And then there were five! On Monday, the eastern Mediterranean country of Cyprus edged out Italy and became the fifth member of the Bailoutstreet Boys! It formally asked for external funding from the EU to shore up its finances.
But before we get ahead of ourselves, let me first give you a quick background on Cyprus.
Aside from its beautiful beaches, did you know that the small island state neighboring Greece joined the European Union in 2004? It then finally adopted the euro as its currency on January 1, 2008.
When the financial crisis broke out in 2008, Cyprus was actually one of the few nations that lagged in showing signs of stress. It wasn’t until 2011 that major problems in its banking sector were highlighted as its exposure to Greek debt surfaced. Its budget deficit also rose to more than twice the EU’s limit (3% of GDP) at 7.4% during the year.
Since then, the country has seen its bonds downgraded to junk status by the three most renowned credit ratings agencies, Moody’s, S&P, and Fitch.
And so, it wasn’t much of a shock to investors that this country of about 1 million people finally knocked on the doors of the EU. It has already been struggling to get cash flowing through the economy. Analysts say that the government has only managed to get by because of the 2.5 billion EUR loan it received from Russia last year.
The Cypriots have been keen on avoiding the EU and IMF for funding. They don’t want to end up like Greece and Ireland who had to agree to tough budget cuts and austerity measures in exchange for money. It would seem that Cyprus was not ready to let go of its low 10% corporate tax rate which has attracted foreign businesses to set up in the country.
But, as the saying goes, desperate times call for desperate measures. Cyprus doesn’t have much of a choice but to seek help from the EU now that there’s a looming deadline for them to provide funds to its second largest lender, Cyprus Popular Bank. Since the inception of the Greek debt drama, this bank has been chalking up huge losses as it is heavily exposed to Greek government debt.
Neither the private sector nor the government seems willing or able to lend a helping hand to Cyprus Popular Bank, which means that they have to turn to the EU in order to secure roughly 1.8 billion EUR in funds, an amount equivalent to 10% of its GDP.
Bear in mind that other banks in Cyprus also hold massive amounts of Greek debt summing up to 23 billion EUR, when its entire economy is worth only 17.3 billion EUR. Imagine how much damage a Grexit could cause to Cyprus!
It doesn’t help that Cyprus’ economic picture isn’t exactly very rosy. Their economy is projected to contract by 1% this year as rising government debt, worsening bank troubles, and increasing unemployment seem to be a recipe for disaster. In fact, credit rating agency Fitch estimated that Cyprus’ government debt will swell to more than 100% of its GDP and that trimming the budget deficit below 3% of its GDP would be close to impossible.
Putting things in perspective though would reveal that the amount of bailout funds Cyprus needs is actually just chump change compared to what Spain is begging for. Analysts estimate that Cyprus would need anywhere around 5 to 10 billion EUR, only 10% of the 100 billion EUR that Spain needs for its banks.
Although Cyprus is asking for so relatively little and their economy comprises a small chunk of the entire region (it’s the third smallest in the euro zone), the EU really shouldn’t underestimate the threat of a full-scale bank run and debt contagion in this country. Perhaps Cyprus’ case could give German Chancellor Angela Merkel enough reason to reconsider giving euro bonds a try.
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