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April 1st, 2013

Cyprus Bailout the Latest in Eurozone Woes

Published March 28, 2013

A solution was reached Monday, March 25, to avert a large-scale banking crisis that has overtaken the small island nation of Cyprus over the last few weeks. After worries that major commercial banks in Cyprus might not be able to sustain long-term debt, major European lenders threatened to cut off short-term loans to Cyprus unless the country made a substantial push to lower its debt.

Protesters in Cyprus rally against government plans to seize individual bank deposits.

Protesters in Cyprus rally against government plans to seize individual bank deposits.

Banks closed in Cyprus over the last week to prevent a large-scale run on the banks, but reopened, with harsh restrictions that prevent customers from withdrawing more than  €300 in cash ($383 USD). Earlier in the week, protests erupted in the streets as Cypriots learned that they would most likely be taxed on their savings to contribute to a bank bailout.

A “bank run” occurs when many bank customers withdraw their deposits at the same time because they believe the bank may become insolvent.

Despite the deal, concerns remain about how Cyprus may impact the economic stability of other eurozone nations, many of whom are still recovering from the global financial crisis of 2008.

The eurozone and Cyprus: how did we get here?

Cyprus officially adopted the euro at the start of 2008, less than a year before the global financial crisis crippled the U.S. and European markets. In changing from the Cyprus pound to the euro, Cyprus joined the eurozone, an economic union composed of 17 countries within the European Union.

Membership in the eurozone and unification under the euro began in the early 2000s. This was hailed as a useful solution to trade barriers and disparate exchange rates between European nations.

As time passed, it became clearer that a singular monetary policy under the euro affected different nations differently based on the size of their economies. Thus, the global financial crisis affected countries like Germany and Italy much less than countries like Cyprus, which makes up just 0.2 percent of a broader eurozone economy of €10 trillion.

Cyprus is a small island nation in the Mediterranean. Picture via Flickr user Christopher Rose

Cyprus is a small island nation in the Mediterranean. Picture via Flickr user Christopher Rose

 

The deal

Negotiations were finalized on terms of the bailout package deal last Monday, cutting it very close to the deadline imposed by the European Central Bank, the main authority for monetary policy in the eurozone. The deal amounted to a €10 billion ($13 billion USD) bailout of Cyprus’s financial sector. In exchange for the funds, Cyprus must dramatically reduce its banking sector, undergo budget cuts and privatize state assets.

Cyprus applied a similar bailout deal last June, but political negotiations failed to produce any solutions. Cyprus has been in trouble with investors for over two years, with their financial situation becoming increasingly dire.

As a condition for the deal, Cyprus’s second largest bank, Laiki, was labeled a “bad bank” and forced to dissolve. The nation’s largest bank, The Bank of Cyprus, was saved and will absorb accounts from Laiki. Customers with deposit accounts over €100,000 will be taxed as a part of this deal.

French Foreign Minister Laurent Fabius spoke Monday, calling the outcome an unfortunate but necessary step to recovering the banking system.

“The Cypriot system was absolutely unsustainable. From the moment that there is an enormous debt compared to production, we had to find a solution,” he said. “The positive side, if we can say it, of this solution compared to the previous one, is that small Cypriot depositors won’t have to pay. But somebody has to pay the bill and it will mainly be paid by the richest depositors.”

Uncertain future for Cyprus

Cyprus is not the first country to require a bailout package to stay afloat. Greece received two bailouts totaling over €200 billion and partial debt forgiveness from some of its private-sector creditors.

For Cyprus, even with the Monday’s deal, the bailout process is not over. Once the eurozone’s finance ministers approve of the package, it must go through the national parliaments of several eurozone countries. The program should be finalized by mid-April.

Still, Cyprus may find itself the first country to be forced out of the eurozone, a move that would mar the image of the euro as a viable and stable European institution.

– Compiled by Ibrahim Balkhy for NewsHour Extra

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