Controversial Cyprus measure re-ignites fears of contagion and retaliation

The proposed measure to bailout Cyprus by imposing a levy on bank deposits has re-ignited fears of a new eurozone crisis.

Markets were alive with rumours as trading opened on Monday morning that conditions would be softened, the deal may or may not pass the Cypriot parliament, or that Russia was offering a direct bailout in return for Cypriot offshore gas concessions.

The debate shifted quickly from if and how the measure, when finally agreed, was unfair to small depositors, and how it could be made more “progressive”, by lifting the ceiling from which the tax would apply, to the possible Russian response and the clear targeting of powerful Russian oligarchs as offshore money launderers.

Russian president Vladimir Putin has already been quoted as calling the depositor haircuts “unjust, unprofessional and dangerous”, adding to concerns that what started as a local problem in an economy which accounts for less than half a percentage point of eurozone GDP, had quickly escalated.

Analysts fear depositors in banks everywhere would now be questioning whether monetary authorities would help themselves to savings to prop up weak institutions.

In a Sunday morning note to clients, Morgan Stanley economist Joachim Fels wrote, “I view this as a worrying precedent with potentially systemic consequences if depositors in other periphery countries fear a similar treatment in the future.”

Another concluded: “So: senior bondholders and Russians helped at the cost of smaller locals.” But while oligarchs may consider a one-off 10% haircut simply the cost of doing business offshore, retail depositors have been heavily penalised as policy makers try to spread the pain.

Already legal advisers are suggesting the plan could be challenged under EU legislation, on the basis of discrimination against one group of domiciled investors over another. Another commentator noted: “At least we can now all agree that customer deposits in banks ARE loans to banks – a point disputed by some bank CEOs in the past.”

Other “trust lines” have been crossed with the public announcement of the measure, however it is finally implemented. Government depositor guarantee schemes may be called into question, leading to more runs on weak banks, further undermining their stability and wider credit markets. Popular unrest grows on the streets of Cyprus as banks remain closed to prevent capital flight, while overall volatility in bond and currency markets has soared.

Russia, meanwhile, finds itself handed a surprise opportunity. Already it is clear that even the hapless government of Cypriot president Nicos Anastasiades is not seen as the main instigator of the haircut. Instead it is German policymakers, many facing election in September, who have pushed the proposed deal, supposedly with the added benefit of hitting the offshore interests of Russian oligarchs.

Yet the proposal appears to ignore the fact that in recent weeks Russia has come close to agreeing to help Cyprus, brought down by its close association with failing Greek banks, so taking some of the strain off other European institutions and the IMF.

“Now it may only agree to adjust its €2.5bn loan and support IMF participation when it has clarity on the impact of the measures on Russian interests, and it has secured some mitigation of the levy’s impact on Russian depositors,” said one commentator.

Only last Thursday, some analysts were warning that the eurozone crisis was far from resolved. Société Générale’s Vincent Chaigneau even wrote: “We fear another shockwave in the spring.”

His colleague, strategist Sebastien Galy, added today: “This will probably go down as an ill-thought-out rescue plan with consequences for peripheral Europe…It breaks a cardinal rule – namely, public trust on which money relies….It could be the trigger that our colleagues were expecting.”

 

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