The Cypriot experiment in financial stability, as viewed by Exotix’ Gabriel Sterne

Gabriel Sterne, economist at Exotix Limited, has outlined a number of reasons why the Cypriot bailout as originally proposed is not fair.

Haircutting insured depositors… that must stick in the throat of Cypriots, and is hard to digest for the entire financial world!? I for one did not see that one coming. The Cypriot authorities and Troika can call it a “tax” rather than a “haircut” but what is in a name?

The deal aims to raise €5.8bn from taxing all deposits; not just those of the stricken banks. It includes a tax of 9.9% on uninsured depositors of all Cypriot banks (i.e. those with deposits of more than €100,000, and a tax of 6.75% on insured deposits. The meeting played out according to the usual late night drama, described in exciting detail in the WSJ.

Abysses are the plural of abyss. The Cypriot president looked one way and saw the political disaster that is taxes on insured depositors; and the other and saw a destroyed business model for his nation. He may have jumped both ways. Our interpretation is the Cypriot president wished to preserve its business model by demonstrating to large depositors it was willing to share the pain amongst all its citizens. From an economic perspective, the case would be that Cyprus could not afford to lose the export-orientated financial and legal services sector, particularly as the rest of the economy is likely to suffer a very deep credit crunch and recession. And we can speculate if Russia’s position with regard to rolling over €2.5bn was a factor in Cyprus’ desire to limit the size of haircut on uninsured deposits.

The EU has been tough with Cyprus and the presidential statement indeed reads as though he was surrounded by desperate choices and had struggled to know in which direction to jump. And by Sunday night it was unclear if the deal would get parliamentary backing in Cyprus as resistance to haircuts on uninsured deposits grew. The FT article points to a major debate over the size of haircuts of uninsured depositors, quoting a senior eurozone official as stating: “We had proposed a levy with a rate of zero below €100,000, and a higher one afterwards,” said the official. “The Cypriot president did not want to agree to a levy higher than 10 per cent, and if you do the numbers you get the 6.75 and 9.9 [per cent].”

In short, we think the decision to tax insured deposits was mistaken, and politically damaging. But we do understand the reasoning. The alternatives faced by Cyprus were also horrible. If only this had not become such a political hot potato in Germany then perhaps the sensible option for a more generous treatment by Europe would have been palatable.

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