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Victoria Mindova

After the Cypriot government has unanimously rejected Europe’s proposal to impose a tax on bank deposits to save the financial system of the country, it is now discussing an alternative rescue plan for the local economy.

The first data show that the government will sacrifice one of its biggest banks, namely Laiki Bank, to save two billion euro. It will also throw into the fight the assets of the social security funds in the country. They have about 2.8 billion euro in reserve, which will allow the country to impose a tax on some deposits (1% -2%) significantly lower than set in the original plan in order for it to raise 5.8 billion euro. Against this amount, Cyprus will receive additional financial support of 10 billion euro from Europe and the International Monetary Fund, and the European Central Bank will not stop the liquidity to these Cypriot banks, which will survive after the reform.
 
Economic expert and professor at the University of Athens Panagiotis Petrakis is analysing the recent developments of the financial crisis of Cyprus and making his forecast of the future developments for the readers of GRReporter exclusive.

What do you think about the Cypriot government’s plan B?

The new form of the Cypriot government’s programme of financial support is much more satisfactory than the plan agreed during the meeting of Eurogroup. The new plan may contain certain hard decisions such as the reform of Laiki Bank but it is more acceptable in practice. Of course, we should not forget that it is not yet clear which scenario the government will choose – to sell the bank or to divide it into a "good" and a "bad" part. Another option is to divide it into two parts and sell the healthy part of the assets and liabilities of the financial institution. Whatever the method of reform, the most important thing remains that the government aims to reduce the burden of cuts of deposits, which should be offset.

In other words, Cypriots have achieved their goal of not seriously affecting the deposits of large depositors. Whether this is correct is another matter. The important thing is that they have achieved to some extent their initial aims. The programme will not burden the Cypriot economy so much and now the picture is better than before.

The most serious criticism I can make is that this decision could have been taken a week ago. My question is, "If there had been another solution, why didn’t they find it at the meeting of finance ministers before last Monday?" I think this was due to a rulers’ weakness and the financial system of the country fell victim to it. However, now there is a solution but the damage has been already done.

Banks in Cyprus will remain closed for over a week. How will this affect the local economy?

It is outrageous for the functioning of the market and the economic system as a whole. Once the banks reopen, there certainly will be exports of capital to the north. This will affect not only Cyprus, but also Greece and the European periphery as a whole. The capital will turn to safer markets.

However, do not imagine that this will be a mass movement of capitals; there will be no dramatic change in the situation either. There will be damage, but it will not be tragic. I insist, however, that if the decision had been taken earlier, the problems today would have been much smaller. Apparently, Cyprus had to go through various emotional and rational development stages in order to reach a more mature decision.

To what extent will the developments in Cyprus affect the Greek economy?

The economic relations between Cyprus and Greece are quite close, but they are not so important if we take into account the volume of the Cypriot business involved in the total volume of the Greek economy. What we are seeing now will have some negative effects, but it will have a positive impact as well. Part of the capital in Cyprus will be transferred to Greece, because we should not forget that the Greek financial system is secured by a support mechanism. Greek banks have been recapitalized. Ultimately, there will be a negative effect but it will be insignificant.

The new plan of the Cypriot government to raise 5.8 billion euro includes the capital accumulated in the social security funds of the country. Isn’t there a risk of the people losing their pensions and insurances?

We, the people from the European south are used to losing our savings (he is laughing).

Seriously speaking, I can say that the use of social security funds is a choice between the present and the future. When the government chooses to use the assets accumulated in social security funds, it chooses to restore the balance to some extent now at the expense of future generations. Policymakers often have to choose between the present and the future. There should be a balanced formula that should not harm the two sides too much. In Greece, for example, the present and the future as regards the funds have lost very much. Cyprus can achieve the balance and avoid the Greek situation.

In the world economic history, social security funds have often been used to absorb similar financial shocks. I think there is not a serious threat to pensions and insurances if a moderate pattern is applied.

So, you do not think that the use of the capital of social security funds will have a negative effect?

I repeat that this decision brings with it both positive and negative consequences. The positive are that this capital will mitigate the effects of the financial recovery programme whereas the negative are that you make the future generations poorer. Now, Cyprus has to make a political choice that will strike the balance between the two.

The Cypriot economy has relied on banking and tourism so far. How will the Cypriot economic model develop after the changes in your opinion?

Don’t imagine that banking services will play a lesser role in the Cypriot economy than before. We can say that the development of the Cypriot economy will slow down but the model will continue to function. Volumes may be lower, but nothing dramatic will happen.

However, all the fuss about Cyprus' financial problem cannot but bring negative consequences for the country and even the euro zone. What do you think is the worst scenario?

The worst scenario is behind us. The decision to impose a poll tax on deposits under and over 100,000 euro was the worst possible scenario that could have been introduced in Cyprus. From now on, everything is better. I think the dramatic shock will be avoided if the Parliament passes Anastasiadis’ alternative and Eurogroup approves it. My predictions are that the deputies will adopt the plan and the euro zone finance ministers will welcome it as well.

Will Cyprus raise 5.8 billion euro in this way?

In addition to reforming the banks, there will be a tax on deposits, which will not be a toll tax. It will affect only some deposits and mainly those exceeding 100,000 euro. The money from social security funds will be used too. I think the country will be able to raise the necessary funds.

Greece needed financial assistance because its deficit was very high and it was unable to serve its external debt. Cyprus’ macroeconomic indicators are significantly better than Greece’s. Why did Cyprus come to seek financial support from Europe and the International Monetary Fund?

The problem started with the "voluntary" reduction in the face value of Greek government bonds. It affected the Cypriot banks and broke the balance of the local economy.

The need to recapitalize Cypriot banks would have increased the external debt very much and it would have taken Cyprus out from capital markets lending. This would have driven the country to borrow more money to cover the recapitalization needs of the banks and to pay the bond loans with maturity in this period. This has led to the need for Cyprus to take financial aid from Europe, although its macroeconomic performance is relatively good.

We cannot compare the situation of Greece to that of Cyprus. The Greek case really is a precedent as regards the volume and the seriousness of the situation. I will repeat myself, but it is important to understand that if plan B, as it is called, had been adopted last week, the crisis would have been overcome with greater ease and more decisive dynamics.

Do you think the stage of "cutting all deposits" was only a political move rather than a real solution to the difficulties of the Cypriot economy?

I think so. Regardless of the political side and the interests embodied, I think that Cyprus played its role in the process. The government could have introduced a limited programme of fiscal consolidation, as all countries do in a similar situation, to mitigate the negative effects but that did not happen in time.