Sigrún Davíðsdóttir's Icelog

While waiting for a Cyprus bail-out – or a bail-in

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Someone will have to take losses as Cypriot banks deleverage and the sovereign debt is brought down. The next big date for Cyprus is the beginning of June when a redemption on a €1.4bn euro bond is due – not a trivial sum in an €18bn economy. It might all be undramatic ­– but so far the EZ has shown amazing aptitude for tension and brinkmanship

After Pimco was hired to find out how much would be needed to recapitalise the Cypriot banks the first number the Pimcoans aired was €10bn, not a trivial sum in an €18bn economy. Following this shock, Blackrock was asked to review the Pimco methodology, after which Pimco continued its work. Instead of publishing the report as first intended it will be kept confidential until a bailout has been negotiated (or until it is leaked).

The number optimistic Cypriots are hoping for from Pimco is €8bn but that might be somewhat optimistic – €8.8bn might be more realistic. That the report isn’t made public might indicate that Pimco landed on the scary €10bn.

Now, why would 10bn be scary? Because, in this €18bn economy the €10bn adds to the 2.5bn loan already received from the Russians and to the ca €5bn the state will need to fulfil its obligations until it can return to the market. At the end of the third quarter of last year the public debt stood at 82% of GDP. The worst case bailout need of roughly a GDP would pull the debt up to a crippling 140% or so.

The feeling in Cyprus is that €10bn for the banks means that there will a great pressure on the island’s government to privatise in full. There are still plenty of semi state-owned entities, i.e. companies where the state owns 51%. This counts for telecoms, utilities companies and many others. – This makes me think of Iceland after the war and up to the 80s when political power was concentrated around state-owned companies, creating some very cosy relationships but not the most effective use of resources.

In spite of a left-leaning population in Cyprus the unwillingness to privatise doesn’t necessarily stem from ideological aversion but from the envisaged pain from sacking people, adding to the growing number of unemployed people. In a country of only 800.000 this is understandable. Unavoidably, privatisation spells loss of jobs and those in charge know it will hit family and friends. Privatisation in Cyprus will no doubt happen – but it will be painful if it needs to be done in a short span of time at exactly the time austerity is arriving on the shores of Cyprus.

Cyprus clearly has unrealised state-owned assets, which it wants to make money on according to its own plan. The same counts for revenue in sight from gas resources, now in sight off the shores of the island. Cyprus doesn’t want to pledge this revenue against the coming loans. The worse the situation is shown to be the less flexibility there is for the new Cypriot government following presidential election on February 17 and a second round a week later, in case no candidate gets a majority. The strongest candidate is Nicos Anastasiades, a conservative from Angela Merkel’s sister party in Germany. Merkel has already showed up on the island to support Anastasiades.

This time, the Troika won’t be the only lender. Russia has a stake in keeping the island afloat and has alread indicated it wants to add to the bailout packet, through the IMF.

The bailout hinder right now is the persistent rumour of money laundering in the island. Cypriot authorities have answered by pointing at the island’s track record in fulfilling the requirement of the OECD and other international instituations. That hasn’t helped and now, having realise that more is needed, the Cypriot Parliament and ministers have promised that whatever needs to be investigated can be so, however the Troika will want to go about it.

In summer when Cyprus requested a bailout my first impression of the Cypriot situation was that Cyprus will be another Greece with bad news surfacing over months and possibly years. My Cypriot sources strongly reject this theory and are adamant that in spite of being geographical neighbours, Cypriots and Greeks couldn’t be more different.

For a bailout to do the trick two things seem to be essential – to force the banks to shed debt and to find some way of writing down or extending maturity on Cypriot debt. This will have to be done, in order to find a sustainable solution but the question is how fast and how, which ultimately means that someone is going to lose. With no write-down, the bailout won’t be sustainable anymore than it was first and second time around in Greece.

Only recently Germany’s finance minister Wolfgang Schäuble last aired his argument that Cyprus isn’t important enough to save but he seems to be isolated here. The reputational argument is: if the EU can’t bail out one of its smallest brothers how convincing is it that they are able to see a big brother like Spain through its difficulties? The troika will fix a programme and loan for Cyprus. From EU sources it seems likely that Olli Rehn’s view will prevail – no write-down.

The financial argument is that there are no proper private sector investors to drag to the barber’s chair, forcing them to take a haircut. The bank debt hasn’t yet migrated to the state except for the €2.5bn Russian loan. As to the two biggest banks one is 85% owned by the Cypriot state and in the other the shareholders are the general Cypriot public, with the largest shareholder owning 1%. A hair-cut will hit domestic investors and the state.

How might things proceed? The wishful scenario is that after the signing of the MoU, possibly in March, Cyprus will – as it has already started – implent the necessary measures, demanded by the lenders. Well on track, let’s say six months later, it will ask for longer maturities. Russia has already indicated it is willing to extend the maturity of the five year loan 2.5bn loan from end of 2011. This needs to have happened by beginning of March when a €1.4bn is due on a Cyprus euro bond.

This is the undramatic version. Something dramatic might of course upset this smooth forecast. There has been a flurry of guesses today, following an FT article last night, which spelled out options, ia some form of a bail-in – looks like capital controls – that would hinder depositors in moving their money, to be discussed at an EZ meeting of finance ministers in Brussels today. Cypriot ministers ruled this firmly out. The EZ group chairman Jeroen Dijsselbloem refused to answer such a hypothetical question when asked if he would like to keep his money in a Cyprus bank. After the EZ meeting we seem to be back to wishful scenario. Until the unforeseen strikes.

*An earlier Icelog on Cyprus, a link to a recent update on Cyprus on the Prodigal Greek – and another earlier blog on Iceland and Cyprus.

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Written by Sigrún Davídsdóttir

February 11th, 2013 at 11:09 pm

Posted in Iceland

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