Cyprus and Greece share strong ethnic, linguistic and cultural ties. They also have the kindred experience of suffering major economic crises during the past five years and needing bailouts from their European Union partners. But in light of Greece’s recent confrontation with its euro zone partners over an extension of its assistance program, Cyprus is eager to emphasize the differences between the Mediterranean neighbors.
“The situation in Cyprus is entirely different from Greece,” says George Theocharides, associate professor of finance at Cyprus International Institute of Management in Nicosia. “There is quite a different reality here.”
Indeed, although Greece has engaged in brinkmanship over what amounts to a third bailout package, Cyprus has been emerging from its 2013 program more quickly than the International Monetary Fund and others expected.
Back then, following what the IMF described as one of the largest banking collapses ever recorded, Cyprus gave an unprecedented haircut to bank deposits of more than €100,000 ($113,000) and imposed capital controls. The government shut Cyprus Popular Bank, also known as Laiki, at that time the country’s second-largest bank, and rolled its dud assets and uninsured deposits into a so-called bad bank. Cypriot bondholders also took massive losses as the troika — the European Commission, European Central Bank and the IMF — imposed a tough austerity program in return for a €10 billion ($11.1 billion) loan plan. The economy shrank by 5.4 percent in 2013 and by 2.3 percent in 2014, according to Hellenic Bank, now the second-largest lender in Cyprus.
Yet those numbers were better than the declines of 8.7 percent and 4.5 percent, respectively, that the IMF had predicted, and far better than the effect of the devastating recession in Greece, which has slashed economic output by more than a quarter over the past five years. Cyprus even recorded a small primary budget surplus (that’s before interest expenses) last year.
Credit for the better performance goes at least in part to the bailout provisions that severed long-standing financial links between Cyprus and Greece. In March 2013 Cypriot banks had to sell off any branches in Greece and dump their Greek bond holdings. The divestment was controversial at the time and cost the Cypriot banks fully €23 billion in loans to the Greek private sector, but the move also ended the Cypriot banks’ exposure to continued economic stress in Greece.
The country still remains vulnerable to developments in Greece via the Cyprus subsidiaries of the big four Greek banks: Alpha Bank, National Bank of Greece, Eurobank and Piraeus Bank. If there were a meltdown in Greece, Cyprus would feel some pain via those institutions. “I still don’t think you can rule out a Grexit,” or Greek exit from the euro zone, says Andreas Theophanous, professor of political economy at the University of Nicosia. “You can’t expect a country like Greece, with 30 percent unemployment, to then come up with a budget surplus.”
Those Greek bank subsidiaries can tap into Central Bank of Cyprus funding if they experience liquidity shortfalls. Under Cypriot banking regulations, “the CBC can also block them sending funds back to Greece, limiting any damage,” says Fiona Mullen, director of Sapienta Economics, a Nicosia-based consulting firm. In terms of other links to its Mediterranean neighbor, Greece accounted for just 9.5 percent of Cyprus’s goods exports in 2013, the most recent year for which figures are available, and only 5 percent of services exports — less than the share represented by Russia or the U.K.
Russia, meanwhile, may be more of a risk for Cyprus than for Greece. “The recession there affects us, as Russia is a major source of tourists, and many Russian companies and their subsidiaries invest here,” says Andreas Assiotis, head of economic research at Hellenic Bank. Prior to the bail-in, non-EU residents held roughly 50 percent of deposits in the Bank of Cyprus, the largest lender at the time. Many of the depositors were Russian oligarchs? who were using the accounts as offshore shelters for their wealth. Russian tourist arrivals in November were down 25 percent from a year earlier, according to Reuters. With tourism accounting for some 11 percent of Cyprus’s gross domestic product and Russians generating about 30 percent of all tourist receipts, the economy stands to take a painful hit.
Cypriot President Nicos Anastasiades and Energy, Commerce, Industry and Tourism Minister Yiorgos Lakkotrypis traveled to Moscow this week to address these issues. Lakkotrypis told journalists he would meet with Russian airlines and tour operators “with a view to limiting any possible losses from this market.” More controversially, Anastasiades signed a memorandum of understanding with President Vladimir Putin to allow Russian naval vessels to dock at Cypriot ports, a move widely seen as a political reward for continuing Russian investment support.
Another risk is domestic politics. With some 51 percent of all bank loans currently classified as nonperforming, according to CBC figures, the troika has insisted on new legal frameworks for insolvency and foreclosure. Yet antiausterity parties in Cyprus’s parliament, encouraged by the hard-line stance of the new Syriza government in Greece, have so far blocked the minority government’s efforts to implement these laws. In return, the troika has suspended a further loan tranche — money the country needs to cover a €500 million bond payment due in July. A total of €2 billion in maturing debt needs to be paid or rolled over this year, and an additional €737 million in 2016. Cyprus must also sell off state telecom outfit Cyta by the end of the year, according to the troika’s terms, while its electricity board and ports authority are also in the privatization pipeline.
The opposition Democratic Party had indicated it would back a revised version of a package of insolvency and foreclosures bills, but optimism that a deal could be done was dashed on February 25 when parliament failed to reach an agreement. Parliament was scheduled to resume debate on the bills on March 2.
“We fully expect the law to go through within the next week or so,” says Assiotis. If this happens, investor interest in Cyprus may jump. “Once the foreclosures law goes through, you might see investors moving to buy up assets,” says Sapienta Economics’ Mullen. “There are many real estate projects in particular out there — half-finished resorts and complexes — that would become attractive propositions.” Another potential draw for investors is the country’s low corporation tax rate, which at 12.5 percent is among the lowest in Europe. “People here are realizing that foreign investment isn’t just about getting tourists to buy holiday homes,” Mullen adds, “but about securing more strategic investments for sustainable growth.”
Get more on macro .
