A “bad haircut” or a necessary bail-in? Economists debate the Cyprus debt crisis at Columbia University
ΣΧΕΤΙΚΑ ΑΡΘΡΑ
By Ellie Ismailidou
“Oh, you are from Cyprus?” said the Vietnamese barista in Toronto to a Cypriot university professor reaching for his Cypriot credit card to pay for coffee. “I wouldn’t take money from your bank right now.” Stavros Zenios, a professor of public and business administration at the University of Cyrpus, told this anecdote with bittersweet humor Monday night to a diverse audience of students, diplomats and businessmen at Columbia University’s School of International and Public Affairs (SIPA).
His experience is indicative of the confusing situation around the Cyprus debt crisis. A small Mediterranean island of merely 860,000 citizens, Cyprus managed to shake the world’s markets and gain international notoriety when it had to reach a last-minute $13 billion agreement with the European Union and its international creditors on March 25th.
Yet as the international community has its eyes on Cyprus, how much does it really understand about the causes of the Cyprus debt crisis? And how effective has the solution, the notorious bail-in that saved the country’s ailing banks and averted the country’s possible exit from the Eurozone, been for Cyprus’s recovery?
These were some of the questions that Zenios, a former tenured faculty member at the University of Pennsylvania’s Wharton School, tried to address during his speech during the event hosted at SIPA yesterday.
Zenios named the Cyprus debt crisis “the perfect crisis” – an allusion to the perfect storm – because of key characteristics of the Cypriot economy: declining competitiveness; increasing debt overhang of businesses and households; a society that was “living beyond its means,” and most importantly, a banking sector with assets as high as eight times the country’s GDP, which relied mainly on what Zenios called “hot money,” namely “money that is coming in and out of the banking system.”
Zenios highlighted the fact that a high sovereign debt or a gigantic banking sector are not ailments for an economy in and of themselves. “You can have a big debt, as long as you keep your debt-per-taxes ratio low,” he said. “Relying heavily on the banking sector is a problem only when banks are not regulated.”
Under these circumstances, could Cyprus have learned from the ordeals of other EU member states with similar financial struggles, such as Greece or Ireland? “Ireland and Cyprus had something in common, unlike Greece: they did not start off with a big sovereign debt,” said Seamus O’ Cleireacain, a panelist at last night’s event and a professor of economics at City University of New York and at Columbia.
Both Ireland and Cyprus were eventually shut out of capital markets, said O’ Cleireacain. But Cyprus, he added, was not nearly as quick as Ireland to react. “When you are facing this type of conditions, you don’t have the world media talk about ‘prolonged negotiations’ and you comply with the creditors’ requests. This is what Ireland did by setting the paradigm for the ‘golden boy of austerity’,” he said.
However, in Ireland’s bail-out, the government provided a 100 percent guarantee of all bank creditors, depositors and bond holders, said O’ Cleireacain. Whereas, in Cyprus’s case, the so-called bail-in stipulated that bondholders and savers with more than 100,000 euros ($130,460) in their accounts at the country’s two largest banks would be forced to take losses.
Also, as Zenios pointed out, due to the bail-in Cyprus became the first Eurozone member country to impose capital controls inside the monetary union, namely restrictions of the amount of money that businesses and individuals can transfer domestically or abroad without prior approval from monetary authorities. At the beginning of April, the limits were 25,000 Euros ($32,615) for domestic transfers and 5,000 Euros ($6,523) for international transfers.
Due to these elements, the bail-in agreement had important negative implications, according to Preston Keats, a member of yesterday’s panel and an executive at the Swiss investment bank UBS, who specializes in political and country risk assessment.
First, by forcing depositors to lose part of their money to save the ailing banks, the agreement sets a precedent for deposit haircuts and eventually will lead to depositors’ flight to other countries, said Keats.
Second, by imposing capital controls, the agreement creates the perception that depositors will not be able to freely move their money in and out of Cyprus’s banks in the future. Therefore, it further encourages capital flight, he added.
The panel’s moderator Alexis Antoniades, an assistant professor of economics at Georgetown University, pointed out that the imposed austerity has the potential to kill growth, while banks are still faced with the possibility of insolvency.
“People from foreign countries will not be likely to invest in Cyprus when there is even a minor risk of Cyprus leaving the Euro,” he concluded.
“It looks like the bail-in agreement basically tells investors to move their money to U.S. or Swiss banks,” mentioned Zenios towards the end of the event.
He called the agreement a “bad haircut” and said that it is a prime example of “bad politics getting in the way of good policy.” He concluded that as a result, the IMF projections for Cyprus’s GDP growth went from negative 3.5 percent before the haircut, to a current negative nine percent.