Cyprus, a seemingly insignificant Mediterranean isle near Greece and Turkey, has been experiencing a massive debt crisis in recent weeks, one that could actually have profound effects on the international community. The Cypriot banking sector makes up a huge proportion of the national economy, with national bank deposits worth over eight times the national GDP [1]. A significant portion of these come from wealthy Russians who seek Cyprus’s lower tax rates and lax scrutiny of large deposits.
Cypriot banks invested heavily in Greek debt, buying up large sums when interest rates were high and the threat of default was low. However, during the restructuring of Greek debt, Cypriot banks were forced to accept revalued Greek debt, leading to huge losses, and thus the current crisis. In total, Cyprus needs 17 billion Euros to fill the holes in its banks and economy, an amount equal to 160% of its GDP [2].
To help Cyprus and protect the integrity of the Euro, the EU proposed a 10 billion euro bailout, centering on taxing bank deposits. The EU planned to tax accounts up to 100,000 Euros at a rate of 6.75% and accounts over 100,000 Euros at a rate of 9.9% [3]. The Cypriot government moved against this proposal, with good reason, but this opens the door to an influx of questions. Traditionally, bank accounts have been viewed as private assets. Yet, the EU felt such a measure was appropriate to bail out Cyprus. The fact that the EU feels entitled to invade private assets sets a worrisome precedent – that all private assets may be subject to government control. This is especially disconcerting as the economic uncertainty in Cyprus stems directly from the banking industry and not from individual citizen action.
Cypriots, naturally, have reacted viscerally against this proposal. The EU responded by suggesting lower tax rates on bank deposits, but Cyprus seems unlikely to accept this at all. Meanwhile, corporations like Russian natural gas giant Gazprom have offered to bail out the nation with the stipulation that Cyprus surrender its underground deposits of natural gas – to which the Cypriot government said no. The massive Church of Cyprus has even offered to put its buildings up as collateral for government bonds. Other options include defaulting and causing greater stress on the Eurozone, accepting aid from neighbor Russia, or accepting an EU-approved plan; but all possibilities seem undesirable at this point.
The Cypriot crisis gives several lessons for the world. The first is that the banking industry always needs regulation. Cypriot banks were permitted to stock up on Greek debt, thus failing to diversify assets and leading to this catastrophe, for which uninvolved citizens must pay. The world also needs to really learn just how interconnected it really is. In trying to save Greece, the EU mortgaged the future of Cyprus. Now, in trying to save Cyprus, Russians and multinational corporations could lose millions, simply for having bank accounts on the island. The ripple effect is immense, thus countries need to work collectively instead of individually, in order to ensure the security of the world economy. Finally, Cyprus will set a precedent for the world on the taxation of bank-holdings. This tax, in effect, penalizes people for saving in banks, and could set the country’s banking sector back significantly. Still, without major reform, Cyprus will cease to exist as it does today, so drastic action is necessary. Regardless of what happens, Cyprus will set a major precedent for the power of government during crises.
Sources
[1] http://www.tv5mondeplus.com/video/19-03-2013/chypre-airbus-438609?t=1\
[2] http://dealbook.nytimes.com/2013/03/20/all-the-plan-bs-for-cyprus-look-dreadful/
[Image: http://www.telegraph.co.uk/finance/financialcrisis/9751679/Cyprus-could-default-within-days.html]
