Commentary is wildly diverging over whether the Cypriot parliament’s rejection is a big deal or not. Surprisingly many articles predict something like Europe-wide bank runs, Russian Mafia killings, and what not. Frankly, I am not that worried, yet:
(1) While politically, the credibility of the Eurozone rescue is at stake, economically, this is a storm in a teacup. Financially, Cyprus is less relevant to Europe than Orange County was to the United States when it went bankrupt.
(2) The Cypriot parliament is unlikely to engage in a pure game of brinkmanship: They have the short straw, for if nothing is agreed, Cyprus is (now) bankrupt the moment people are allowed to withdraw their deposits. Greece, Spain, and others all had to find money from somewhere to contribute to their fiscal consolidation, Cyprus will not be allowed as an exception, not at this time (with a German election looming). So the Cypriot MPs will know they have to “find” €5.8bn somewhere fast.
The alternatives for the Cypriot parliament are:
- To make things more progressive: protect the small depositors more, and hit the large ones harder, and possibly also recruit unsecured debt holders for a haircut. They even have the option to keep the deposit guarantee of up to €100,000 in place. But in essence, the first alternative is to administer, in aggregate, the short sharp shock that was agreed over the weekend.
- If that fails, the second alternative is spread the pain in time, i.e. go down the route of even more austerity than already planned under the proposals. Not a good move, in Greece’s experience and in my opinion, but it can’t be ruled out that the Cypriot parliament opts for some nifty fiscal illusion that suggests Cypriots aren’t really paying when they are.
- If that can’t be agreed upon either, the alternative of finding the 5.8bn from existing creditors alone is purely academic. As Martin Wolf points out, unsecured bank creditors aren’t enough to solve the problem, and a voluntary sovereign debt restructuring at precisely the time the Cypriot banks need to be re-capitalized can only be pulled off with a long grace period by the ECB to finance the liquidity of a local banking system that will face a bank run. It’s unlikely anyone can pull this off now.
- The real third alternative therefore is default (or hoping for a magic wand from somewhere, which would amount to the same thing eventually).
The 5.8bn will not come from Germany and friends, for the threat that Cyprus has to pay its share, once it is made, cannot be easily withdrawn. Consistency and Reputation are very precious assets in any game, to the extent that it is rational even for madmen protect their reputation as madmen.
The deposit-haircut is not fair, in the sense that it creates unfair horizontal re-distribution among Cypriots. That is what the parliament needs to think about. And I see this as part of a functioning democratic process. They can take as long as they can muster keeping the deposits locked down, but no longer.
But of what are being painted everywhere as the Cypriot “horror”-scenarios, all three (short sharp shock, austerity, default) are eminently survivable for the Eurozone. What we must hope, however, is that the Cypriot MPs aren’t simply playing for time hoping for manna from abroad. Europe, the ECB, and the IMF have too much credibility at stake by now to go and say “these 5.8bn, we didn’t mean it”. They fear a different contagion, a contagion of leniency across the Eurozone.
Economically, recruiting deposit money and other creditors surely has to be less gruesome than totally unsustainable debt levels. Apart from the deposit guarantee on the first €100,000, which may still be saved, it is obviously permissible in principle: The deposits and the loans were made to private institutions, not the government. Any other fudge, whether it means more long-term liabilities for the Cyprus government than already planned in the current proposal, or a back-tracking of the EU, ECB, and IMF, will have longer-term, and more severe side effects than the immediate haircuts.
As long as the Cypriot parliament is clear that the 5.8bn must — on the face of it — come from Cyprus, we should all follow the democratic processes in Cyprus with relative calm. Creditors may yet be recruited to help out, and they should be. Only when there are signs that Cyprus is playing for time and nothing else, it’s time to worry. But there is absolutely no sign of that right now.