Cypriot imbroglio a lesson in how not to deal with debt problems
The European Central Bank has pulled the plug by threatening not to accept Cypriot government debt as collateral
Cypriot lawmakers raise their arms to vote against a controversial bill to tax deposits in Nicosia yesterday. Photograph: Yiannis Nissiotis/Reuters
A camel, it is said, is a horse designed by a committee. This is unfair to camels, which are well-adapted to their environment. The same, alas, cannot be said of euro zone rescue programmes. The proposed Cyprus intervention, rejected yesterday by the Nicosia parliament, won’t help the euro zone make a smooth exit from its wave of crises. Indeed, the imbroglio should serve as a lesson in how not to deal with financial and sovereign debt problems.
Let us start with why some bank restructuring was inevitable. The government of Cyprus is both highly indebted and responsible for a banking sector that is too big to save. According to the IMF, gross government debt reached 87 per cent of gross domestic product last year and would reach 106 per cent of GDP by 2017, without the bailout. The sovereign credit rating is also far below investment grade: Standard & Poor’s rates Cyprus CCC+. That is not surprising: the banking sector still has assets over seven times GDP.
ECB pulls the plug
The banks stand on the edge of collapse. But it is the European Central Bank that has pulled the plug by threatening not to accept Cypriot government debt as collateral against liquidity support. Banks have to be recapitalised. Taxpayers cannot do this, on their own. Without taxing depositors, the proposed rescue package would have had to be €17.2 billion, instead of €10 billion, or close to 70 per cent of GDP. This would have brought sovereign debt to some 160 per cent of GDP: an unsustainable burden. Indeed even the actual bailout package looks unsustainable, since it would appear to bring gross debt to 130 per cent of GDP. Under the programme, public debt is to fall to 100 per cent of GDP by 2020. Achieving that will demand substantial fiscal tightening and lending to Cyprus on easy terms. A restructuring of public debt is still likely.
Is there no alternative to the bail-ins? Yes: direct bank recapitalisation by the euro zone, for which the sum required is a small matter. If the banking union had been up and running, that would have happened. It is not, presumably because core countries do not want to bail out mismanaged banking systems, such as the offshore hideaway for Russian capital that is Cypriot banking. The banking union will not arrive before the cleaning up of past mistakes and establishment of new arrangements.
Turn then to whether what was done was right. The answer is: yes, though only up to a point. Many insist that any tax on deposits is theft. This is nonsense. Banks are not vaults. They are thinly capitalised asset managers that make a promise – to return depositors’ money on demand and at par – that cannot always be kept without the assistance of a solvent state. It is inconceivable that banking – a risk-taking financial business – can operate without exposure to loss of at least some classes of lenders. Otherwise, bank debt is government debt. No private business can be allowed to gamble with taxpayers’ money in this way. That is evident.
The question, then, is not over the principle that lenders can face losses. It is about which of them should do so and to what extent. Apparently on the insistence of Nicos Anastasiades, the president of Cyprus, losses are to be imposed on deposits of less than €100,000, the upper limit for deposit insurance in the euro zone. The idea is to tax these smaller deposits at 6.75 per cent and bigger ones at 9.9 per cent. That may now change – and for good reason. But forgoing the former would mean raising the rate for deposits above €100,000 to 15 per cent, to raise the required sum of €5.8 billion. A good thing, I would say. But the Russian government does not agree. Nor does that of Cyprus.