Cyprus: What’s Next?

It now appears that the Cypriot Parliament will reject the government’s amended plan for haircutting deposits. The revised proposal, which reportedly exempted depositors under €20,ooo, satisfies almost no one – Cypriot depositors, the Russians, nor European creditors (including their increasingly agitated banking regulators). The government looks ready to try and renegotiate the bailout, but no creditors have stepped up to fill the hole left by the failure of the tax. There may be pressure on Cyprus for additional fiscal measures, but it’s hard to see that as confidence boosting given the damaging growth effects we have seen in the periphery following aggressive fiscal cutting.

The most likely scenario would seem to be to revise the tax to fully exempt deposit insurers. But how to fill the gap while still maintaining a viable debt path? One approach would be to restructure the sovereign’s €8.2 billion debt. I have blogged in favor of this in the past. Whether or not it becomes part of the plan, I think the government will have a hard time explaining to its citizens why external bond holders are being paid in full while they are being taxed.

One thoughtful approach on how to move forward has been tabled by Lee Buchheit and Mitu Gulati. Their plan has three elements:

1. Protect all insured depositors (no tax).

2. Uninsured deposits in excess of €100,000 would be replaced, at par, with interest-bearing and tradeable bank certificates of deposit. A menu of different rates and maturities could be offered, and the CDs could be partly secured by natural gas revenues. (I would add here that the CDs could alternatively include an option that would pay out if the government is successful in exploiting its natural gas reserves.) This would mean a loss to depositors in net present value, but provides security and principal conservation.

3. The maturity dates of all sovereign bonds would be extended by five years, without a haircut to interest or principal.

This approach would reflect a rank ordering of creditors that makes sense (and more closely matches the principles of creditor ranking in bankruptcy), as well as a more politically sustainable burden sharing. It would lock in funding for the banks. Most importantly, it keeps Cyprus’ main creditors “at the table”. If good policies and a natural gas boom makes Cyprus’ debt and fiscal policy sustainable, creditors would avoid a loss of principal and perhaps even capture some upside; if not, the future restructuring could be calibrated to the need. Anna Gelpern and Felix Salmon also have analyses of the proposal out.

Whatever path is chosen, they need to move quickly. The bank holiday is unsustainable for long on political and economic grounds, and if not resolved the question of euro exit could move to center stage.

Read Robert’s prior analysis on Cyprus, “Why Cyprus Matters

This piece is cross-posted from Macro and Markets with permission.

3 Responses to "Cyprus: What’s Next?"

  1. Aegean1972   March 20, 2013 at 5:31 am

    IMO, If Cyprus goes with Russia, it will make a huge strategic mistake, which in the long run it will cost them a alot..

    On the other hand i also expected Germany to be smarter than that and apply to Cyrpus a package similar to that of Greece, that would gradually bring the nation in organizational and financial order, so people would have time to "digest" it slowly and not rebel against it. The solution that Germany chose (haircut) is efficient, but on the other hand it is causing the one thing that no one wished for in any market: A Bank run within an EU country and possibly the first Euro-exit. With Italy being next in line for a troika, you dont "stir the soup" this hard, because the pot can overturn and then it ll be very difficult to get things in order. Can u imagine what is going to happen in Italy in a year from now when they wont be able to delay (anymore) the arrival of a troika force?

    Germany needs more diplomacy in enforcing "the German way" around europe. No one doubts that Europe will get stronger from the German organizing that is being enforced. But they have to find the "fine line" between organizing the euro-south (ASAP) and not having the southerners rebel. Thats a challenge.

  2. Aegean1972   March 20, 2013 at 8:58 am

    if Cyprus goes bust, you ll see how fast Italy shapes up ;)

  3. La resistance   March 22, 2013 at 10:34 pm

    We, the citizens, refuse to allocate our own funds in any form to bailout the gambling debts incurred through the financial speculation of investment banks.

    Sign :