Panicos Demetriades, then professor of financial economics at the University of Leicester, said in mid-2011 that Cypriot banks have big business connections with Russia and warned that the problem with small Cyprus was that it could not afford to support such a large banking system. Today, Mr Demetriades is the governor of Central Bank of Cyprus and his warning became reality. For the last couple of weeks Cyprus has been trying to mend its economy and get much needed 17 billion Euro aid. In the end the Cypriot government got what it needed, but at the cost of closure of her second largest bank, social upheaval and deterioration of relations with its biggest business partner: Russia.
What caused financial instability in Cyprus? After the country was accepted into the EU and then to “Euro-Zone”, Cyprus’s economic credibility increased, and money flowed into the country. As interest rates went down, the amount of overall public debt rose as Cyprus could borrow more cheaply. Consequently rising income also pushed up employment costs and unemployment; a growing current account deficit and overall debt (8 times more than her GDP) became very hard to control without aid. The unexpected hit came from Greece, where the Cypriot banks had lent high sums, and lost their money as Cypriot government deleted Greek debt in her own account. When Russian aid to her economy proved insufficient, the Cypriot government turned to the EU for help.
The bailout plan became effective after a weeklong drama in the parliament on the details of the plan: Around 10 billion Euros were provided by the IMF and the EU, while the rest would be provided from the savings in bank accounts in the gigantic banking sector of the island via a special tax. The original plan was to tax accounts with less than 100,000 euro by 6.75% and from savings above 100,000 euros, a 10% tax, along with additional structural agreements to the Cypriot economy. This plan was rejected in the Cypriot parliament on March 19th. After adjustments, a revised plan got approved in late March, with no tax levy on accounts worth less than 100,000 euros. According to this plan 40% of all savings will be available for withdrawal, yet the remaining majority of the money will stay in Cypriot banks. Meanwhile, the banks in the country were kept closed to prevent bank-runs. After the storm settled down the bailout costs were higher than expected: 23 billion euros with 13 billion provided by Cyprus itself. The plan had other implications for Cyprus than just financial afflictions, as relations with Russia shaken and public opinion was negative.
The EU had concerns over the spill of the crisis to the rest of the Eurozone as Cyprus is now the fifth economy in need of assistance. Even the idea of Cyprus returning to use its Cypriot pounds is causing a shiver, as this might mean a big risk for the of the European project. If Cyprus were forced to leave, others may follow.
The Russian side of the story is linked to Cyprus’s relations with Russia as a tourist and bank haven. An influx of Russian assets was one of the factors behind the previous success of the Cyprus economy. Now that the bailout plan is taking primarily Russian savings of more than 100,000 euros as part of the rescue operation, Russian investors are shaken. As the financial system is no longer “safe” for them, the Russian rich are looking for a new safe haven.
The people of the Republic of Cyprus are not entirely happy about the way the plan goes. Financial instability has meant rising unemployment and a harsher life for the people, causing civil unrest. There are mixed views towards what is going on: On the one hand, there is a feeling of being betrayed by the EU from some, on the other hand others are openly criticising the government for taking the side of the EU and calling for closer relationship with Russia. The Cypriot people are angered with the overall mismanagement of the economy and how the burden, in the form of economic misery, has been placed on their shoulders. One event portrays a crystal clear view of the discontent: President Nicos Anastasiades and Central Bank Governor Demetriades received threats from a group on March 20th and both were threatened with their lives and their families’.
The Cypriot government is caught between two giants; the EU and Russia; both are looking to their own interests. The people of the divided island republic, however, are also raising their voices in protest. But perhaps in vain if their struggles continue to be viewed as Lilliputian and dwarfed by the financial interests of Europe and Russia.