On the 27th of January Dr Michael Sarris[1]
gave a very lucid account into the functioning of the Eurogroup, as was
experienced by the Cypriot delegation during the two meetings of March 2013.
The first meeting resulted in a decision for a bail-in of Cypriot banks by all
depositors and the second decision of bail-in from depositors with deposits of
over 100,000 euro.
He highlighted that the current narrative is based on
looking only at some of the symptoms of what is wrong with the European construction
and not at the underlying problems. He believes that many Member States took
seriously the benefits of the Eurozone and less seriously the obligations
emanating from being a member. However
the Eurozone architectural construction had shortcomings that were not
addressed, as for example, the lack of a mechanism to control imbalances, in
both surplus and deficit countries. “When we realised that they were a lot of
fires burning – we concentrated on rules to avoid new fires from developing,
rather than to put out existing fires.”
Crisis mismanagement and a faulty decision making process are at the
heart of the Eurozone’s continuing troubles.
He identified two main flaws in the decisions taken to
address the euro-crisis:
First, the introduction of credit risk in government debt
(Deauville October 2010) and of spreads in the borrowing costs Southern
Eurozone States in 2011 following the announcement of a bail out for
Greece. This meant that Eurozone
countries were borrowing at different, for many much higher, rates;
The second was the introduction of risk in the relations
between depositors and banks which resulted from the March 2013 Eurogroup
decision on Cyprus.
He noted that in a similar situation with respect to Ireland, the option of a bail-in was rejected. Both of these decisions are testimony that “made-to-measure” decisions are taken for political reasons rather than the uniform application of the rules. In his assessment, from the first indications of the euro crisis until July 2012, progress was made in addressing the problem, but after July 2012 the euro crisis was caught up in the German elections and the progress was derailed. In fact “politics took over economics”. The path towards creating a banking union is a prime example of this process.
More specifically with respect to Cyprus, until 2008, it had
problems which were disguised behind respectable growth rates, social stability
and almost non existent unemployment. However, there were also serious problems,
such as lack of competitiveness, but this was partly shielded by the large inflows
of funds from Russians, there was big credit expansion and a real estate
bubble. Everybody on the island was euphoric at the time.
Cyprus in 2007 was 1st with the highest primary budget
surplus from all the Member States running at 5.5% of GDP. Following a spree of
government spending, by 2009, Cyprus was in the 17th place. Consumption was
encouraged rather than investment. By May 2011, Cyprus was shut out of the
financial markets. A series of missed opportunities to ask for help from
Brussels followed – including at the time of the Greek bail-out since Cypriot
banks had 50% of their business in Greece and lost several billion euro
overnight with that decision or following the massive explosion of the power
station at Mari in July 2011.
By the time that Cyprus did ask for help in the summer of
2012 – this was refused. At that time, both the IMF and Germany were adamant, that
they were not going to allow this since they believed that lending more money
would make the debt unsustainable.
In February 2013, following the Presidential elections, the
new government within days of being sworn-in tried to negotiate support. Two
dramatic Eurogroup meetings followed in March 2013, during which a “staggering
lack of collegiality” was demonstrated by the other Member States and during
which despite the private discussions of sympathy no statements were made by
any Finance Ministers for the defence of Cyprus. With the Eurogroup decisions, Cyprus
found itself in a terrible situation and shock waves hitting not only Cyprus
but markets throughout Europe. Undermining confidence in the banking system in
Cyprus was a serious blunder with lasting consequences.
Cypriot economy is without a doubt going through a very
difficult time but is has been weathering the storm better that was expected
and already some positive indicators can be seen: Cyprus is keeping on track
with the reforms identified by the Troika and the economic indicators are much
better than those forecasted even though still in a difficult situation. Hope
is also based on the prospects of Cyprus to be an energy exporter in the next
years.
Max Watson[2] in his analysis
focused on what he called the “staggering lack of collegiality” that was
evident in what happened in Cyprus and that this is not “healthy” for the EU. He
considers that three waves of mistakes were made: the surplus was left to erode
sharply; they delayed action and took no measures when Russian loan came in
2011; and the Central Bank’s total lack of measures to counter the problems and
particularly the real estate bubble.
Max analysed the mistakes of Cyprus, which in fact were not
that different from mistakes made in Ireland or even the US. However, what was
different was the scale of banking losses relative to GDP. When the IMF then
decided to set a limit on the public debt ratio of 100% of GDP in the case of
Cyprus – which in the case of Greece was set at 120% – this had dramatic
implications for the kind of solution that could be envisaged for the island.
With respect to lessons learned, there is no prior case where a bail-in has
been applied to bank deposits in such a way, in an international rescue package
- possibly except for the case of Costa Rica in 1986.
In his concluding remarks, Max said that the difficult
question for the future is how far Cyprus constitutes a precedent. Clearer
rules on bank resolution are now being put in place across the EU, and the
taxing or haircutting of small deposits seems to be ruled out for the
future. But there were also objections to the Cyprus 'business model'
- apparently referring to the size of the banking system relative to GDP
(not just to allegations of financial crime). Would this business model concern
be a template for the future? Would it be applied to all countries
alike? And how about the public debt limit being set as low as 100%
of GDP: what does this imply for other future cases? These are very important
issues, and they seem to remain unclear, which is troubling.
Androulla Kaminara[3]
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