What's Happening In Cyprus?

Even a week after Cyprus' plans to tax depositors, no resolution is in sight. There seems a high probability of the country defaulting on its sovereign debt if a firm proposal on raising 5.8 billion euro does not meet with success. The markets in Europe are stressed over this matter and have traded in the red zone for the entire week so far.

Equity and bonds as asset classes have seen a steep decline over the last few years. Under such circumstances, bank deposits looked like the only safe option for investors. Now, with the country’s decision to tax depositors, this class has also come under threat.

The tiny island country in Europe has spared those having less than 20000 euro in their bank accounts from the deposit tax. It has levied a tax of 6.75% on deposits between 20,000-1,00,000 euro in banks and 9.9% on those over 1,00,000 euro. The country’s parliament, however, voted against this plan on Tuesday (March 19), which means that the ECB may not go ahead with the 10 billion bailout package.

The German Finance Minister too has expressed regret over the decision of the Cypriot parliament and has said that this would lead to further weakening of the Euro region’s economy. This has created a huge uncertainty in the global capital markets.

Cyprus is a tax haven and has large deposits from wealthy Russians lying in its banks. As talks of taxing the rich is gaining ground worldwide, Cyprus has actually proceeded to implement it, though it has run into a wall at the moment.The country is now left with the option of tightening its fiscal policy. Greece, which has already taken such measures, is now seeing a huge decline in business sentiment. The PMI data from Greece also hints at a sharp decline in the output. Any such measure in Cyprus would ultimately lead to a decline in the industrial output as also in the employment rate and GDP. This would prove be a big drag on the local as well as the European economy. The European debt crisis has killed growth in many countries, and a similar fate seems to be unavoidable in Cyprus.

After Cyprus’ parliament refused to pass a legislation to tax bank deposits, ECB has warned that it would cut off emergency lending to the country’s banks starting next week. Its government is discussing an alternative plan, and the world is awaiting fresh developments in the island country.