By Fiona Mullen, Director, Sapienta Economics Ltd.
The head of the Eurogroup, Jeroen Djisselbloem, said in Germany’s Die Sueddeutsche Zeitung on July 10 that the reason Cyprus had not been given a full bailout like all other countries was because it would have made Cyprus’ debt unsustainable.
This is (now) the official Eurogoup line and you will hear it from several quarters. It was a principle, Europe has to stand by its principles, and so on.
Before arguing why this particular argument is such a damaging one, it is important to explain something that many Cypriots do not understand.
(But EUR 10 bln is still better than EUR 0 bln)
Without the EUR 10 bln from the troika all of us would have lost every last cent at Laiki and Bank of Cyprus (BOC). By March 2013 they were both insolvent. The so-called deposit insurance fund has just a few hundred million to cover a liability of tens of billions, so the notion of insured deposits is in fiction.
Since Emergency Liquidity Assistance (ELA) is ultimately a liability of the sovereign, the government would have been saddled with the combined EUR 11 bln from a defunct Laiki and BOC. That would have meant far nastier cuts in the public sector, with a bigger impact on consumer spending, on GDP and so on into the downward spiral.
The government would have defaulted on its June-July local and international debt, defaulted sooner or later on ELA and Cyprus’ future in both the eurozone and the EU would have been in doubt, leaving it far more vulnerable to Turkey.
So, while we rave and rant about the harshness of the bailout, we have to remember that from a north European perspective, they generously lent us nearly 60% of GDP, with a very long grace period, so that Cyprus could stay in the elite club.
The ropey debt sustainability argument
Now, back to the argument about principle.
There were all kinds of perfectly rational (for those making them) calculations (mainly political ones) being made by eurozone leaders for not giving Cyprus the full amount needed. But the debt sustainability argument is not one of them.
First, because its logic is risible.
The logic goes something like this: “We did not want you to have a debt/GDP ratio of more 100% of GDP so we invented a solution that killed your only growth sectors, created massive uncertainty and made your debt ratio way higher than it would have been if we had given you the whole amount you needed”.
Before March 15 my debt/GDP ratio peaked at 139% of GDP. In my June forecast it peaks at 158% of GDP.
But you don’t have to believe my forecast, go look at other private-sector forecasts such as Exotix and you’ll find similar ratios.
Only the European Commission/IMF forecast doesn’t change much before and after March. And that’s because poor desk-level economists had to reverse-engineer a growth forecast that had a debt/GDP ratio of 100% of GDP by 2020.
You might argue that the harsher, more debt-creating solution was only imposed after the haircut on all depositors was rejected by parliament (not the government, as falsely reported elsewhere: DISY abstained).
But if we are dealing with principles, then someone should have said “sorry but this second solution will push the debt ratio well beyond 100% of GDP. We have to think of another solution or let Cyprus fall out of the euro”.
The road not travelled
There were a couple of options that could have been tried if only anyone had slept properly that week.
One obvious one was to give parliament a second chance. Anyone who knows Cypriots well knows that they will always say no the first time to an idea they don’t like. It is their (far more peaceful) equivalent of running riot and smashing up public buildings.
And after ten days of living with closed banks, many were beginning to doubt the wisdom of parliament’s vote. So, perhaps they should have been given two options: haircut on all but no capital controls; haircut on only the >100,000 (including the widows, orphans, the provident funds, etc) but with indefinite capital controls.
Even if all those lawyer-MPs with wealthy clients had still gone for the second option, and debt was still unsustainable, at least they would not be able to blame it on the north Europeans.
Another option would have been to pledge, say, EUR 10 bln until 2014 (of which around EUR 3 bln was due in debt repayments so EUR 7 bln would be for the banks). Then, an undefined additional amount would be coming only if Cyprus had reached primary surplus by, say, 2014 (the current target is 2016).
It would still have involved a good bank-bad bank split, losses for bondholders and maybe even a small haircut on uninsured depositors. But since it would be less economically damaging, a primary surplus would have been achievable far earlier and would thereby have dealt with the sustainability question. Once you reach primary surplus (a budget surplus excluding interest payments) your debt starts to fall.
Debt ratio is arbitrary and seems to have been secret
Second, the debt ratio argument is arbitrary. The “sustainable” debt/GDP ratio for Greece was 120% of GDP. It was dropped to 100% for Cyprus. This was partly because the Greek debt haircut demonstrated that 120% of GDP was not sustainable.
But the debt/GDP ratio in Italy has been over 100% for decades, Ireland, with a debt/GDP ratio of 117.6% of GDP last year, may get a new “precautionary credit line” when it comes to the end of its programme. If other bailout countries are treated differently in future, then we shall know for sure that the ratio was made up.
Third, the 100% seems to have been a secret ratio. I heard a lot about sustainability and had a lot of discussions with both local and non-local economists about 120% of GDP. But although I was following the Cyprus crisis non-stop, somehow I only discovered that 100% of GDP was the special Cypriot ratio afterwards.
A whiff of WMD
Last but not least, this particular justification, because it is based on bad logic, has the whiff of weapons of mass destruction (WMD) about it. The reason why Tony Blair is not running any institution that the man on the Clapham omnibus will have heard of is not so much because Britain helped the US invade Iraq but because of the way it was justified.
Voters were supposed to believe it was done on the basis of principle, rather than all kinds of other hard political considerations, such as the US needing a foothold in the Middle East because it could no longer rely on potentially unstable Gulf allies (think of Bahrain and the US 5th fleet).
The public didn’t believe the “principle” reason, so believed all kinds of conspiracy theories instead.
The same has happened in Cyprus. People sense that the sustainability argument is false, so, many believe that it was all about grabbing Cyprus’ gas (which I very much doubt it was).
And yet there were plenty of hard political considerations for not giving Cyprus the full bailout: the decreasing appetite among north European taxpayers for bailouts and the need to send a warning to other countries that do not want to cut spending (France).
And then there were the commercial considerations. The Cypriot banks did not have many debts, so no EU bank would lose money. EU banks had spent 2012 shifting their inter-bank deposits out of Cyprus while Christofias dithered, so hitting Cyprus hard would not really affect them.
Last but not least, the sale of the Greek branches and the transfer of ELA to Cyprus ringfenced Greece, so Cyprus could be hit without being systemic.
Not very nice reasons for a Cypriot to swallow but far closer to the truth than some arbitrary ratio loosely based on the now infamous Reinhart-Rogoff study and its missing data points.
From the point of view of EU leaders, there was another good reason for not giving Cyprus the full bailout.
Bailing out banks encourages them to keep lending to high-spending governments instead of lending to small businesses. This is bad for employment, which is bad for social cohesion and therefore bad for the future of the EU.
Indeed, to give him credit, Djisselbloem recognises this. In an interview with the Financial Times on March 25 http://www.ft.com/intl/cms/s/0/68c9c18e-955e-11e2-a151-00144feabdc0.html#axzz2ZOzh5dk0 , he said “Having cheap money because the risk will be covered by the government, and I will always get my money back, is not leading to the right decisions in the financial sector.”
Unfortunately Djissellboem’s straight talking was shot down by other European leaders, even though they later agreed on bail-ins as the preferred method for troubled banks.
Far better, it seems, to hoodwink the electorate with a dodgy argument about principles than to tell them the straight truth.
But the cost of bad logic is to undermine voters’ confidence in politicians and hand more votes to fringe and extremist parties. We can already see the signs right across Europe.
Let enough of those get into power and we’ll see them pull down the whole European Union edifice, with goodness knows what consequences for European peace.
Monthly reports on the Cyprus economy, policy and politics are available at www.sapientaeconomics.com