Last Minute Agreement Saves Cyprus From Bankruptcy

Cyprus, the tiny island country in Europe, finally managed to strike a last minute deal with its international lenders to avoid the prospect of bankruptcy, which had looked almost unavoidable following the protests in the country as well as the rejection by the country’s parliament to tax bank deposits. The idea of a ‘bad bank’ and a ‘good bank’ has finally been implemented by the policymakers and will come into force soon. With this, the country has secured a 10 billion Euros bailout package and it will see a first tranche of the bailout coming its way in May 2013.

As per the new deal, Cyprus will dissolve its second largest bank, Laiki, into a bad bank, which will contain toxic assets and unguaranteed deposits (each over 100000 Euros) to be taxed. The guaranteed deposits from this bank will be shifted to the largest bank of the country, the Bank of Cyprus. The large deposits in Bank of Cyprus will be frozen until there is clarity on the tax structure to be imposed on these deposits.

Last week, the Cypriot parliament had refused cow down to the government’s move to tax deposits in the country. The new deal promises that deposits below 100000 Euros will not be taxed. However, large deposits will see the government’s official raid at a much greater extent than originally planned, and does not require any vote from the parliament. Reports say that the lawmakers have already passed a legislation which sets the framework for the new action.

This deal was required in order to secure the bailout from the country’s international lenders. As per the original plan, Cyprus was required to raise 5.8 billion Euros. With the bank restructuring, it has managed funds worth 4.2 billion Euros. It is now expected that the country will increase taxes as well as adopt a route of privatisation to raise more funds. This will hit surely its economy, as it may cease to be the tax haven that it was so far. Besides, the shutting down of its second largest bank has already indicated massive job losses in the banking sector and privatisation will again lead to higher unemployment levels.

Due to its policies which gave it tax haven status, Cyprus has had an oversized banking sector, which is 8 times larger than its GDP. The country represents 0.2% of the Euro 17 economy, and hence, the restructuring of the banking sector will not have any significant impact on the European economy. The global capital markets, however, were concerned about the exit of Cyprus from the Euro 17, which has sent an unfavourable signal about the integrity of the region.