* Heads for 10 bln Troika bailout; Can't pay civil servants, refuses to implement austerity *
The government of Cyprus is expected to run out of public funds to pay its civil servants by the end of next month and may resort to a 10 bln euro bailout from the European Commission and the European Central Bank, the fifth eurozone member to do so. The bailout would be just over half the size of the Cyprus economy, estimated at about 17 bln.
However, it is unclear if the third party to the ‘troika’, the International Monetary Fund, will join the team that is expected to arrive on the island next week. The current communist administration has long been hostile to IMF recommendations for austerity measures and radical reforms, such as the abolition of the cost of living allowance, an automatic wage indexation system that has propelled labour costs to unbearable levels for employers.
Whether it will be a ‘troika’, or just the Commission and ECB officials, one thing’s for sure: Cyprus will need to convince its Eurozone partners that it is serious about austerity measures which it has not implemented so far. Apart from the abolition of the COLA, the European officials will also highlight the need to cut back on generous pension benefits afforded only to civil servants, as well as the extensive reduction of the civil service itself.
Finance Minister Vasos Shiarly and his predecessor, Kikis Kazamias, have earnestly tried to introduce some austerity measures, but the ruling Akel party has not been forthcoming. Up until recently, Shiarly had been saying that Cyprus needed “only 300 mln euros” to cover its public sector shortfall until the end of the year, but even those comments seem to have been over-optimistic.
This is probably why the government announced on Monday that it was seeking a bailout from the EFSF/ESM support funds, contradicting the administration’s earlier comments that Cyprus would not seek a bailout, on the hope that a second loan from Russia or China would materialise.
In order to justify the money to pay the civil service on the eve of taking up the EU Council rotating presidency and less than eight months before the next presidential elections, President Christofias and his Cabinet have recently launched a vicious attack on the island’s banking sector, saying that the banks alone were to blame for the crisis because of their exposure to Greek sovereign debt. No mention of the public sector deficit running wild, nor the need to implement strict austerity measures.
The EC/ECB mission will be the first chance for the experts to dig into the island's finances and assess how much aid it needs and what it needs to cut.
"The exact number has not been decided yet. It was to be 6 bln for the state financing and 2 bln for the banks but that is optimistic - it is more likely to be seven and three - up to 10 bln euros in total," one euro zone official said.
While the sum is easily within the range of the European Financial Stability Facility (EFSF) bailout fund, it may lead to demands for collateral or for private bondholders to take a writedown as they did in Greece.
Cyprus is the euro zone's third smallest economy but it joins Greece, Ireland, Portugal and Spain in seeking EU rescue funds to try to stay afloat, in the latest sign that policymakers have failed to prevent the debt crisis from spreading.
European leaders will meet at a summit on Thursday and Friday but they are not expected to come up with a lasting solution to the region's problems that have also sent Italy's borrowing costs soaring.
HURT BY GREECE
Cyprus' most urgent needs is to plug a 1.8 bln euro regulatory capital shortfall in its second largest lender, the Popular Bank, by the end of this week.
Potential aid could be more comprehensive to cover fiscal requirements, Finance Minister Shiarly told Reuters. This is in stark contrast to Akel and other government statements that the aid would only be required to bailout Popular.
Banking officials have also suggested that the administration wants to corner the island’s main lender, Bank of Cyprus, into accepting a bailout as well, despite its recapitalisation plans of just over 1 bln euros nearing completion. The only stumbling block to conclude its recap with own funds is the bank’s plans to offload all or part of its profitable insurance divisions, EuroLife and General Insurance, to foreign investors, a move that was seen favourably by the bank’s local shareholders as well as the insurance sector in general. The government seems to disagree.
"We will continue efforts to secure a bilateral loan [from Russia or China], which can be used accordingly," government spokesman Stefanos Stefanou said.
"For Spain it's about sectoral help for the banks. Cyprus is, in terms of volume, rather an island that we must help because it has been so handicapped by the Greek deficit at the moment," Austrian Finance Minister Maria Fekter said.
Cyprus has been shut out of international capital markets for more than a year, with yields on its 10-year benchmark bond at over 16% on Tuesday. Sidestepping EU aid earlier, it secured a 2.5 bln euro loan from Russia in late 2011.
The loan amount is expected to cover its needs in 2012, but not in 2013, when Cyprus has 2.25 bln euros in refinancing, including a euro medium term note (EMTN) redemption. It now seems that the loan will not even sustain the civil service as far as November, as initially hoped.
President Christofias has been accused by the opposition of ignoring warning signs that the economy was in trouble, suggestions the government strongly denies.
SHARES, EURO FALL
Global share prices and the euro slid as investors bet that European leaders - due to meet this week for the 20th time since the currency zone's debt crisis hit Greece in 2010 - would fail to come up with radical measures to back up weak countries.
Germany's Chancellor Angela Merkel dashed any hope that Berlin would allow joint bonds issued by the euro zone or other measures sought by partners.
Italy's funding costs have soared too, which means it could be next.
Spain formally submitted its request for up to 100 bln euros of funds to bail out its banks, agreed on June 9.
Moody's cut the ratings of 28 out of 33 rated Spanish banks by one to four notches in a decision announced late Monday afternoon in New York. Those downgrades followed a cut of Spain's sovereign rating to just above junk status earlier this month.
With its coffers emptying rapidly and hurtling towards an immovable deadline, Cyprus suffered a further sovereign credit rating cut on Monday by Fitch, to the junk BB+ grade.
Jean-Claude Juncker, head of the Eurogroup of euro zone leaders, said Cyprus would have to negotiate aid conditions with the EU and the ECB.
"This will include measures that will address the main challenges of the Cyprus economy, primarily those of the financial sector, and I expect that Cyprus will engage with strong determination in the required policy actions," he said.
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