Cyprus Financial Crisis – An Overview

Abstract
The paper is an overview of the sovereign debt crisis in Cyprus. It also discusses the reason and options available for the Cyprus government to deal with the debt crisis.
INTRODUCTION
Government debt and reckless banking systems are some the major causes for financial crisis. Recent on the list is – Cyprus, the sovereign debt crises which involves the exposure of Cypriots bank to the Greek Debt Crisis. A small country is being brought to its knees by a huge banking system which has recklessly been lent money from overseas. The tiny island nation has managed to put the entire Eurozone on red alert. Looking at the bigger picture the problem is a lot to do with who banks in Cyprus and why. Cyprus is one of the countries in the world which is classified as being a tax haven. Iceland in 2008 and now the Cyprus fiasco, both the small island nations let themselves become home to casino banks transacting many times the size of their actual economies. Much of that money transacted is from wealthy Russians. The Russians depositors have been using the sector for tax evasion and secret operations. Well the crisis can be blamed on a number of other factors which played a role – real estate bubble, euro membership and financial ties with neighboring defaulting countries. Banks were allowed to borrow from overseas indiscriminately, lending it on again in even greater quantities. But when these loans could not be paid, the banks went bust, threatening the savings of all those with accounts in the banks.
The original plan few months ago was madness; controls on money leaving the country have had to be introduced. Targeting the deposits of domestic savers however small their savings were. The plan protects the depositors who had less than euros 100,000 was safe as per the EU intervention.  Depositors over euros 100,000 will see their claims taken into a bad-bank, from which they could get back very little. Lenders to the banks (mostly bonds) will also be hit which was not case in the original plan, and is the right approach because there is no reason why only tax payers of Cyprus should bailout the reckless bankers backed by the lender such as rich Russians, hiding their money away in a secretive tax haven. It many ways it repeats the bitter Icelandic experience, well the question needs to be asked haven’t we learnt anything from the past crises. However, by targeting the Cypriots or the external forces, it could have major implications for the future business activities in the country.  And it is thought-provoking this approach is been accepted by EU, well it is rich Russians who are set to lose out, not German, French and British Banks.
LITERATURE REVIEW
Prior research paper regarding financial crises is fairly extensive, as is the literature examining the causes, crisis management and remedies.  
One of Research paper suggests that causes are two thoughts. A first thought puts the blame on economic fundamentals and bad policies of the borrowing countries. The second thought points out that financial panic, resulting in sudden shifts in market expectations and confidence. So whose fault was it? The countries who borrowed too much? Or the lenders, who knowingly lent too much?  Are the international organization and/or credit rating agencies who failed to blow the whistle also to blame? (Rosa Maria Lastra (1999).  The speed with these seemingly healthy banks failed calls into question of efficiency of the current measures of bank performance and financial health. The financial statements that these banks file with their regulators gave little indication of their deteriorating assets (Thomas J. Linsmeier 2011). Crises have become more contagious over the past four decades out of carelessness and wishful thinking with regard to the power of finance. Rather than being natural outgrowths of unfolding capitalist regimes, modern finances has been used as a means for the few to get rich quick, with disregard to the real economy(Sara Hsu 2012). (Singala and Kumar 2012) indicate that euro zone nations faced their own element of fiscal problems due to banking sector distress, property bubbles, and budget deficits caused by excessive spending.
Cyprus Debt rises
At Euro 15,320 million, Cyprus’s public debt in 2012 shows the second-largest annual increase in Euro zone debt, after that of Spain. It rose from 71.1% of the GDP in 2011 to an alarming 85.8% of the GDP in 2012. – Economic Times
Public Debt
             
