Winners and Losers

In the early Monday morning hours in Brussels, the EU/IMF agreed to bail out Cyprus, thus avoiding an imminent collapse of the Cypriot banking system when the banks re-open later this week. Stock markets throughout the world initially rallied, from relief. But the euphoria has faded through the day, after the Dutch Finance Minister (head of the Eurogroup) said the Cyprus rescue represented a new "template" for resolving euro-zone banking problems, and that other countries may have to restructure their banks. A new European "bail-out", "bail-in" regime has apparently begun.

Given the composition of the Cyprus deal, it is clear that the Germans, with the IMF by their side, prevailed in the negotiations, with their insistence that, as a condition of a bail-out loan being advanced from the EU, there be in addition a "bail-in" of, at least, large depositors in the Cypriot banks. Russians, on the other hand, who hold the bulk of these large deposits (large defined here as over 100,000 euros) are furious -  Russia's prime minister, Dimitry Medvedev, was quoted by news agencies as telling a meeting of government officials that "in my view, the stealing of what has already been stolen continues".

Here's the essence of the final loan package: The EU/IMF will loan 10 billion euros (of the 17 billion needed) to the Cypriot government. Cyprus's commercial banking system is not being bailed out, but rather completely restructured, with one of the two principal banks, Laiki Bank, being liquidated, with its viable assets and insured deposits (under 100,000 euros) going into a new "good" bank. The remainder, including deposits over 100,000 euros, will go into a "bad" bank. The "good" bank will then be blended into Cyprus's other main bank, Bank of Cyprus, which won't be closed, but rather recapitalized by forcing bondholders to take a cut, and imposing a tax on uninsured deposits (over 100,000 euros), reportedly as much as 30-40%. Moreover, what's then left of the "large" deposits must remain in Cyprus, as the government introduces "temporary" capital controls. All this is designed to raise an additional 5.8 billion euros. to total a full rescue package of 17 billion.

With this dramatic shrinking of its banking sector, and with the imposition of capital controls, Cyprus's status as a largely-unregulated, offshore financial centre is suddenly gone. Its economy, already in recession (it declined 2.3% in 2012), will weaken further, especially as austerity measures accompanying the EU/IMF 10 billion loan are implemented. A Greek-style GDP slide (20% drop in 5 years) is not improbable. Cyprus's formidable offshore Aphrodite natural gas field (to which Turkey also claims territorial rights)  doesn't come on-stream until later this decade, and there is nothing else on the island, with financial services gone, that could spark economic growth until then (unless the Turk and Greek Cypriots finally agree to ratify the Annan Plan, reuniting the island into one nation and one economy).

Ironic, then, that Greek Cypriots today are actually celebrating the annual holiday that recognizes Greek independence - from the Ottoman Empire in 1832. The Republic of Cyprus will now be, for some years to come, utterly dependent on new foreign powers - the European Union and other international lenders.