After six months of broad stability in euro area markets, Saturday morning’s announcement by the Eurogroup of its framework for the Cyprus bailout – based on an offer of up to €10bn of multilateral funds while bailing-in Cypriot bank depositors and junior bondholders (but not sovereign bondholders) – has ushered in a new, possibly damaging, phase of the single currency’s crisis.
The complex agreement, which envisages Cypriot government debt rising to 100% of GDP by 2020, includes a restructuring and recapitalisation of its banks, an increase in Cyprus’s withholding tax on capital income, an increase in its super-low corporate tax rate and expectations of a new contribution from Russia. But all of that has been lost in the negative headlines surrounding the demand that bank depositors need to contribute €5.8bn via a supposedly one-off, oxymoronic ‘stability levy’ on their savings.
Given German exhortations about the nature of some of the high-value funds lodged with the Cypriot banks, the 9.9% charge on deposits worth more than €100k did not come out of the blue. But the planned 6.75% charge on deposits up to €100k, which is designed to by-pass (and has the effect of undermining) the euro area deposit guarantee scheme, was a surprise as evidenced by the queues that formed outside Cypriot bank cash machines on the weekend. And it is a risky move, which has the potential to trigger contagion at banks right across the recession-mired periphery. After all, who in their right mind would trust the eurogroup’s assurance that its decision to apply a levy on bank deposits will be a one-off? Depositors in Spain and Portugal will no doubt be afraid.
With this being the euro area, together with the conspiracy (to snatch household savings) we also get the risk of a major cock-up, since it remains to be seen whether the Cypriot government will even be able to pass the legislation required for its deposit-grab. With President Anastasiades’ governing coalition holding just half of the 56 seats in the parliament, and some members of the government’s junior partner, the Democrats, arguing against the legislation, a positive vote is no done deal, hence its postponement to today and the possible imposition of an additional Bank Holiday tomorrow. And most recent reports suggest that moves are afoot to alter the balance of the levy, to place more burden on deposits over €100k. But the Cypriot government appears to have no choice other than to raise the €5.8bn one way or another from bank depositors. And if the bill does not pass and it can’t, the ECB’s threat to withdraw emergency liquidity assistance from Cypriot banks risks triggering financial meltdown in the member state and contagion across the periphery and beyond. So, all eyes today will be on Nicosia.
But whatever the outcome in Cyprus, there is almost certainly going to be longer-term damage to the banking systems in the euro area periphery. While talk of banking runs is likely hyperbole, this decision will inevitably add pressure on to the peripheral banks already-fragile deposit bases. As we argued last week only by restoring stability can deposit, and hence lending rates, be lowered in the periphery. The decision on Cyprus makes that process much less likely.
Chris Scicluna, Head of Economic Research