Tuesday, March 19, 2013

What if the Cypriot parliament votes against the deposit levy?

This is the question which is now holding global financial markets on the edge - could it really happen and what would it mean, we assess the possible scenarios below.

Could the Cypriot parliament vote against the levy?

According to Reuters, Cypriot government spokesman Christos Stylianides told state radio that the vote “looks like it won’t pass”. Meanwhile, via Zerohedge:
  • CYPRUS PRESIDENT: PARLIAMENT BELIEVES BAILOUT PLAN UNJUST, GOVERNMENT MAKING OTHER PLANS.
  • CYPRUS PRESIDENT: PARLIAMENT WILL REJECT BAILOUT PLAN
As we were tweeting yesterday, the DIKO party (junior coalition member with 8 MPs) had said it would not vote for the deal without some improvements, although we suspect reducing the burden on small depositors could help convince them. The European Party (2 MPs) had previously said it would not support he levy, however, according to CYBC, it has now said it would support the levy if depositors are compensated with interest bearing government bonds (we assume linked to gas revenues, something which the government has already offered).

That said, according to the Cypriot press, the latest proposal sees deposits below €20,000 exempt, deposits between €20,000 and €100,000 taxed at 6.75% and deposits over €100,000 taxed at 9.9% - this is unlikely to satisfy demands to exempt smaller depositors. It also seems unlikely to raise the required €5.8bn, not least because it applies the same rate as the original to a smaller pool of deposits.

Separately, there are conflicting reports this morning on whether the vote will be delayed again. The government is unlikely to put this to a vote until it is almost near certain of getting it through.

What would the fallout be?

The fallout of voting down the package could be explosive and we can only speculate about what could happen next, but its eurozone membership would likely be brought into doubt. As we noted in our flash analysis, there are few other alternatives for Cyprus to raise the necessary cash, while the eurozone has made it clear it cannot foot the entire bill (such an option would make Cypriot debt unsustainable anyway).

The eurozone would likely give Cyprus a few days either to change its mind or come up with an alternative way of financing the €5.8bn. Another parliamentary vote could be held (the EU of course has form when it comes to demanding the 'correct' vote).

The ECB has already reportedly warned that rejecting a levy would have dire consequences. Specifically, the two largest Cypriot banks would go without recapitalisation and could see their liquidity from the ELA (sanctioned by the ECB via the Bank of Cyprus) cut off, leading to them becoming insolvent and collapsing – putting their €30bn of deposits at risk, since the government obviously cannot guarantee them. This would likely bring down most if not the entire Cypriot financial system.
With the financial sector close to or in the process of collapsing and no support forthcoming from the eurozone or ECB, since Cyprus rejected their terms, Cyprus could even be forced to leave the eurozone and begin printing its own new currency, one that would have little international trust and could lead to a spiral of hyperinflation, etc, etc (i.e. a very nasty scenario).

There is, of course, a chance that if faced with the prospect of Cyprus leaving the euro, the rest of the eurozone could blink and find an alternative way to bailout Cyprus but the politics of such a scenario would get very ugly indeed. The ECB may not follow through on its threat to withdraw liquidity for Cypriot banks but this would only be a temporary reprieve. The Cypriot government will run out of cash at the start of June when it needs to pay off a €1.4bn bond, while the banks' position could be worsened by the likely deposit outflows once banks open, even if the tax is not applied.

What are these “other plans”?

It’s not clear exactly what Cypriot President Nicos Anastasiades meant when he suggested the government is making 'other plans'. We have long noted that deeper connections to Russia remain a viable option for Cyprus. With Russia angry at the eurozone for trying to burn some of its depositors, some more financial support could be forthcoming (but maybe only for Cyprus outside the eurozone) – with significant geopolitical implications as we noted here.

