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Global Markets

Cyprus and the next Greek bailout

27 June, 2011 | Posted By: Jim Leontiades

DR. JIM LEONTIADES
CIIM, The Cyprus Business School

A mighty struggle has been taking place in Athens. Like the Greek heroes of old, George Papandreou has been engaged in a struggle against the barbarians (foreign and domestic) to save Greek finances. Nothing is settled as this goes to press in a situation which may yet yield some surprises but it appears the prime minister may be victorious in persuading his own parliament and subsequently the international negotiators to agree to a further injection of the funds needed for the second bail-out.
Let us hope that the prime minister succeeds in leading Greece away from the brink of the biggest economic crisis it has faced in modern history. Even if he succeeds it is just as well to keep in mind that this is only a skirmish, not even a battle in a war which is far from won. This second bailout was desperately needed to save the not only the Greek economy from major default but also the banks as well as the finances of other member countries. In the heat of the struggle it is easy to lose sight of the fact that staving off financial bankruptcy is not the same as laying the foundations for prosperity. This appears to be as elusive as ever. Although some of the measures Greece was pushed to adopt are no doubt merited and even beneficial, there is still no coherent plan or even a target date for a return to prosperity.
The prospect of an economic recovery has scarcely been mentioned in the current frenzy of bargaining between the troika (ECB, IMF, EU) and the Greeks. This has been all about avoiding a near term Greek default and saving the Euro-zone. If successful, the most likely outcome will be a “soft restructuring”. Creditors will more or less voluntarily extend the time allowed before they demand payment on their Greek bonds. The basis of the second bail-out will be an exchange of more austerity on the part of the Greeks for an additional injection of external financial support.

SUCCESSIVE BAILOUTS

The first bailout failed because its prescription of higher tax rates and lost jobs brought about a decline in economic activity which actually reduced the tax intake.The second bailout, currently being negotiated, appears to prescribe more of the same, even higher taxes and in addition sales of government property including even motorways. How will this bring about a return to some form of normality? It won’t. The crowds on Syntagma Square sense this and protest.
The economists and other technocrats working on the current crisis seem to have completely overlooked the human and political dimension. Whatever the economic arguments, an indefinite number of years of future austerity on top of what has already been imposed does not appear to be even remotely socially or politically acceptable. Whether this means Greece will leave the Euro is still one of the “known unknowns’. However the need for another bailout to succeed the one currently being negotiated, if not quite a certainty, is certainly a high probability.
Complicating an already difficult situation and clouding the future is the rise of acrimony in the negotiating process. The once friendly “all in it together” feeling between Euro-zone members seems to be evaporating. This is happening not only between Greece and the others but also between other Euro-zone partners. Most notably, Germany is squabbling with France. Finland and Slovenia have indicated that they are uncomfortable with the Greek bailout. Ireland is positively irate about its own bailout and seeks to renegotiate the terms. Thousands continue to protest in Spain.

MESSAGES FROM THE FINANCIAL MARKETS

There is a message in all this for Cyprus. In any new, third bailout, crisis will be much more serious than the first two. Previously voiced apprehensions about the viability and internal contradictions of the Euro-zone will be much more believable. Contagion, the spread of default risk to other countries, will be more widespread, possibly including relatively new “peripheral countries” such as Italy.
The international community will be asking: Is Cyprus another “Greece” waiting to happen? Cyprus already shares one feature which is common to all the peripheral countries currently in crisis, public sector spending that is out of control. To finance this, Cyprus has been turning increasingly to foreign borrowing. Even the prospect of a third Greek bailout will shake international markets and affect the ability of Cyprus to meet its international borrowing requirements.
Already borrowing costs for Cyprus have been rising. On June 14, investors were demanding a 7% return, considerably higher than the 5.37% required to finance Spain or the 4.59% required for Italian 10-year bonds. A few days later (17 June) the yield required by investors for the same Cypriot bonds jumped from 7% to 7.38%. The rapidity with which the cost of financing the national debt has been changing is one of the key features of this crisis. Countries that thought they were safe suddenly found they could not afford to pay the unexpectedly higher price for new capital that the market suddenly demanded.
The government should not underestimate the speed with which this economic tsunami can descend on us. As a minimum, Cypriot preparation for the after effects of a third Greek bailout calls for a much reduced national deficit and a sharply reduced dependence on foreign borrowing. It also calls for much greater economic literacy than has characterised the government’s recent handling of national finances. Populism and government by pressure group carry a major responsibility for the current Greek chaos.