Can an Island Sink?

by Andrew Stuttaford

Cyprus, said Angela Merkel in the course of the bailout talks, “must realize that its business model [offshore banking, tax haven etc.] is dead”.

Quite how  Cyprus was expected to make a living was left unexplained.

The Cypriot government (Bloomberg reports) has now thrown some new projections into the mix:

Cyprus’s economy might contract as much as 13 percent this year under the weight of austerity measures and a restructuring of the country’s banks as agreed in return for a bailout, the government spokesman said.

“In 2013 the recession may not be 8.7 percent as is estimated, it may reach 13 percent,” Christos Stylianides said in comments carried on state-run CyBC today.

Writing in the Daily Telegraph, Open Europe’s Mats Persson returns to the question that Angela Merkel did not address:

The combination of the depositor tax, the capital controls and the bank restructuring under the Cypriot bailout will lead to GDP collapsing, meaning revenues etc will fall as well. The question is, where in the world will growth come from that will allow the country to bounce back in 2015/16 as forecasted by the EU/IMF/ECB Troika? … The financial services sector, along with real estate and related businesses, which accounted for around 30 per cent of Gross Value Added in the economy is now essentially gone as a source of growth.  Cyprus two largest banks – key employers – will be restructured and unemployment will undoubtedly rise.  Small businesses will have lost cash as part of the deposit tax.  Cyprus’ main trading partners, Greece in particular, remain mired in recession.  The government will be cutting spending and raising taxes, laying off public sector workers and embarking on some strict labour and product market reforms – as part of the standard Troika bailout package. Cyprus’ greatest hope is tourism, but an over-valued euro won’t help in boosting this sector…

Persson concludes that “the risk is that Cyprus turns into a bit of a zombie economy, entirely reliant on cash from the eurozone and European Central Bank to stay afloat.”

There’s a very good chance of that indeed.  Sooner or later, probably at about the time that it realizes that it is rapidly heading towards a second bailout, Cyprus will be forced again to ponder whether it would be better off out of the single currency, a difficult calculation which could be avoided if the euro were to divide—as it should—into two, northern and southern.

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