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Cyprus crisis: What happens next? Cyprus crisis: What happens next?
(2 days later)
Cyprus, one of the smallest members of the European Union, has become the latest high-profile casualty of the long-running eurozone crisis.Cyprus, one of the smallest members of the European Union, has become the latest high-profile casualty of the long-running eurozone crisis.
The Mediterranean island agreed a bailout deal with European authorities and the International Monetary Fund (IMF) at the weekend. A bailout deal worth 10bn euros ($13bn; £8.5bn) was agreed with the EU and the International Monetary Fund (IMF) last week. But since then the Cypriot parliament has rejected the proposal of a one-off levy on people's bank savings.
But on Tuesday, Cyprus's parliament voted to reject the deal, which would have taken a percentage of people's bank savings to raise 5.8bn euros towards the bailout. Cypriot authorities are now in a race against time to agree an alternative plan that will raise the 5.8bn euros it needs to unlock the bailout funds before a Monday deadline set by the European Central Bank (ECB).
That has left Cyprus in crisis. If it fails to agree a bailout, its President, Nicos Anastasiades, warns the country will default, the banking system will collapse and it may be forced to exit the euro. So what happens next?
So what could happen to Cyprus now? Perhaps the worst-case scenario is that a bailout deal is not agreed by Monday, and the ECB cuts emergency funding to Cyprus's two biggest banks, as it has threatened to do.
Perhaps the worst-case scenario is that a bailout deal is not agreed and Cyprus will essentially declare itself insolvent, and its banking system will collapse. That would probably cause the Cypriot banking system to collapse, leading to the effective bankruptcy of Cyprus's government, and possibly its exit from the euro.
Cyprus's government cannot afford to bail out its banking sector, and international investors are refusing to lend to it, so without a bailout, it cannot pay off its debts. There is no official mechanism by which euro members can leave the single currency.
Furthermore, Cyprus's two biggest banks are reliant on the European Central Bank (ECB) for emergency funding to keep them afloat, and the ECB has let it be known that this funding is contingent on a bailout plan being implemented. But if the banks are allowed to collapse, Cyprus will be left without a functioning banking system, no willing creditors and an economy in crisis.
President Anastasiades warns that Cyprus will also be forced out of the euro, although there is no official mechanism for exiting the single currency. The ECB's move would leave the government with little choice but to exit the euro so that it could begin printing its own money in order to provide the banking system with liquidity.
The impact of a default for the wider eurozone is unclear. Investors suggest the relative small size of Cyprus's economy means the "contagion" risk is low, and the crisis has yet to unsettle European markets. Leaving the euro would also allow it to devalue its currency to help exporters, further boosting the economy.
On Tuesday, President Anastasiades held talks with MPs aimed at coming up with an alternative plan that may get the parliamentary seal of approval. What impact that would have on the wider eurozone is unclear. The risk of direct contagion to other economies is small, as European banks are not heavily invested in Cyprus's relatively small economy.
Further talks with the EU, the IMF and the ECB are scheduled, while the Cypriot finance minister is in Moscow, looking for possible assistance. But more widely, the exit could cause a loss of confidence in the eurozone project. Investors may consider withdrawing from Greece and other struggling euro members now that a euro exit is perceived as a real possibility.
It was the planned levy on bank deposits that provoked the most anger among MPs and the Cypriot public. Equally, if Cyprus recovers quickly from its current crisis outside the euro, other members may question the value of eurozone membership.
But unless the government can find another way of raising that money, they may have to stick with the levy - but perhaps charge those with the biggest bank deposits more. Cyprus's politicians are still trying to hammer out an agreement through which they can raise the 5.8bn euros demanded by the EU and IMF.
That would be likely to hurt Russian customers the most. They are believed to hold some 20bn euros of deposits in Cypriot banks. With the initial plan to impose a levy on all bank deposits rejected by parliament, a number of alternatives have been suggested.
