Friday, 10 April 2015

Cyprus And Its Own "Grexit": A Roadmap for Greece?

Greek deputy finance minister Dimitris Mardas reassured the finance world last week that Greece would in fact meet an April 9th deadline to repay a 450 million euro IMF loan instalment on time, after comments his superior had made on television were construed by many to suggest that the country was actively considering renegading on its debt.  It did little to help already skittish investor confidence, and reignited speculation amongst many financial journalism outlets on a potential "Grexit" that is now to be expected whenever the newly installed anti-austerity government in Greece pokes its creditors in Brussels and Berlin in the eye.  But while the fracas unfolded in Athens, across the Mediterranean an unlikely and largely unheralded success story quietly wound down Monday.

in late 2012, the Cypriot government was in trouble.  Facing an over leveraged banking system exposed to (perhaps ironically) the stumbling Greek economy and an overheated real estate market, the subsequent downgrade to "junk" status of the country's debt meant that Cyprus was suddenly unable to turn to global equity markets in order to finance the stimulus and rescue packages needed to save its faltering economy.  Facing a looming default, in March of 2013 the Cypriot government agreed to a rescue package with the "troika" (the IMF, ECB, as well as the European Commission and Eurogroup representing the EU) consisting of a 10 billion euro bailout as well as strict reforms meant to forcibly instill confidence in the Cypriot banking system as well as the creditworthiness of the government.  The portion of reforms aimed at preventing a large scale exodus of money from Cyprus's banks are known as "capital controls", and were implemented in the hopes of buying more time for efforts to recapitalize the country's banking system and prevent panicked runs on the banks, which would most likely have resulted in a collapse of the system.  Initially quite strict (withdrawals from personal accounts were limited to 300 euros per day, and transfers to foreign banks were severely limited as well), the restrictions on the Cypriot euro were gradually lifted as the banks were further stabilized and confidence was slowly restored.

The measures were never popular, with leftist parties opposed to the package floating alternatives ranging from a reduction in the size of the military, a corporate income tax increase, and even outright nationalization of the banking sector.  A common theme among many opponents was resistance to what many believed amounted to EU-imposed austerity, championed by technocrats in Brussels who were only interested in preserving their economic and political union and cared little for the average Cypriot.  A blog attached to The Economist even went so far as to call the package "unfair" and "self defeating", arguing that the high political cost of such austerity preconditions for bailouts made them impractical if the EU hoped to maintain the goodwill of its constituent states.  Others worried that the implementation of such harsh measures would push Cyprus into the arms of Russia, from whom it had already received substantial financial aid.  Ultimately, it was not an easy road to recovery in Cyprus; the country's significant community of wealthy Russians who had stashed their wealth there had to be placated, and the first parliamentary vote on an assistance package failed amidst widespread protests.  And yet last month, two years removed from the bailout, a Bank of Cyprus official referred to the capital controls as "irrelevant", suggesting that the country's top economists were now confident enough in the state of the recovery that they were considering doing away with the last of the monetary restrictions first put in place two years ago, a milestone they quietly fulfilled earlier this week.

Cypriot president Nicos Anistasiades heralded that admittedly largely symbolic day as indicative of "the full restoration of confidence in our banking system and the stabilization of the economy of Cyprus."  And he's not wrong in asserting that significant progress has been made.  The flow of money within the country is now unhindered, the country has resumed borrowing (paywall) and the economy is finally expected to return to growth in 2015 after three years of recession.  While decisive action on the part of the ECB and Cypriot lawmakers no doubt played an important role in staving off a default and subsequent exit from the Eurozone, capital controls were imperative in allowing the structural issues within the economy (the banking sector's debt obligations at one point were nine times greater than the size of the Cypriot economy) to be resolved.  Despite initial public backlash, Cyprus today is in markedly better condition than Greece.  While the full extent of Greece's sovereign debt issues mean that capital controls, should they be implemented, would be in place for potentially much longer than they were in place in Cyprus, they present a more desirable alternative to the "Grexit" as a means of quarantining the country's financial troubles until a deal finally resolving the crisis is struck (or the ruling Syriza party in Greece is voted out), as opposed to continuing to simply bankroll the Greek government while subjecting it to austerity measures which are doing little to improve the long term viability of the country's economy.  But given how the Bank of England has all but thrown in the towel when it comes to Greece, it remains to see how much appetite remains amongst the EU's other core economies, especially Germany, for continued support in order to stave off a Greek default, especially given the latter's penchant for creative schemes aimed at alleviating its strict bailout conditions.  Barring a significant change in tune from the government in Athens however, its looking highly unlikely that a currency quarantine will be given a chance to help rectify the country's long running debt issues.