**Sleight of hand in EUR 1.2 bln deduction for cocos**
By Fiona Mullen, Director, Sapienta Economics Ltd
Digging into the figures reported by Monday’s Phileleftheros (full story in hard copy only) reveals that there is a sleight of hand in the figure being reported on Pimco’s worst case scenario.
Phileleftheros reported, no doubt in good faith, that Pimco’s worst case scenario is EUR 10.1 bln.
Phileleftheros reported, no doubt in good faith, that Pimco’s worst case scenario is EUR 10.1 bln.
But this figure includes a deduction of EUR 1.2 bln for cocos—those deposits which many depositors turned into high-yielding convertible bonds but which will soon be turned into very low-value shares.
If we add the EUR 1.2 bln back in then the worst case scenario from Pimco is in fact EUR 11.3 bln and not the EUR 10.1 bln reported. It also implies that the baseline is EUR 8.2 bln, not the EUR 7 bln reported.
Meanwhile other reports have said that the baseline figure is EUR 6 to 9 bln.
Why is the coco deduction important? Because those of us who have been calculating how much Cyprus will need to find to bring its debt/GDP ratio down to the magic 120% that might just make it sustainable have been assuming that the EUR 10 bln reported a few weeks ago does not include deductions.
And we have been relying on cocos to meet some of the gap.
So if the cocos are already included in the EUR 10 bln or so that has been the main reference for our assumptions, then Cyprus must find even more to bring its debt level down to a more sustainable level.
The various options for debt sustainability were the subject of a seminar last Wednesday hosted by the European University of Cyprus and organised by Alexander Apostolides, Lecturer in Economic History.
In my own presentation, I had estimated that Cyprus would need to find only EUR 3 bln to bring its debt/GDP ratio down from an estimated 136% of GDP by 2016 to 120%.
I said the government could find EUR 1.2 bln from cocos and perhaps EUR 2 bln from privatisation.
I now have to revise that and say it has to find an additional EUR 1.2 bln from somewhere else.
One other option that has been hotly debated is a Greek-style haircut on bondholders. Outstanding European Medium Term Notes (EMTNs) are EUR 3.8 bln, of which I am reliably informed around EUR 2.5 bln are held by non-Cypriot institutions.
(The rest of the debt is either domestic debt held by the banks that need recapitalising, debt held by Russia or debt held by senior creditors like the European Investment Bank, so not really cuttable).
Until the European University of Cyprus seminar last week, most people thought that a haircut on EMTNs was not possible because of the English-law contracts under which the bonds were issued.
But Mitu Gulati, an expert lawyer on sovereign debt restructuring from Duke University, argued that there were enough gaps in the Cypriot contracts that the government might be able to implement a haircut if it wanted or needed to.
It would be an “ugly solution”, he said, not as “elegant” as the one proposed by his co-speaker, Lee Buchheit, partner at Cleary, Gottlieb, Steen & Hamilton LLP.
Buchheit argued that extension of maturities and an amendment to the European Support Mechanism (ESM) treaty might deal with the problem of sustainability and bondholder “holdouts”.
These are bondholders who refuse to take a haircut, then sue for the full amount. It has stymied a final resolution of the Argentina default for years.
Now that we realise that Cyprus has to find perhaps EUR 4 bln or more to get to the magic 120% of GDP (which let’s face it is still a long way from comfortable), we might find the bond haircut idea coming back to haunt us, or worse still, the nutty idea of grabbing the deposits of anyone over the insured threshold of EUR 100,000.
This raises the question of whether the authorities’ focus on a single uncomfortable figure and attempts to massage it will end up having caused the country more harm than good.
Surely it is far better to have an honest assessment of the requirements and an honest debate about how to deal with it, rather than ending up with a reputation for not being quite honest about the problem.
This will only test the patience of already tetchy European taxpayers even more.
Can we at least hope that this debate might take place after the election?
