News Analysis

Wednesday 17 September 2014

Finance ministers have turned Cypriot problem into a crisis

Published 20/03/2013 | 17:00

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THERE was an insurance company at one time, which promised in its adverts not to turn a problem into a crisis. A pity they are not running the eurozone.

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Its finance ministers have done just that: turned a problem – admittedly a tricky one – into a crisis. It is not yet a full-blown crisis of the kind we have seen several times since the Irish banking crash. Markets are spooked, not panicked. But it is a nasty crisis just the same, and it could get worse.

It is nasty because it is intensely political – and psychological. Cyprus is too small to matter financially. Its banking losses may be proportionately twice those of Ireland's, but its planned bailout was only a quarter as big.

Psychology is a peculiar thing. In last December's Budget, Ireland's DIRT tax on bank deposits was increased by 10pc, to raise €60m. The total take is almost one per cent of depositors' savings – not once, but every year.

It is a different matter to touch the capital sum, as happened in Cyprus. That really frightens people, and not just in Cyprus. Everyone is asking: "Could it happen here? Is my money safe."

The smart answer is that the Cypriot plan was a levy – a tax – and no one is safe from taxes. We have had our own levies, in particular the four-year one on private pension funds. It is extremely damaging but, since hardly anyone understands it, protests are muted.

The smarmy smart answer is that one can be pretty sure that the eurozone rulers will not make this mistake again. If there is one thing which should be safe in any new rescue scheme, it is small deposits.

That certainly applies to Ireland. Most of the really nasty stuff has already been done, although one would not be surprised if savers suffer more blows in coming Budgets.

Nevertheless, great damage has been done, and a full-blown crisis cannot be ruled out. If the Cypriots do not accept the plan, the ECB had threatened to withdraw support from the country's banks, which would mean a lot more deposits disappearing.

But last night the ECB appeared to back down on that threat. The Cypriots may have learnt something from their Greek compatriots – that in these circumstances the creditor is in as much trouble as the debtor.

This will provoke some rueful "what ifs" in Ireland. Was the ECB bluffing when it warned against burning Anglo bondholders? Maybe. It does not matter now, but there are other, more pressing worries for Ireland.

At the heart of the stand-off was the Cypriot determination to protect its offshore banking centre by not hitting large depositors with the 17pc levy which would have been needed to leave smaller deposits alone.

Other finance ministers would have been quite happy to spare deposits less than €100,000. Many would like to see the back of the Russian money which flooded into Cyprus. In that sense, they are entitled to feel a bit aggrieved at getting all the blame.

But they should have seen it coming. For Ireland, the sombre fact is that these governments feel much the same way about the Dublin financial services centre.

There is already trouble over the proposed financial transactions tax, which Ireland refused to adopt. An Irish government may yet face a Cypriot moment.

In the more immediate future, if agreement cannot be reached on a compromise package – and if the Cypriot government should fall – the eurozone will be back in full crisis mode. In the past it has tended to respond by breaking cardinal principles, which in this case would mean subsidising Russian oligarchs and loading Cyprus with unsustainable debt.

Such a rumpus could set back efforts to restore Irish banks to normality. They still require €80bn in emergency lending from the ECB. This figure has almost halved from the depths of the crisis, but more deposits are part of the process of reducing it further, not fresh withdrawals.

It has certainly set back the general attempts to bring stability to the euro. If they can get into so much trouble over Cyprus, what might happen when Spain has to fully come to terms with the losses in its banking sector?

In the view of some, including ECB director Jorg Asmussen, the efforts of Ireland and Portugal to return to market borrowing and exit their bailouts could also be hampered. Both countries are in the unfortunate position of having done most or all of what was expected of them, only to find that the eurozone has not done what was expected of it.

At the back of that failure is the clear unwillingness of citizens in the creditor countries to provide actual financial transfers to the indebted ones. That is understandable, but a stable monetary union requires a degree of collective financing.

Yesterday, one of the strangest supporters of that view was speaking in Dublin. Strange because Peter Bofinger is one of Germany's most eminent economists and his are rare opinions among German economists.

"Cyprus, along with the Italian election, is another wake-up call. Without a change in policies, the euro will not survive," he said.

Do not be surprised, though, if its leaders, once they have switched off this particular alarm, turn over for yet another snooze in the comfort blanket.

Irish Independent

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