Other options which have been bandied around include: a financial transaction tax and the recent proposal from Lee C. Buchheit and Mitu Gulati (the men partly behind the Greek restructuring) to convert deposits into deposit certificates with fixed long term maturities. However, the former has been widely rejected by Cyprus and may not yield sufficient funding. The latter is an interesting proposal but may only offer liquidity support rather than solvency, while the banks would still remain under-capitalised. Such a proposal would still require significant backing from the eurozone and Russia – both of which are likely to come with onerous terms – and present similar obstacles to a deal.

So, all in all a 'No' vote, however tempting to Cypriot MPs, only leaves more drastic alternatives, hence it remains a possible but not probable outcome.

6 comments:

Denis Cooper said...

Comparatively small sums of money are needed to keep Cyprus in the euro, and I'm not talking about bribes to its parliamentarians but the sums needed to save its banks and financial system at least for the moment.

I've always expected that the eurocrats would do whatever they could, legal or illegal, ethical or unethical, to preserve the present eurozone intact.

Because if any country leaves the euro, even a country as small as Cyprus, that would set a precedent and the whole project could start to unravel.

Rik said...

1. According to a post in ZH (Why now, follow the money) there are >100 Bn deposits. At min. rate of 6.75 means more than 5.8 Bn tax.
Something is not correct.

2. Getting harder and harder to get adjustments approved in the North. In Germany it is quite clear that the Cypriots want them to pick up the bill and as to be expected they donot like that.

3. There is legally no possibility to exit the EZ only. Legally it has to be done via EU exit. Unless a political agreement can be made. But that requires all 27 to agree.
With some ???. The UK, Spain (re Catalunya, it simply opens up the possibility to negotiate yourself in per direct).

4. Hard to see how Cyprus can be systemic (a formal precondition for help). Hardly any international financial institutions have assets or liabilities there (there are only 2 Bn bankbonds for instance). So they could drop it, damage re Italy and Spain has already been done, for the largest part at least. And guess what these survived. You are a moron to keep funds there but so were you when you did that before in Cyprus and still the majority does it.

5. Anyway this call will have one time to be made anyway. Totally unlikely that Italy and Spain will get their restructuring in order without pressure and there is not enough money to give in (and it would be political suicide in the North as well).
So now it is: setting an example and run a minor risk of contagion (as now most will have happened and fall out looks limited and things are reletively well overseeable) or do it later with likley a much bigger country.
The bet seems clear the present one is a much better deal. Only win some time (to be waisted again probably) but get a much bigger and much more uncertain other bet.
However Merkel backed of no 2 or 3 times so not unlikely she will do it again. But doubtful if say the Finns and the Dutch will back off.
Also difficult to see how the gap could be filled otherwise.

Governtbonds (Gassy ones) simply looks to increase sov debt. Doubtful the IMF will accept that and end up in a new Greek drama.

6. Also towards the financial markets. These seem to make things up that support their position and start to act strangely when politics donot follow that. 100K guarantee is not an EU guarantee it is one by Cyprus (obo EU directives) which is pretty different. As Cyprus is broke it can not meet its obligations.
Off course the EU is pleased when markets make these assumptions.
This is not a bankunion by (convenient) misunderstanding of the financial world.
Put your money in a risky place bear consequences not only receive the revenues.

7. Russians are supposed to come up with 2.5 Bn but are not asked anything. Simply not a way to do business. Totally unprofessional.

8. Anyway imho most likley scenario small move by the EU and Cyprus at the end of the day agreeing. The other alternatives are several times worse for them. EU the cowards will not miss an opportunity to kick the can and at a low price.
But we are dealing with villagepoliticians and even a more disastrous and incompetent brand. A moron could have foreseen these troubles why their presiddent not? And assured support first or let another one take the blame for a failure (likely they would have backed off then).

Rik said...

@Denis
You probably make the same mistake the Eurocrats are making (at least in the early stages of this crisis).
Some problems can be 100% nearly decided by the politicians but others cannot.
Characteristics where troubles might arise on this point.
1. A long term problem (like this crisis);
2. Top of the agenda (not only political but also public opinion), again like this crisis;
3. Related to 2, a lot of media attention (like this crisis);
4. No platform for any solution that really is a solution (again like this crisis).

