Cyprus set to join the euro bailout queue

Cyprus poised to become the fifth eurozone member requiring a bailout as it battles to shore up a banking sector battered by Greece's economic meltdown.

Despite the present difficulties, the capital, Nicosia, remains busy and economists say the island’s banks have not experienced a run on money and are flush with deposits.

NICOSIA // Cyprus takes over the EU's rotating presidency next month just as it is poised to become the fifth eurozone member requiring a bailout as it battles to shore up a banking sector battered by Greece's economic meltdown.

An end-of-month deadline looms for the small Mediterranean island to find €1.8 billion (Dh8.2bn) - about 10 per cent of its GDP - to recapitalise Cyprus Popular Bank, its second-biggest lender. The bank posted a record loss last year after taking a 76 per cent writedown on its Greek government bond holdings.

Cyprus hinted strongly yesterday that it imminently may apply for assistance, both for its banks and its general coffers.

"The issue is urgent. We know the recapitalisation of the [island's] banks must be completed by 30 June," said Vassos Shiarly, the finance minister.

A rescue package for Cyprus would not affect the EU's economy, nor strain the bloc's emergency funds, even after bailing out Greece, Ireland and Portugal and pledging €100bn for Spain's ailing banking sector.

With a population of just under a million, the divided island, represented internationally by its majority Greek Cypriot community, is the EU's third-smallest economy and accounts for just 0.2 per cent of the euro zone's GDP.

But the spectacle of another bailout, no matter how small, would deal a further blow to the euro zone's credibility.

The timing is particularly unfortunate for Cyprus, which has been proudly preparing to take over the EU's presidency on July 1.

But the humbling prospect of seeking external aid, together with record unemployment of 10 per cent and falling tourism revenues, has dampened the celebratory mood.

Cyprus's historically resilient and resourceful economy was also hit by a bizarre explosion last July that destroyed the country's main power station, sending electricity prices soaring.

The recent discovery of offshore gas riches offers some consolation, but the reserves could take at least five years to exploit fully while Cyprus's needs are immediate.

This month, for the first time, the president, Demetris Christofias, the EU's only communist leader, acknowledged that he could not "absolutely exclude" the possibility of turning to Brussels for financial assistance.

He had vehemently rejected any such recourse, fearing the EU would demand stringent austerity measures like those foisted on Greece, Ireland and Portugal.

Cypriot banks lost more than €3bn in last year's "haircut" of Greek government bonds. That could be the tip of the iceberg because they also have up to €22bn in outstanding loans to Greece's private sector - some €5bn more than Cyprus's GDP.

Little wonder Cypriots are anxiously watching next weekend's elections in Greece. A victory for anti-austerity parties could result in Athens crashing out of the euro zone, exposing the net private assets of Cypriot banks in Greece to devaluation.

The causes of Cyprus's economic difficulties are the subject of bitter political controversy. The government argues the banking sector's exposure to Greek debt is the sole source of its woes.

The conservative opposition in the predominantly capitalist country counters that Mr Christofias's fiscal profligacy also led to Cyprus's exclusion from international capital markets, a point confirmed by credit-ratings agencies.

The government is working on a fresh package of spending cuts to meet a promised deficit target of 2.5 per cent of GDP.

But Mr Christofias, who has close ties to the powerful labour movement, pledged last week that belt-tightening would not come at the expense of workers' salaries or benefits. His right-wing opponents accused him of "irresponsible populism".

Last year, Mr Christofias turned to Russia, where he studied during the Soviet era, rather than his EU partners for an emergency low interest loan of €2.5bn to finance this year's budget deficit.

The cash came with no demand for structural reforms.

The president, who once jokingly described himself as the "EU's red sheep" and blames the excesses of "capitalism" for global economic instability, is now rumoured to be in contact with China for a similar loan.

A positive response from Beijing would give Nicosia some potential leverage with Brussels to secure better bailout terms.

Michalis Sarris, the Popular Bank's chairman and a former finance minister, believes Cyprus will "realistically have to seek" EU funds, a move he said no longer carries a stigma.

But he said Cyprus should come up with a convincing plan to cut spending to pre-empt much tougher austerity measures it may be forced to enact later.

"It is no secret that our civil service is overpaid and overstaffed and we need to control that on both accounts," Mr Sarris said.

Firm action now, he said, would safeguard Cyprus's low 10 per cent corporate tax that underpin its large and cherished services sector, attracting thousands of foreign companies to Cyprus.

All is not doom and gloom. The island's banks are flush with deposits: there has been no capital flight. Central Bank data for April showed a 0.5 per cent year-on-year increase in total deposits to €71.6bn. Of that figure, there was a 29 per cent increase by other eurozone residents.

Symeon Matsis, an independent economist in Nicosia, said: "That's a vote of confidence in Cyprus's banks, despite the difficulties."