Source: Eurostat
CAUSE
The financial mishaps soared due to Cypriot banks inflating seven times the size of its economy due to massive inflow of offshore money, mostly from Russians looking to save taxes in Russia. The situation become problematic because Cyprus invested in Greece, which itself came under financial turmoil and required bailout. The Greece left Cyprus undercapitalized and Cyprus government was unable to address the financial problems resulting from investment in Greece.
OPTIONS
The Key to successful banking regulation is to know, what banks are really worth.  –Charles Bowsher, U. S Comptroller General (1991)
In 2008, the Icelandic government could not afford to bailout its banks. Instead it sought to protect savings of domestic Icelanders, a limited bailout, although letting the reckless banks go bust to their foreign creditors. Iceland predictably went through a crisis, but it economy is now growing, unemployment falling, and its experience measures favorably against that of Ireland, Spain and even the UK. Iceland’s crisis is an eye opener in accessing and dealing with the happening in Cyprus. Even before we get to the options suggested by financial wizards. Let’s focus on the financial aid required to overcome this situation. According to the draft document prepared by creditors it is around 23 billion euros. So will Cyprus be able to meet its side of the bailout which is around 13 billion after the bailout of 10 billion euros.
·         Selling gold bullion to raise money
European Commission assessment of what Cyprus needs to do to raise the remaining sum, that the country is expected to sell gold reserves in excess in order to raise 400 million euros. While the sale of gold in itself is not the magic bullet, even a small gold sale can help address severe debt problems. The sale of gold would allow Cyprus to raise three percent of what it must contribute to the bailout. However, there are limitations on the amount of gold a country can sell. The Central Bank Gold Agreement originally signed in 1999 and currently in its third incarnation, caps gold sales at 400 metric tons a year. Cyprus’ total gold bullion reserves stood at 13.9 tonnes at the end of February 2013, according to data from the World Gold Council.
·         Turkey: Off-shore natural gas reserves
The troika (which consists of the European Commission, the European Central bank and the International Monetary Fund) hopes that the proceeds from natural gas exploration will allow Cyprus to keep its debt under control. However, according to a New York Times report, this move could create geopolitical tension. Last month, Turkey challenged any move by Cyprus to speed its exploration. Turkey, a regional energy hub, could help lessen the financial turmoil in Cyprus. However, before providing assistance to Cyprus, Turkey would like to see progress towards a resolution of decades-long conflict between Greek and Turkish Cypriots that has divided the country into two.
The Unresolved Conflict
A number of current disputes between Greece and Turkey are made worse by the historical environment that existed between the two countries. The two countries had frequent wars, especially from 1892 to 1922 although the first war goes back to Greece’s liberation from Ottoman rule in 1821. This historical legacy of frequent wars creates a situation where the Greeks and Turks cannot trust each other. The Greeks mistrust the Turks because of the Ottoman rule, and the Turks mistrust the Greeks because of their liberation from Ottoman rule and because of Megali Idea, a dream of uniting all territories that once were Greek.
The present disputes between the two nations spring partially from this historical hatred. The most serious dispute between the two nations is that over the continental shelf. The Greeks and Turks cannot agree on how it is to be divided between them. The continental shelf has become a question not only of international law but also of energy. Such an issue could spark a war between Greece and Turkey if Turkey decides to authorize exploration for oil in territory that Greece considers theirs. (George Stergion Kaloudis)
Ankara won’t allow South Cyprus to breach Turkey’s continental shelf for exploration of oil and gas in the Eastern Mediterranean. “Our country and Northern Cyprus have objected to exploration activities by South Cyprus. The unilateral stand of South Cyprus means the extortion of Turkish Cypriots’ rights,” he said, noting that Turkey had previously stated that international firms who cooperate with the Greek Cypriot government won’t be allowed to join new projects in Turkey. – Deputy Foreign Minister Naci Koru – 22/02/2013
·         Leaving the Euro behind
Paul Krugman, columnist at The New York Times, argues that Cyprus needs to leave the euro. Krugman writes that staying in the euro means “incredibly severe depression, which will last for many years while Cyprus tries to build a new export sector. Leaving the euro, and letting the new currency fall sharply, would greatly accelerate that rebuilding.” Cyprus has two major exports, banking services and tourism. Krugmannotes that the exports from banking services “just died out,” referring to the closure of the second largest Cypriot bank (Laiki Bank), the freezing of deposits of over 100,000 euros, and capital controls limiting withdrawals to 300 euros a day.
No national banking system can survive such a restructuring. Thousands will lose their jobs, not just in the banks but in legal, accountancy and business services industries that the banks have supported. An immediate collapse of 10pc to 20pc in national income is in prospect, with unemployment soaring to more than a quarter of the population. – Jeremy Warner, Assistant editor of The Daily Telegraph.
CONCLUDING REMARKS
The crisis in Cyprus shows how damaging the banking industry can be when it gets too large, just as in Iceland, Ireland, Spain and the UK. For the country to emerge from this crisis, Cyprus, like so many other countries, needs to get control over its banks in order to get them to invest in productive industries, rather than being part of a global speculation and tax avoidance ring. Being controlled by global financial interests does not benefit ordinary people, their economy or democracy. Although Cyprus is going someway to making reckless lenders share in the pain, the failure to truly discriminate between domestic and foreign debts, and the lack of real help from the EU, means much suffering lies ahead. The Cyprus government cannot protect all the deposits under Euro 100,000. Not having its own currency, Cyprus has no ability to bring in inventive policies to keep money moving round the economy. So when we talk about financial aid from the EU through bailout loans. By taking Euro 10 billion of loans from EU and IMF, Cyprus is taking on a further debt of 60 per cent of national income, on the top of the existing 60 per cent owed. These loans are not viewed as payable, looking back at Greece, Portugal and Ireland in the recent past, or African and Latin America in the 1980s and 1990s, huge suffering is about to be imposed in the name of trying to pay.
Reference
Sara Hsu “The increasing Virulence of Man-Made Crises: Financial Crises and Global Instability”, Journal of Economic Issues, Vol XLV I No.2 June 2012.
Subbaiah Singala and N.R.V.V.M.K Rajendra Kumar “The Global Financial Crises with a Focus on the European Sovereign Debt Crises” ASCI Journal of Management 42(1):20-36

 – Prof Prasad M L
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