CYPRUS IS heading towards its own ‘fiscal cliff’, needing to find around €2.1 billion in maturing debts by July, or else face default, one economist said yesterday.
Speaking at a seminar on the eurozone debt crisis with special reference to Cyprus, economist Fiona Mullen said Cyprus faces a “hard deadline” on June 3 when it needs to find over €1.4 billion in maturing Eurobonds and a further €714m by July 4 for maturing government-registered stocks.
“If we can’t pay that then we go bust and then we’re not just junk status we’re basket-case status, It takes a very, very long time to get back from default status,” said Mullen at the event organised by the European University Cyprus.
According to Mullen, there are three main obstacles to an international bailout following a preliminary agreement reached with the troika in November 2012: German opposition; the size of the Cyprus economy, and debt sustainability.
German opposition to a bailout is mainly due to upcoming elections in Germany but also, a touch of envy regarding the 80-plus German shipping companies based in Limassol. This opposition from our EU partners remains the “biggest risk” for Cyprus, she said.
“The German press is really scathing about Cyprus, and without question, says that it’s a centre for money laundering, regardless of any international reports on Cyprus or its record,” said the director of Sapienta Economics.
A second issue is the question of whether the Cyprus economy is “too small to bother”. The German finance minister has recently questioned whether it even poses a systemic risk to the eurozone, a precondition to any EU bailout. The European Commission and European Central Bank (ECB) are with Cyprus and against the Germans on this point.
The third issue is debt sustainability and whether, mainly, the IMF believes Cyprus can pay the debt back.
According to Mullen’s forecasts, Cyprus’ public debt to GDP ratio will reach 135.8 per cent in 2016, assuming the recapitalization needs of Cyprus’ banks are estimated at €10 billion, and the EU/IMF/ECB troika agrees to lend Cyprus €17.5 billion soon.
“The good news is we only need to find €3bn to bring it to 120 per cent of GDP, a figure which the IMF seems able to live with,” she said.
The economist weighed out the pros and cons of the options laid out before Cyprus.
One is for the EU to lend directly to the banks through the European Stability Mechanism (ESM). However, this would never materialise before June, making it a non-option for Cyprus.
A second option is a Greek-style haircut on bonds which raises many legal questions as Cyprus comes under different laws than Greece.
American academics and legal experts Mitu Gulati and Lee Buchheit yesterday argued at the seminar that these legal obstacles were not as insurmountable as people might imagine, suggesting ways to “persuade” creditors averse to anything other than a full repayment of debt to reconsider their position.
The two also suggested a haircut now on bonds owned by the private sector would make more sense than waiting until further down the line to implement a writedown on debt that has “migrated” to the hands of the EU taxpayer (assuming Cyprus is bailed out by the EU and pays off its debt using ESM funds).
Regarding a possible writedown on government bonds, Mullen argued that this could only really apply to Eurobonds, the total outstanding debt for which comes to €3.8bn. From that amount, €1.3bn is held by local banks.
Assuming a 75 per cent haircut was made possible, a writedown of bonds held by local banks would basically increase their recapitalization needs by nearly a billion euros.
So, the net effect of a writedown really affects the €2.5bn in foreign-owned Eurobonds, which saves the state around €1.9bn.
A third option is a deposit haircut which Mullen described as “scary”. Since the government guarantees all deposits less than €100,000, a haircut could only be applied on any deposits that exceed that amount, which at the end of 2011 came to about €35bn.
“A haircut on deposits will kill our banking system dead. The banking system survived an invasion and if you do this to it, it will kill off the professional services sector which is the only sector that’s been creating jobs the last few years,” she said.
A fourth and likely option is converting the bonds of junior bondholders (who claim they were duped by banks into buying the convertible bonds) into bank shares.
Mullen estimated this could raise €1.2bn for banks which would go straight into their core tier 1 capital, immediately knocking €1.2bn off the troika bill.
“It’s a political issue. Can you get away with it politically? How many were retail investors? How many were mis-sold?”
Regarding the proposal by presidential candidate Giorgos Lililkas to sell parts of Cyprus’ possible gas reserves, the economist argued the money would never come in time and would not be enough to meet Cyprus’ needs at this stage of the process in the energy sector.
Another likely option is privatisation of semi-government organisations like the electricity and telecommunications organisations and the ports authority. In the short-term this could potentially raise €2bn and in the long-term maybe fivefold that amount, if one overcame expected union dissent.
Buchheit countered, however, that privatisations are complicated processes that always take a lot more time than one estimates with the end result not necessarily in anyone’s favour. Privatisations are demanded by EU governments so they can turn to their electorates and say, look the recipient country is contributing with their own money to this bailout, said Buchheit.
A final option raised by all three speakers was to extend maturing debt by a few years. Instead of wiping out debt or cutting it down, Cyprus could convince its creditors that it will pay further down the line with interest.
In the short-term however, the new Cyprus president will need to decide on one of the above options or a combination of them to find the €3bn needed to convince the troika that its debt is sustainable, said Mullen.
Should the banks’ recapitalization needs be estimated at €9bn instead of €10bn, then this automatically goes down to €2bn.
“The new Cyprus president will have to choose the option with the least political cost. It’s a toss up essentially between convertible bonds and privatization,” she said.
