Jim Power: If this legalised robbery is fair game for Cyprus then what next?
Published 19/03/2013 | 17:00
Cyprus is a country with a population of around 862,000 people and has an economy that accounts for just 0.2pc of eurozone GDP. So in the overall scheme of things, Cyrpus is tiny – but over recent days, the symbolic importance of the country has become massive and the European Union-backed response to the problems in the country have sent shockwaves across Europe and indeed the world markets and populations.
The Cypriot economy is on the brink of bankruptcy and, in order to avert such an eventuality, an agreement has been reached, with the backing of the EU, to impose a once-off levy of 6.75pc on deposits under €100,000 and 9.9pc on deposits over €100,000.
This is the first time in the eurozone crisis that personal deposits have been hit in this manner. Not surprisingly, this has elicited a very negative response within Cyprus, but more pertinently, it has justifiably scared the living daylights out of every personal depositor across the eurozone.
So it should.
An argument is being made that Cyrpus is somewhat of a unique case and will not create a precedent for other countries. The size of the banking sector in Cyprus reached more than 8.5 times the size of its GDP, which makes Ireland's banking crisis look somewhat better.
A relatively small part of the liabilities of the banks is accounted for by bondholders, and hence, rather than burning bondholders – as has happened to a limited extent in some other countries – the focus was switched to the deposits in the system. Most of those deposits are personal, with a significant portion of them owned by Russians.
The apparent view of the EU authorities is that much of this Russian money is laundered, or hot in any event, so burning those depositors is not seen as such a bad thing. However, even if one shares that view, it is unfortunately not possible to discriminate between overseas and domestic depositors. Vladimir Putin and his Russian depositors are not over the moon at this latest development.
The other point about Cyprus is that it requires a bailout of around €17bn, which is roughly the size of its GDP. If a full bailout of €17bn were granted by the EU and other backers, it would create a totally unsustainable debt situation for the country.
Hence, loans of €10bn are being given and most of the remainder will be made up by this once-off savage attack on depositors. As well as this deposit levy, further measures have been agreed – these include a fiscal consolidation of 4.5pc of GDP (roughly 20pc in Ireland), the privatisation of state assets, a withholding tax on capital income and an increase in the corporation tax rate.
In Ireland's case, the fiscal adjustment is massive, but depositors were not attacked, although pension-holders were with a totally undesirable, unfair and potentially disastrous pension levy. In the case of Cyprus, the fiscal adjustment is smaller, but depositors are making up most of the rest of the adjustment.
It is, of course, possible to argue that imposing a levy on deposits is just taking money from people who have it, whereas the fiscal adjustment process could end up taking money from many who might not be able to afford it.
However, the reality is that the domestic deposits in Cyprus consist of after-tax income and so this levy is a savage form of double taxation.
The decision to impose a levy on depositors creates a very dangerous precedent. Cyprus is not the only country in the eurozone in serious trouble, and depositors in every other eurozone country with banking and debt problems must now be very fearful.
If this legalised robbery is good enough for Cyprus, then God only knows what else is possible. This weekend marked a dangerous phase of the crisis, and the closure of the Cypriot banks until Thursday is an indication of just how risky it is.
Once any state starts to dip into personal assets with the backing of the EU authorities, confidence in both can be very quickly eroded with potentially disastrous consequences.
Could we now see the renewed spectre of depositors moving their deposits out of the eurozone banking system? Of course we could, unless the Cypriot parliament manages to get an amended deal today. The risks to the stability of the eurozone banking system have been moved up a notch by this crazy development.
Jim Power is an independent economist