Last Saturday, Cyprus finally reached an agreement on the
terms of its bailout with a group of international lenders,
consisting of the IMF, ECB and EU. The original set of terms was
a bitter pill to swallow.
Particularly unpalatable was the proposal to tax insured
deposits at 6.75%. The final agreement eliminates this clause
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Ultimately, uninsured depositors will have to bear the entire
burden of rescuing Cyprus's two beleaguered banks - Cyprus
Popular Bank and Bank of Cyprus. In order to receive the euro 10
billion ($13 billion) bailout package, Cyprus will have to itself
put up a substantial amount. The Popular Bank of Cyprus, also
known as Laiki Bank, will be closed. Its good assets and insured
deposits will be transferred to Bank of Cyprus.
Deposits above euro 1,00,000 will be utilized to fund the amount
to be paid by Cyprus. These frozen deposits are expected to
amount to euro 4.2 billion ($5.5 billion) and depositors could
lose up to 30%-40%. This is substantially higher than the
originally proposed rate of 9.9% on these deposits.
Incidentally, most of these deposits are from Russia. Weak
financial regulation and low corporate taxes have turned Cyprus
into a destination for funds from affluent individuals and
businesses from all over the world. This is why the country is
hugely dependent on its financial sector. In fact, Russian funds
amount to $31 billion in bank deposits. This figure is
particularly relevant when compared to Cyprus' GDP of $25
However, all this has come to an end thanks to the terms of the
bailout. The fact that foreign depositors will be paying for the
country's bailout has effectively ended Cyprus' lucrative
offshore banking sector. This will lead to a huge loss of income,
a rise in unemployment and a reduction in GDP. Brokerage agency
Exotix has forecast a 10% decline in GDP this year itself.
Further action would mean going against the very spirit of the
European Union. This would mean more trouble for Cyprus' economy,
already facing a downgrade from rating agency Fitch. It would
also send a negative signal to those parking funds in other
troubled euro zone countries like Spain, Italy and Greece.
What the Cyprus deal illustrates is that the Eurozone still has
economic issues which remain a long-term concern. In any case,
the rest of the region is anything but in the pink of economic
health. This is particularly relevant to U.S. companies with
large exposure to the Eurozone. According to Citi Research, a
),as of 2010 several large U.S. companies drew significant
revenues from the region.
These include the likes of
General Electric Company
The Coca-Cola Company
Philip Morris International, Inc.
Ford Motor Co.
). Earlier this month,
) lowered its earnings forecast, saying that it had been affected
by the global economic situation. Meanwhile,
), a significant indicator of the health of the world's economy,
said monthly sales had declined significantly.
), around 50% of international sales of US companies can be
attributed to Europe. Until now, share prices have been
unaffected by the precarious European situation combined with
such heavy exposure. However, markets have been sensitive on
occasion. Indices had declined after Jeroen Dijsselbloem, head of
the Eurogroup of Eurozone finance ministers, said that the
approach used in Cyprus would be used in other countries facing
Of course, stocks recovered when he said: "Cyprus is a specific
case with exceptional challenges," but such concerns linger in
the background. And capital controls cannot be one of them. This
would go against the very spirit of the currency union and lead
to a further loss of confidence. The Cyprus pact has put the
brakes on a greater crisis for now. But, surely, the Eurozone
will have to find a more permanent solution to its economic