natural resource and cultivate tourism. Peace talks are set to resume in October. That political process is worth watching, as unification could nourish a country with otherwise woebegone prospects.

Categories: Europe, Finance

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