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Cyprus Update: Capital controls still in place, economy sinking with no end in sight

It’s been one month since Cyprus reached a deal with the EU, ECB and IMF (collectively known as the Troika).  The bail out was supposed to save the country from a collapse of its financial system and help build up the economy again.  Instead, the bailout/bail-in is a disaster and the country is nearly forgotten as the Troika moves on to prepare for the next bailout victim.


The terms of the bailout were unprecedented because they called for a bail-in of the banks by the uninsured depositors (those with accounts over €100,000).  It was initially estimated that these depositors will loose 20-40% of their money, but as is usually the case with bailouts and bail-ins, the exact amount is really a moving target.  Estimates today suggest that these depositors stand to loose 60%.  This, of course could change, but if it does, it can only go up and not down. 

As it stands right now, in addition to the haircut, these depositors will also be forced to covert some of their money into shares of the re-born banks.  Add capital controls, which lock up their money for an unspecified period, and you might as well write-off 100% of the uninsured deposits.

Capital controls were another ‘feature’ of the plan, which killed the main objective of having a unified currency in the first place; free movement of capital across member countries.  Today, there are Cyprus Euros, which are stuck in Cyprus, and EU Euros.  Cyprus officials suggested that these controls will be in place for weeks, not months, until they have time to recapitalize the banks.  This is also changing as recapitalization of the banks is taking longer than expected (capital controls tend to last for years, not weeks or months).  In the meantime, the citizens of Cyprus suffer while their fate is in the hands of bureaucrats.

Cyprus will keep capital controls in place throughout the summer tourist season despite a marginal easing to help struggling local businesses stay afloat, a government adviser said on Friday.

The measures would be lifted only after the restructuring of Bank of Cyprus, the island’s largest lender, a process involving a 60 per cent haircut of uninsured deposits and the acquisition of some assets from Laiki Bank following its collapse last month.

 “September is the earliest likely date for wrapping up the restructuring but it could easily be pushed back further,” the same adviser said.

Capital controls were imposed in March by the central bank, initially for two weeks while the government finalised a €21bn bailout agreement with the EU and International Monetary Fund.

They have since been extended at weekly intervals to prevent a massive run on deposits.

The ceiling on transfers by individuals was raised from €2,000 to €5,000 a month, “to make things easier for families with children studying abroad”, one official said.

But most of the controls that have transformed Cyprus into a cash economy since last month’s bailout were left in place. Cypriots can only withdraw €300 a day from banks and are banned from cashing cheques or opening new bank accounts.

“The inconvenience gets to you, not being able to do online banking and having to keep large amounts of cash in different receptacles at home,” said Aglaia Demetriadou, a primary schoolteacher in Nicosia.

Read the full article from the Financial Times.

The justification for going after uninsured deposits, was not only due to the massive protests in the country, which lead to the parliament rejecting the deal, but also because it was sold as taking money from wealthy Russian oligarchs who make up the bulk of the uninsured deposits.  This, of course, was not true as you can see below:

The bulk of the depositors are domestic and the bulk of the uninsured depositors are Cypriot companies, pensioners and retired expats living in Cyprus.  Besides, a lot of Russian (and Cypriot government ‘friends’) money fled before the bail-in deal was reached as we mentioned in our earlier post here.  You can also see a list of people and companies who pulled their money out before the deal here from Zero Hedge.

With access to bank accounts still restricted and capital controls in place, Cypriots are hoarding money. Trade credit has dried up, choking business activity.

New-car sales plunged by 59% in the year to March. Sunseekers tend to shun crisis-stricken countries: the number of tourists in the first quarter was 10% down on the same period of 2012. And this is just the beginning. An economy already in recession—GDP fell by 2.4% last year—is about to nosedive, undermining the assumptions on which the bail-out was based.

The central bank has already relaxed some domestic-banking restrictions. The cash limit on withdrawals remains €300 ($390) a day, but use of standing orders and direct debits has been restored. Electronic transfers of capital remain blocked. Far more important are still-stringent external controls. Cypriots cannot, for example, take more than €2,000 in cash when they leave the island.

Such controls can be lifted only when the banks at the heart of the crisis have been restructured. That is crucial for restoring confidence and averting a flight of money once it can move. The aim is to bury Laiki, the country’s second-biggest bank, and to resurrect Bank of Cyprus (BOC), its largest. But the process is complex and vulnerable to delay.

When the final rescue deal was announced on March 25th, Laiki was to be split into a “good” and a “bad” bank. The bad bank’s losses would be absorbed by shareholders, bondholders and uninsured depositors (the latter providing the biggest pot of money, worth an estimated €4.4 billion). That split is occurring. The assets and liabilities of the good bank, including Laiki’s insured deposits, have been moved to BoC. But instead of the bad bank retaining non-performing loans (where borrowers are behind on payments), all Laiki’s domestic loans are going to BoC, net of expected losses. That leaves BoC exposed if such loans turn out even worse.

BoC, for its part, is supposed to recapitalise itself from its €10 billion-worth of uninsured deposits, by converting a chunk of them into equity. When the revised bail-out was announced, it was hoped that the forced conversion might affect only 37.5% of these deposits. But it now looks as if 60% of uninsured deposits will be required to recapitalise BoC.

That’s because the harsh treatment meted out to Cyprus has inflicted huge damage. Before the bungled bail-out, a worst-case scenario envisaged the two big banks requiring €7.8 billion in recapitalisation; now €10.6 billion may be needed to clear up the mess, according to a leaked European Commission document. Some of the big BoC deposits, such as those held by local authorities and state schools, will be safeguarded, but others will not be so lucky. The central bank said this week that insurers, charities and private schools would incur losses of 27.5%.

Whatever the eventual scale of its recapitalisation, the credibility of the restructured BoC will still be shaky since it will be so heavily exposed to an economy laden with debt. Private debt of households and firms in Cyprus is close to 300% of GDP, the third-highest in the EU. Bad loans are set to soar as unemployment, currently 14%, rises and as property values sink.

Before the bail-out, the European Commission was predicting drops in GDP of 3.5% in 2013 and 1.3% in 2014. By early April it had changed this outlook to declines of 8.7% and 3.9%. But even this may be too optimistic, according to Fiona Mullen of Sapienta Economics, a local consultancy. She thinks that output will shrink by 15% this year; and she predicts a further drop of 15% in 2014, followed by a 5% fall in 2015. That would mean a cumulative four-year decline in GDP since 2011 of 33%, outstripping even Greece’s likely six-year decline of 24%. If such gloomy predictions turn into reality a labour exodus of biblical proportions rather than capital flight may be what really undoes Cyprus.

Read the full article from The Economist.

Life in Cyprus is going to get a lot worse before any recovery is in sight.  ‘Foreign’ depositors who were supposed to bear the brunt of the bail-in (that’s at least how it was sold to the public) will not be as bad off as the people of Cyprus, they will be the ones most affected by this tragedy.