The Cypriot rejection on Tuesday night of
the euro-zone bailout package for the country's ailing banks has triggered a
power struggle between the island nation and the European Union. If Brussels
gives in, future efforts to save the euro will be made more difficult. All
hopes are now on Russia.
Efforts to save the euro have long been
criticized for being undemocratic, with bailout packages being assembled behind
closed doors in Brussels. But after Tuesday evening's vote in the Cypriot
parliament, that critique will be difficult to maintain. Not a single
parliamentarian in Nicosia cast a vote in favor of the bailout package, one
which foresaw a mandatory levy on accounts held with Cypriot banks.
Thirty-six lawmakers voted against the
deal and 19 abstained, including those belonging to President Nikos
Anastasiades' center-right DISY party. With their veto of the expropriation
plan, parliamentarians in the island nation showed that representatives of a
small European Union member state can indeed block euro-zone efforts to save
the common currency.
Anastasiades, of course, didn't exert much
effort to find a majority for the deal, even though he had agreed to it in
Brussels. On the contrary, even before the parliamentary debate began, he said
the package was unlikely to pass -- a virtual invitation to lawmakers to reject
it. The move could even be a tactical one. Anastasiades can now return to
Brussels in the hopes of leveraging better conditions out of Cyprus' euro-zone
partners by highlighting his country's rebellious parliament.
It could also be useful as a lever in
Moscow. On Wednesday morning, all eyes were on Russia in the hopes that the
country might jump in to provide Nicosia emergency aid. Russian investors have
parked billions of euros in Cypriot bank accounts -- indeed the presence of
Russian money is one reason why Cyprus' banking sector holds assets worth more
than seven times the country's annual gross domestic product. According to
media reports, Anastasiades spoke with Russian President Vladimir Putin
immediately following the failed parliamentary vote and the Cypriot finance
minister flew to Moscow on Tuesday night.
Bullied from Abroad
In the coming negotiations, the Euro Group
must be careful as it seeks to maintain its credibility. The vote on Tuesday
evening made one thing clear: The main concern in Nicosia was not in fact those
who held smaller sums in Cypriot accounts. By Tuesday morning, the original
deal had been changed to exempt from the bank levy those holding less than
€20,000 in their savings accounts. That the parliamentary veto was nonetheless
unanimous shows that lawmakers are primarily interested in maintaining Cyprus'
role as a low-tax paradise and offshore business haven. It also shows that
Cypriots are unwilling to be bullied from abroad, particularly not by the
Germans.
The facts of the case would seem to belie
the intense emotions it has triggered. Two large Cypriot banks have run into
difficulties and Nicosia is unwilling to liquidate them or allow them to enter
into insolvency because that could fatally harm other banks in the country and
destroy the country's reputation as a financial center for the foreseeable
future. But bailing the banks out is beyond the means of the government, which
is why Cyprus needs billions in aid money from the European Stability Mechanism
(ESM), the euro-zone's permanent bailout fund. The euro-zone, led by Germany,
came up with a not unreasonable demand in exchange for assistance: Namely that
the bank customers, whose accounts are to be saved, contribute to the bailout.
Nicosia's refusal, however, has now
escalated the bailout from a question of policy to a question of principle. The
sums involved, after all, are relatively small in comparison to the past needs
of other nations-in-crisis. The Cyprus package called for €10 billion from the
ESM and a further €5.8 billion to be raised by the account levy. But were the
euro zone to now back away from that levy demand it would be clear to all that
the common currency union could be blackmailed.
If, after all, one of the smallest
euro-zone members can claim to be systemically relevant -- and if that state is
allowed to block efforts to tap into other possible sources aid money before
European taxpayers are forced to fund the entire bailout -- then all countries
that run into trouble in the future will refuse to budge in negotiations with
Brussels.
What About European Taxpayers?
And there will be future negotiations.
Banks in Spain too are in need of bailout money from the ESM. The key sticking
points are similar to those in Cyprus: Should some banks be liquidated and how
heavily should investors and creditors be involved in the bailout?
This week, it has repeatedly been said
that the euro zone must be careful not to erode the trust of the financial
markets in the common currency. But the trust of European taxpayers in their
leaders is likewise precarious. And it will be endangered if the impression is
once again given that taxpayers alone must bear the risks associated with
propping up the common currency.
What, then, will happen next in Cyprus?
Time is of the essence. Banks in the country can't stay closed forever, and
should they open before a clear path forward has been established then a run is
practically a certainty. And a bank run could be the coup de grace for the
country's financial system.
The rapid turn toward Russia on Tuesday
night makes it clear that Cyprus is quickly pursuing a potentially promising
Plan B. Because many rich Russians have long used Cyprus as a low-tax locale to
park their money, it is hoped that Moscow might spring for the €5.8 billion in
bailout money left open by Tuesday evening's parliamentary rejection. According
to media reports, the Cypriot government is attempting to strike a quick
natural gas deal with Russia, granting Moscow concession rights to the large
natural gas reserves that lie off the coast of Cyprus in exchange for
much-needed cash.
Game of Chicken
The Euro Group would only be able to
accept such a compromise if the money from Russia did not come in the form of a
loan. That, after all, would increase Cpyriot sovereign debt to an
unsustainable level -- exactly what the first deal was trying to avoid.
The alternative would be for Cyprus to
allow the European deal to fall apart completely, eschew the €10 billion from
the ESM and try to find the €17 billion it needs from elsewhere. Here, too,
Russia would be the primary hope.
What, though, if Russia refuses to bail
the country out and Nicosia can find no other partners willing to help? Then
the Cyprus situation would turn into a game of chicken: Who is more afraid of a
Cypriot insolvency? Cyprus itself or the rest of the common currency area?
Brussels, after all, is concerned that if Cyprus is allowed to fall, it could
lead to a resumption of capital flight from other struggling euro-zone
countries and rapidly spiralling sovereign bond rates for Italy and Spain.
One thing, though, is clear. If the euro
zone blinks in its game of chicken with mini-member Cyprus, it will be
forfeiting many future duels as well.
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