Over the past week, the financial crisis in Cyprus has
dominated headlines. On Tuesday the Cypriot parliament voted down the first proposed solution to the crisis, which involved a tax on bank savings at 6.75 percent on deposits of 20,000-100,000 euros, and 9.9 percent for deposits of 100,000 euros or more, that would generate the 5.8 billion euros to secure a bailout from the EU. It comes as no surprise that this proposition was voted down, due to the political consequences that come with taxing the bank accounts of all citizens. In the context of IPE, such a unpopular tax would anger constituents thereby making it highly unlikely that incumbents in the Cypriot government would be reelected. In the worst case scenario, it could lead to mass protest which would threaten Cyprus's political system and eliminate faith in its economy.
How did all of this start? An article in The Atlantic provides a fairly detailed summary. It highlights four essential things you should know about Cypriot banks in order to understand how this crisis came about. First, Cypriot banks have assets equal to about eight times the country's GPD, due to its status as a tax haven. Second, many Russian oligarchs looking to avoid taxes in Russia make up a huge percentage of the assets in Cypriot banks. Third, Cyprus invested heavily in Greece in the form of loans to the Greek government, which has opened black holes on bank balance sheets. Fourth, Cyprus is highly dependent on central bank financing to stay afloat--Cypriot banks are too big for Cyprus to save. All of this led to a bailout offer by the European Central Bank (ECB), in which Cyprus has to come up with 5.8 billion euros.
Since the Cypriot parliament voted down the first proposed plan (for good reason), the ECB has warned it will take the bailout deal off the table if a new plan is not in place by Monday, March 25th. At a recent meeting in Nicosia, the capital, politicians again ruled out an unpopular tax on bank deposits and agreed to set up an investment fund as part of an alternative plan.
This crisis in Cyprus highlights several important points. First, the constraints politicians face when making decisions that affect the economy. Second, the problem of being tax haven. Third. the problem of the ECB, conditionality, and its implications for certain Eurozone countries (i.e. Cyprus, Greece, Spain). If Cyprus cannot formulate a plan by Monday, it is likely that we will see contagion within the Eurozone, possibly in the form of bank runs.
I think it is interesting to consider some of the other plans that are being tossed around across the web. In a recent article (which I cannot now find for the life of me), taking Cyprus off the Euro was discussed as a possible solution so that the Crypriot government could print off the rest of their debt. The author made the point that this doesn't really change much though since inflation acts as a tax of sorts on people anyways. He calculated that the magnitude of the tax would end up being about the same, but the distributional consequences would be radically different.
ReplyDeleteI really hadn't considered the fact that the latest proposed plan of the taxing was turned down due to "political consequences". It is so true though, and also just not rational (or really ever done before) taxing those with savings. But, I am glad this plan was turned down, even if for re election purposes. This is such a great modern-day (happening now) example of political implications as well as having a steady economy with no deficit etc. I like how in the "Cyprus Bank Bailout" article you chose that the author points out that there must have been a logical economic reason for the immediate tax on savings, because politically it just doesn't make sense. Finally, I really appreciate in your blogpost, that you showed the four main points found. I had no idea the banks in Cyprus had such a surplus of assets, as well as lending to Greece(which ties back into what we discussed last class with the eurocrisis!). Great/ relevant post!
ReplyDeletehttp://www.economist.com/news/leaders/21574492-being-tough-bank-creditors-could-prove-costly-northern-european-taxpayers-septic-isle?fsrc=nlw%7Chig%7C3-27-2013%7C5392059%7C38549709%7C
ReplyDeleteThis is a link to an article about how Cyprus' previous plans wernt even plans at all and although current discussions are coming up with adequate ideas they are doing little to put our minds at rest.
It somehow feels as though this is a loose loose situation, one that has dire consequences not just for what the EU means but for the international economy as well.
Another interesting link to the Cyprus bailout is its effect on other countries. Clearly it has great effects on the eurozone, but an article done by the Guardian outlines how the relationship between Russia and Germany is strained. With many Russian oligarchs, and even Putin himself, about to lose money in Cyprus banks, they have aimed their anger at Germany and have even gone as far as to say the EU bailout is Germany's way of punishing Russia. A strained relationship between Russia and Germany is bad for both countries with Russia being Germany's second main trading partner and for Europe in general with Germany being the strongest economy in the EU.
ReplyDeletehttp://www.guardian.co.uk/world/2013/mar/29/cyprus-bailout-germany-russia-relationship