Crisis In Cyprus Case Study Analysis Help With Solution
CRISIS IN CYPRUS
Cyprus, a small island country, joined the EU in 2004 after much political uncertainty and with the support of the United Nations (UN). It adopted the euro in 2008 and became one of the smaller members of the eurozone with 0.2 per cent of the zone’s GDP.19 Cyprus’s economic performance had been stable at that time, except for a mild recession in 2009, which was cushioned by fiscal spending worth 4 per cent of GDP and bank lending.20 Fiscal stimulus resulted in a fiscal deficit of 6 per cent of GDP in 2009. The current account deficit improved from 2008 to 2009 and was mainly financed by foreign direct investment (FDI) into the country.
Cyprus was a tax haven and attracted a lot of foreign deposits.21 Joining the eurozone was a positive signal and led to an increase in inflow of foreign deposits. The banking system also experienced a similar boost. Banks in Cyprus could use only 30 per cent of foreign deposits to extend domestic loans before joining the eurozone. However, after adopting the euro, all eurozone deposits became local deposits and led to a boom in local lending.22 In 2011, the IMF remarked that during that period of high growth and the property market boom, the economy of Cyprus also developed some “vulnerabilities.”23
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1. The banking system grew rapidly, which led to a high growth in credit. By 2011, total bank assets in Cyprus were US$197.6 billion (835 per cent of GDP), out of which US$119.6 billion (500 per cent of GDP) were extended within Cyprus and US$37.7 billion (160 per cent of GDP) extended to Greek borrowers. By 2012, the total bank liabilities in Cyprus were US$166.4 billion (see Exhibit 5).24 Those loans took a hit on a couple of counts: first, during the Greek debt restructuring in March 2012, Greek bonds faced a 75 per cent cut, which caused the Bank of Cyprus a loss of US$2.08 billion (4.4 per cent of the bank’s assets)25; second, bad debt due to the poor performance of the Greek economy26 meant that the ratio of non-performing loans (net of provisions) to capital rose from 16.1 per cent in 2008 (Q4) to 34.8 per cent in 2011 (Q1).27
2. The poor performance of the Cypriot economy led to poor performance of public finance. Access to financial markets became difficult, which made debt rollover difficult, adding to the debt woes.28
The economic situation in Cyprus had been weakening since then, and the country had raised the issue of a formal bailout in the latter half of 2012. By November 2012, it was negotiating a bailout program, becoming the fifth EU country to request a bailout from the Troika. It was estimated that Cyprus would need close to US$22.75 billion in assistance, which was nearly equal to its GDP in 2012.29 Inability to find a way to reduce the cost of the bailout to more tolerable levels delayed the bailout program. On the one hand, the IMF wanted significant debt relief before it could make a commitment to the bailout. On the other hand, EU leaders had grown weary of the Cypriot president’s “lack of willingness to accept the reality of the situation.” They wanted to wait for the new government to be elected by February 2013 before engaging in any further discussion.
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