An alley in the Cypriot city of Nicosia.
Why is attention fixed on a dot-sized European country? Because what starts in Cyprus, a tiny isle of 1.1 million people, could soon spread to London or New York or Hong Kong, making misery for many millions more.
Cyprus has caused turmoil in world markets for the past two days, as its government debated whether to tax bank deposits. It eventually decided against the tax, but not before the mere prospect of it set off a run on ATMs and made observers worry that financial contagion could spread throughout the continent and then beyond. Below, a guide to understanding how this island�s outsized effects.
What would the tax have done?
A one-time tax of 6.75% on all bank deposits under 100,000 euros ($131,000). Deposits greater than that would receive a 9.9% tax. The tax would�ve raised 5.8 billion euro ($7.6 billion) to recapitalize banks and service debt.
Why�d the government want it?
To receive a 10 billion euro ($13 billion) bailout, President Nicos Anastasiades agreed to the taxes. Cyprus badly needs foreign aid, and a deal has been in official discussions since June. The complexity of any package delayed it, as did the opposition from Anastasiades� predecessor. The money, in part, comes from the Troika: the International Monetary Fund, European Commission and European Central Bank. But the tax on depositors ensures a major portion comes from Cyprus too.
And here�s the larger picture. Cyprus is badly indebted. Its debt-to-GDP ratio pushed to 127% in the third quarter of 2012, the latest period tabulated by European Union officials. Such high debt reflects Cyprus� ill financial health. Only Greece (at 153%) has a higher level. The bailout would begin to reduce its debt, sending it back below 100% of GDP within the year.
Cyprus is in a particularly bad position because much of its economy is tied to neighboring Greece, the host of its own monetary problems. Making it worse, Cyprus was a major Greek bondholder, so when the second Greek bailout package went through last year, it caused a 4.5 billion euro ($5.9 billion) hole in the Cypriot budget.
And now it�s not happening?
Despite Anastasiades� best efforts to push the measure through parliament, it failed to muster the necessary votes. Indeed, not one member of parliament voted yes. (There were 36 voting no and 19 abstaining.) The opposition party had suggested asking Russia or China for the money instead of accepting the Troika�s deal. Anastasiades eventually floated a new proposal: banks accounts under 20,000 euros ($26,000) would be exempt. He must try to strike a new deal for Cyprus that would stave off default.
How unpopular is this in Cyprus?
An understatement. It�s deeply, deeply unpopular. Cypriots made a run on all available ATMs this weekend, depleting cash reserves across the country. Cyprus, in response, also suspended electronic transfers.
So a depositor�s money is just gone?
They�d be compensated with bank shares. Yes, stock in the banks that are basically bankrupt now. What�s more, depositors who keep money in Cypriot banks for at least two years would receive government bonds that compensate their losses. Cyprus eventually expects a windfall of revenue from newly discovered natural gas deposits.
Is there any precedent for this?
Well, when we�re discussing tiny European islands containing potentially destructive forces, Elba in the early 19th century seems a close parallel.
Financially speaking.
Oh. Well, no. That�s why the Cypriots are so upset. The Cypriot bailout is the first to take directly from citizens� wallets.
As members of the European Union�albeit the smallest nation contributing just 0.2% of the bloc�s total GDP�Cyprus helped bailout Ireland, Portugal and Greece, then Greece again. So they�re understandably feeling a bit betrayed by the whole matter.
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