Cyprus bailout: A suboptimal and unjust agreement of the Eurogroup

2013-03-16

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The Eurogroup has reached a political agreement over the terms of the macroeconomic adjustment programme for Cyprus. The Memorandum of Understanding that the Cyprus government will have to sign, will now be finalized by the European Commission, the European Central Bank, the International Monetary Fund and the euro area’s permanent bailout fund, the European Stability Mechanism, who will operate in tandem to provide the technical features and conditionality clauses to the Eurogroup’s decision.

As is always the case with such agreements, the economically most optimal choice is sacrificed to the altars of political expediency, yet while no one would be surprised from an awkward deal coming out of the Eurogroup, given their impressive record in such ill-advised bargains, the agreement on Cyprus differs fundamentally from the previous adjustment programmes that were implemented in other Euro Member States. A key differentiating element is the unprecedented decision to proceed with the imposition of levies on bank deposits. Such a scheme has been propounded with the objective of broadening the tax base in Cyprus and is predicated on the appreciation of the fact that the domestic banking sector is eight times larger than the total output of the economy, as contrasted to a 3.5 times average in the EU. Notwithstanding the far-reaching ramifications such a decision will have on the economic life of the island, the ad hoc manner in which a political decision on tax policy was forwarded is opaque and evidently undemocratic.

The one-off levy on bank deposits, affecting both resident and non-resident depositors, will be brought into force on Tuesday, March 19, 2013, following a bank holiday on Monday. Electronic transactions have already been subjected to limitations and cooperative banks that are open on Saturdays were forced to close their doors to people who rushed en masse to withdraw their life-time savings. The levy will amount to 9.9% on deposits above €100,000 in Cypriot banks and a tax of 6.75% on all deposits below €100,000. While this measure is expected to raise revenues of €5.5 billion, it ought to be noted that this is done to the detriment of all depositors in present time, while engendering an aversion of savings in Cypriot banks for the short-to-medium term.

On the legal and moral front, this decision to effectively deprive everyone of their savings, must be denounced as unjust; for even if it were true that Russian oligarchs have been laundering their ill gotten gains in Cyprus’ banks, it still is unacceptable to use that as an excuse for impoverishing the wider public, especially at a time when a series of tax hikes have already been introduced. In effect, the average depositor is punished for the frivolous speculation of Cypriot banks in the bond markets and for the probable non-enforcement of anti-money laundering legislation. The cost for the downsizing of the Cypriot banking system will be borne by those who had no substantive gain from the speculative bonanza that preceded the economic crisis.

Nevertheless and to remain impartial, I am of the opinion that it would be incorrect to attribute all the misdeeds to the Eurogroup while absolving local politicians from their responsibilities. For instance, the government of ex-president Mr. Christofias had ample time to proceed with proactive measures that would have ameliorated the shock of the crisis. Instead it obstinately denied that the eurocrisis would affect Cyprus. As for the current president, Mr. Anastasiades, he campaigned on a platform that ruled out the very possibility of imposing across the board losses on bank depositors—whatever that may suggest for the integrity of the new government. In addition it should be noted, as a reminder to Cypriot citizens and as a piece of information for readers who are not acquainted with the reality of the Cypriot political life, that over the last years all political parties facilitated, in one way or another, the following:

• the aggrandizement of the property market bubble, from which the government raised substantial revenues in the short term without even considering the long term costs on the economy and the environment,
• the unbridled expansion of the banking sector and its institution as a central pillar of the Cypriot economy, underpinned by the narrative of Cyprus becoming a major financial center,
• the concomitant increase of Russian foreign investments, which occur in the penumbra of doubts and suspicions over the enforcement of anti-money laundering rules,

All these now-structural flaws, have greatly influenced the way in which the Eurogroup approached the case of Cyprus. The decision on Cyprus is suboptimal in economic and moral terms, but it would be a pernicious folly to place the brunt of the barbs on European decision-makers while ignoring the systematic embezzlement of the Cypriot public by political parties who only considered their narrow benefit, while cavalierly ignoring any constraints and the long term costs.

There will be more to write about the case of Cyprus as the Memorandum of Understanding gains form. Whatever the case, a complex, interweaving web of factors related to institutional inadequacy and political opportunism, will severely hamper economic activity for years to come and will have a deleterious effect on the social fabric, by placing asymmetric burdens on life-time savings and the lower-to-middle parts of the income distribution. Both European and Cypriot decision-makers in the European Council are accountable for what is to follow.

Picture credit: hellenicleaders.com