They simply had forgotten that their homecountries are democracies with elections and that the crisis would take so long that any country would have 2 may be even 3 or 4 elections before things are stabilised (not even to mention solved).
The voter has simply become the most important decisionmaker.
And the longer it is suppressed (like EU issue in the UK or anywhere else for that matter) and the more promisses are broken and the closer elections come, the more powerful the voters get.

That is why imho this would never work out as thought by the Eurocrats. You need 17 countries for a period of 10 years going along with it. Either the unpopular austerity route or the even more unpopular larger-permanet-transfer route. All basically on hogwash. Completely that that would work. You have 10 or more relevant decision each can kill the thing off and 5,6,7 countries that can do the same if they say no. Winning the lottery is more likley.

It is not the relatively small amount. It is again having to sell an unpopular decision. Most voters simply donot see the difference between 5,6 or 50,60 or 500,600 Bn it is simply alot.
Eurocrats know the difference of course, but for most voters it is nearly the same.
The amount is not the main issue anymore when voters get involved.

Denis Cooper said...

Nevertheless, Rik, comparatively small sums are needed to keep Cyprus in the euro and thus preserve the present eurozone intact, and if necessary the ECB could create it out of thin air.

If Cyprus did leave the euro it would be through blunders, not through the inability to find the money to keep it in.

jon livesey said...

"Nevertheless, Rik, comparatively small sums are needed to keep Cyprus in the euro and thus preserve the present eurozone intact, and if necessary the ECB could create it out of thin air."

You are correct, but there is a catch. Although the sum is small, it is large compared to the Cyprus GDP.

And unless the ECB want to open up a huge can of moral hazard by giving the money outright, it would have to be structured as a loan, and that would take Cyprus into a debt/GDP strata that the IMF say cannot be recovered from.

To be clear, I am not saying this horrible deal is a good one. It isn't. But the errors that led to this situation were made long ago.

The Cyprus banking system is insolvent, and there really are no good solutions. There is a hole of E17bn, and someone has to fill it.

The tragedy here is that ordinary Cypriot has the least leverage that he or she can apply.

Rik said...

@Denis
The ECB can create money, maybe not out of thin air but close to that. Which would however mean printing the PIIGS out and not only Cyprus. Which will be totally unacceptable for Germany CS. It would be basically political suicide for Merkel to allow that. ECB will hardly be eager to do it anyway. It is a political problem both the payers and the receivers donot want to pick up the bill let them fight it out and donot dump it with the ECB.

However the money has to get to Cyprus as well and in the 'right' way. The only way open at the moment is by way of loan. Which is not the right way.
The banks are hugely undercapitalised and simply bust in a normal market not ECB supported. Something need to happen in that respect (especially now with a bankrun in the making).

As it is made a liquidity as well as a solvency crisis. And the IMF has digged itself in (and rightly so) a 6 Bn extra loan will simply mean 150%ish (probably, nearly certain imho, higher imho). Which makes it a huge sovency problem. And we are back to where we started.

As said it is not the amount it is simply that Northern voters will not let their politicians get away
with bailing a taxhaven full of dodgy Russian oligarchs out. And it is not only a German issue. The Dutch just nationalised a bank and wrote off all junior bonds (and wanted to write off part of the senior bonds as well), why should they give better conditions to Russian Billionairs than to their own pensionfunds who held a lot of those junior bonds. Not going to happen. Finns similar story.

Cyprus like most of the PIIGS simply took the wrong time to fight this battle. They have effectively no choice but to accept or become the next African nation. Their businessmodel is gone. Out of the EZ with a huge devaluation it is history as well. Probably even more so.
That is why my idea was for say Italy to get to a real primary surplus via reforms and start to reneg from there. But they make the same mistake as a nation.
They might scare Merkel but they simply donot scare large groups of voters (rightly or wrongly, it doesnot matter).