EU/IMF Grants Cyprus €10 Billion

As we reported recently, Cyprus needed a bailout to ensure that the nation could continue to honour its obligations. Without the bailout, Cyprus faced a disorderly default and potential bankruptcy as early as May. An agreement was reached at the end of last week which would secure €10 billion of funding from the EU and IMF – the deal requires some parliamentary ratification before coming into force.

The move should have been warmly greeted by markets as shoring up the third smallest Eurozone economy and, arguably, consigning the sovereign debt crisis to history, but it has just stirred up a hornet’s nest. Germany was vociferous over its concerns that Cyprus had to do more to prevent its financial institutions from money laundering. Russian nationals hold a very substantial proportion of money on deposit in Cypriot banks and the concept of Russians benefitting from a Eurozone bailout was thought to be unpalatable in Germany; particularly in an election year.

In the end, the bailout comes with an unusual twist; depositors (ordinary citizens) will be required to pay a one-off tax as a contribution to the bailout. Anybody with less than €100000 will be required to pay 6.5% with depositors holding more than this sum paying a 9.9% tax. EU law guarantees funds on deposit in banks, but does not protect them from national taxes. The Cypriot authorities will issue depositors with shares in their banks to the value of the tax.

The tax was unforeseen and has led to mass withdrawals of funds (but only the residual funds –i.e. less the tax- are available) and is hugely unpopular with Cypriots. It may be that the tax structure is altered to protect small depositors by applying the tax above a certain threshold, but this has to be seen.

The Euro has fallen by 3% against the Yen on the news and has slipped to a 3 month low against the Dollar. Asian markets have also fallen as fears mount that this could reignite the European sovereign debt crisis – it is likely that these fears will prove unfounded. In any event, this was an own goal that the EU and IMF could ill-afford to concede at this stage of the game.