European creditor countries such as Germany would support this, as they are feeling political pressure to reduce the amount they spend bailing out their southern European neighbours. They have included:
This may have a wide impact on the eurozone, however. Some analysts have warned that bank customers in other European countries may begin to fear that their savings will also be targeted, should their economies run into trouble. On Friday, Cypriot President Nicos Anastasiades again held talks with the EU and the IMF, while the Cypriot parliament was still waiting to vote on the latest proposals.
If Cyprus decides there will be too much opposition to the levy, it may decide to drop it. But hopes that Russia could come to the rescue appear to have faded: Cyprus's finance minister returned from talks in Moscow on Friday empty-handed.
This would mean finding the 5.8bn euros from another source. Even if the 5.8bn euros are raised and the bailout package secured, the outlook for Cyprus is bleak.
One option could be to ask Europe for a more generous bailout package, meaning that less money needs to be raised domestically. The bailout will come with austerity requirements. Confidence in the banking sector has been knocked and there may yet be a run on Cyprus's banks should their doors eventually re-open.
Despite the growing resentment in northern European countries against bailouts, the authorities may be amenable to this. It was the planned levy on bank deposits that provoked the most anger among MPs and the Cypriot public when the initial bailout deal was agreed a week ago.
The bank deposit levy is unprecedented in eurozone bailouts so far and there is widespread concern that European authorities made a big mistake in insisting on it. They may be prepared to row back. But unless the government can find another way of raising that money, they may have to stick with it - but perhaps in a revised form that charges those with the biggest deposits the most, while protecting smaller savers.
It is also helped by the small size of the current Cyprus bailout (10bn euros) compared with Greece's two bailouts, for example, which totalled 240bn euros. That would be likely to hurt Russian customers the most. They are believed to hold 20bn euros of deposits in Cypriot banks.
A more generous EU deal could come with more onerous austerity measures, however. Given the resentment already present among Cypriots, harsh austerity measures may be difficult to push through. European creditor countries such as Germany would support this as they are feeling political pressure to reduce the amount they spend bailing out their southern European neighbours.
If Europe refuses to offer any more money, Cyprus could try to raise cash through measures like nationalising its pension funds - a move that could raise 3bn-3.5bn euros. This may also have a wide impact on the eurozone, however. Some analysts have warned that the measure would set a dangerous precedent in the world of eurozone bailouts.
But an alternative source of money could come from Russia. In previous rescues, individual accounts have been protected and governments, private investors and banks have picked up the tab. Bank customers in other European countries may begin to fear that their savings will also be targeted should their economies run into trouble in the future.
Russia has already lent Cyprus 2.5bn euros and Russian depositors hold large amounts of cash in Cypriot banks. The unpopularity of the bank levy may also increase public pressure on the Cypriot government should they pass this measure, which would make it difficult to pass the austerity measures that are also required by the bailout deal.
Its leaders have protested about not being involved in the bailout negotiations, and they are angry that Russian customers will be targeted by the proposed levy of deposits. The EU has so far played tough with Cyprus, demanding a deal by Monday and reacting coolly to some of the proposals so far.
MPs have voiced concerns that agreeing to the European deal would drive Russian customers - a crucial source of income - away from the island. But if the EU feels the game of brinkmanship is failing to generate a solution to the Cyprus crisis, it could offer a more generous bailout package, meaning that less money needs to be raised domestically.
Cyprus's Finance Minister, Michalis Sarris, has been in Moscow for emergency talks, but there has been no agreement so far. Authorities may be amenable to this as the bank levy proposal is being increasingly seen as a policy mistake, and the threat of a euro exit too great a concern.
One possible plan is that Russia could take big stakes in Cypriot banks in order to prop them up, or offer another loan. The Cyprus bailout is also relatively small (10bn euros) compared with Greece's two bailouts, for example, which totalled 240bn euros.
Either way, Cyprus faces a difficult economic time ahead, and time is running out to prevent the country's disastrous economic collapse.