Stating the obvious

Cyprus controls an “omnishambles”

By Hugo Dixon

Cyprus’ capital controls are an “omnishambles”. If the Argentine-style “corralito” really can be lifted in seven days, the damage could be contained. But that doesn’t seem credible. Extended controls could spawn bribery, sap confidence, further crush the economy, spread contagion and ultimately lead to the country’s exit from the euro.

The lesson of capital controls elsewhere is that, once they are imposed, they are hard to remove. Iceland’s curbs are still in place five years after they started. In Argentina, they lasted a year.

There’s little reason to suppose it will be much different in Nicosia. After all, the restrictions – which limit both the amount of money people can take from their banks and the amount they can transfer abroad – have been imposed because the lenders do not have enough access to ready funds. If there’s not sufficient liquidity today, why should anybody believe there will be enough in a week, a month or even a year?

The shambolic manner in which the restrictions have been implemented also rams home the fact that it’s unlikely they will be lifted quickly. An earlier leaked draft didn’t mention any daily limits on cash withdrawals; the final version set it at 300 euros per person. The draft said people could take 3,000 euros abroad per trip; in the end, it was cut to 1,000 euros.

A central bank spokesman said the controls would last four days; in the end it was seven, although the central bank’s own press release didn’t even mention a timetable. The tightening of the controls between the leaked draft and the final version might suggest that liquidity is in pretty short supply.

The internal inconsistency of the controls also seemingly gives a lie to the idea that the controls will last only a week. They prevent people spending more than 5,000 euros a “month” abroad on their credit cards; they limit the transfers to people studying abroad to 5,000 euros per “quarter”. Why are there monthly and quarterly limits if the whole exercise is supposed to last only a week?

The European Commission has also given the game away in its statement on Thursday morning backing the controls. While saying free movement of capital should be reinstated as soon as possible, it also says it will monitor any need to “extend” the controls.

There was, and still is, an alternative. The European Central bank could have made clear that it was willing to supply unlimited liquidity to Cyprus’ banks now that they are being recapitalised by converting uninsured depositors into shareholders.

No doubt there are difficulties doing this because the banks don’t have a ready supply of suitable collateral. But the ECB’s collateral rules could be eased and the haircuts imposed by the Central Bank of Cyprus for emergency liquidity assistance could be cut. The country’s largest lender, the Bank of Cyprus, could have further capital stuffed into it if there were still doubts about its solvency. After all, the details of what proportion of uninsured deposits will converted into equity have yet to be finalised.

It’s a mystery why the ECB didn’t take a grip on the situation and act as a proper lender of last resort. Perhaps it has been too busy fighting fires elsewhere after Eurogroup leader Jeroen Dijsselbloem dropped his bombshell by suggesting that the Cyprus rescue could be a model for dealing with other troubled banking systems. But whatever the reason, the ECB’s failure could set off a damaging chain reaction.

The capital controls are supposed to stop a bank run. But they are unlikely to succeed. People may queue outside branches to take the maximum amount they can per day – and then come back tomorrow and the next day to do the same.

The Cypriots will also exploit loopholes. They may even be tempted to bribe banks and officials to bend the rules in their favour.

Foreign transfers are allowed under the new regime provided they are for bona fide trade purposes. It will be up to banks to vet transactions up to 5,000 euros. Those between 5,000 euros and 200,000 euros will be approved by the authorities in daily batches provided there is enough liquidity. Those above 200,000 euros will need to be approved individually by the authorities – again depending on there being sufficient liquidity.

Meanwhile, the customs authorities will have the job of making sure nobody takes more than 1,000 euros in cash out of the country when they leave.

As Reuters reported earlier this week, money oozed out of the country’s banks over the previous week even when they were supposedly closed. It wouldn’t be surprising if it continued to do so now they are partially open.

But much money will stay trapped both inside the banks and inside the country. If restrictions aren’t lifted soon, this will effectively lead to a parallel currency. A euro trapped inside Cyprus won’t be worth as much as one in the rest of the world.

One can imagine that people will be willing to suffer a discount in order to swap euros trapped inside Cyprus for those abroad. The discount for money stuck in bank accounts would presumably be larger than that for hard cash which people will ultimately be able to smuggle out of the country.

Such black market discounts could then be the precursor for a new exchange rate for the Cypriot pound. If controls really aren’t lifted, it may only be a matter of time before Nicosia goes the whole way and introduces its own currency. Given Cyprus’ dependence on imports for oil, electricity and a vast array of other goods, inflation would soar. But the banks could at least be properly open for business.

All this will be terrible for Cyprus. It could also send shock waves through other vulnerable euro zone countries. The ECB should get the show back on the road before it is too late.