Post-Rescue Cyprus Depression

So the rescue of Cypriot troubled banks has been finally approved after 1 week of absolute lunacy in Cyprus, for those not aware yet a quick recap on the key points approved yesterday night:

Key points of the deal:

Laiki bank will be fully resolved – it will be split into a good bank and bad bank. The good bank will merge with the Bank of Cyprus (which will also take on Laiki’s circa €8bn Emergency Liquidity Assistance – a last-resort funding system outside the usual ECB operations). The bad bank will be wound down over time with all uninsured depositors (over €100,000) taking significant losses (no percentage yet but some could lose all their money above the threshold).

The Bank of Cyprus will be recapitalised using a debt to equity swap and the transfer of assets from Laiki. Uninsured depositors will take large hits in this process – again no percentage but reports suggest up to 40%.

These actions will be taken using the new bank restructuring plan passed in the Cypriot Parliament on Friday. Crucially, no further vote will be needed in the Cypriot parliament since there is no direct deposit levy.

The banks will not receive any of the €10bn bailout money, the entire recapitalisation will be done using the tools outlined above.

Significant capital controls are likely to be in place when banks reopen, creating a risk of Cypriot euros being “localised”.

Further tax increases may be included in the detailed plan to be drawn up between the two sides.

  and as a consequence an entire country will be sliding very fast in a Great Depression:

From SocGen:

Depression for Cyprus: Our Cypriot GDP forecast entails a drop of just over 20% in real GDP by 2017. This forecast had already factored in much what was agreed, but did not account for the additional uncertainty shock generated by the past week’s appalling political mess. Risks are clearly on the downside and Cyprus will in all likelihood require additional financial assistance further down the road. Accounting for less than 0.3% of euro area GDP, any downward revision to Cyprus will be barely visible on the euro area aggregate.

Cyprus’ position as a financial centre is over. There are few other alternatives for growth. One option that remains is tourism, but with a significantly overvalued currency it is not clear to what extent Cyprus can take advantage of this.
The capital controls will severely hamper liquidity in the economy, while it will be very difficult for the small island to trade with the rest of the world (it is far from self-sufficient, importing almost everything). The collapse in GDP could be anywhere between 5% and 10% this year, depending on how long capital controls are imposed and the resulting collapse in tax revenue could make the government’s position worse. There is a strong chance Cyprus could become a zombie economy – reliant on eurozone and ECB funding to function, possibly requiring further bailouts.

Capital controls are severe and could de facto lead to Cyprus being seen as out of the euro. Ultimately, money is no longer fungible between Cyprus and the rest of the Eurozone and, at this point in time, it’s hard to argue that a Euro in Cyprus is worth the same as a Euro elsewhere. The real problem though may not be imposing the controls but removing them – Iceland still has capital controls in place, five years after it installed them (despite having the advantage of a devalued currency).

The €10bn bailout will push Cypriot debt to GDP to 140% - if Cypriot GDP falls by just 5% this year, that rises to 148%.

In the meanwhile the bailout deal is already rising anti-Euro sentiments all over the country,  one of the most influential voices speaking against the Euro and the EU is the Orthodox Church Leader Archbishop Chrysostomos II who commented on TV that "with the brains in Brussels... the Euro can't last," certainly the fact that the Orthodox Church of Cyprus lost over 100 million euro holdings in the Bank of Cyprus must have contributed to his anger toward the EU and the Cyprus politicians: "those that brought the place into this mess, should sit on the stool. " (blaming the outgoing government, Ministers of Finance, the Central Bank, and the Executive Directors of Banks).
May his prayer be accepted! When the full scale of social devastation inflicted on Cyprus will be apparent a chopping block would be more suitable than a stool!