The eurozone yesterday struck a deal to hand Cyprus a bailout worth 10 billion euros (US$13 billion), but demanded depositors in its banks forfeit some money to stave off bankruptcy despite the risks of a wider bank run.
Cyprus becomes the fifth country after Greece, Ireland, Portugal and Spain to turn to the eurozone for financial help in the wake of the region’s debt crisis.
In a radical departure from previous aid packages, eurozone ministers forced Cyprus’ savers, almost half of whom are believed to be non-resident Russians, to pay up to 10 percent of their deposits to raise almost 6 billion euros.
“Much more money could have been lost in a bankruptcy of the banking system or indeed of the country,” Cypriot Finance Minister Michael Sarris said, adding that he hoped a levy and bailout would mark a new start for Cyprus.
Without a rescue, Cyprus would default and threaten to unravel investor confidence in the eurozone that has been fostered by the European Central Bank’s promise last year to do whatever it takes to shore up the currency bloc.
However, on the Mediterranean island, initial incredulity at the decision gave way to anger.
Co-op credit societies, normally open on Saturdays, were shut for business in the coastal town of Larnaca as depositors started queuing early in the morning to withdraw their cash.
The bailout was smaller than initially expected and is mainly needed to recapitalize Cypriot banks that were hit by a sovereign debt restructuring in Greece.
The levy on bank deposits will come into force on Tuesday, after a bank holiday tomorrow. Cyprus will take immediate steps to prevent electronic money transfers over the weekend.
“As it is a contribution to the financial stability of Cyprus, it seems just to ask for a contribution of all deposit holders,” Dutch Finance Minister Jeroen Dijsselbloem, who chaired the meeting in Brussels, told reporters.
Such levies break the taboo of hitting bank depositors with losses, but Dijsselbloem said it would not have otherwise been possible to salvage its financial sector, which is around eight times the size of the economy.
“We are not penalizing Cyprus ... we are dealing with the problems in Cyprus,” Dijsselbloem said.
Dijsselbloem said that under the program, the island’s debt would fall to 100 percent of economic output by 2020.
In return for emergency loans, Cyprus agreed to increase its corporate tax rate by 2.5 percentage points to 12.5 percent.
This should boost Cypriot revenues, limiting the size of the loan needed from the eurozone and keep down public debt.
IMF managing director Christine Lagarde, who attended the meeting, said she backed the deal and would ask the IMF board in Washington to contribute to the bailout.
“We believe the proposal is sustainable for the Cyprus economy,” Lagarde said.
“The IMF is considering proposing a contribution to the financing of the package ... The exact amount is not yet specified,” she added.
Cyprus, with a GDP of barely 0.2 percent of the bloc’s overall output, applied for financial aid in June last year, but negotiations were stalled by the complexity of the deal and reluctance of the island’s previous president to sign.
Moscow, which has close ties with Nicosia, is likely to help by extending a previous 2.5 billion euro loan to Cyprus by five years to 2021 and reducing the interest rate.