News Analysis: A ‘Cyprexit’ Might Not Hurt Euro Zone Much

A messy Cyprus exit from the euro currency union would have a devastating effect on the country’s citizens, who are among the most indebted in the euro zone. And for European unity and diplomacy, the Cyprus debacle has already been at least a short-term disaster.

But for the broader financial system in Europe, the losses resulting from a Cypriot banking collapse and the country’s return to its own currency would be minimal compared with the havoc that Greece would have created had it not been bailed out and instead returned to the drachma last year.

And that, economists and investors contend, is precisely why Germany and its Dutch stalking horse, Jeroen Dijsselbloem, the uncompromising leader of Eurogroup of finance ministers were so adamant that depositors — large and small, Cypriot and Russian — contribute €5.8 billion, or $7.5 billion, toward the €10 billion bailout of Cyprus’s largest banks.

Greece may well have been too big to fail last year, but Cyprus, which creates less than one-half percent of the euro zone’s gross domestic product, is certainly not.

From a financial standpoint, what is most noteworthy is that the combined debt of the Cypriot people, companies and government is 2.6 times the size of the country’s gross domestic product. Only Ireland, still struggling to recover from the banking collapse that required an international bailout in 2010, has a higher debt-to-G.D.P. ratio among euro zone countries.

As debts in Europe mount in inverse proportion to the ability of its citizens, companies and governments to make good on them, the view is forming in Berlin and Brussels that — especially in the wake of the latest Greek rescue — a signal must be sent that for the euro zone to survive in the long run, citizens and investors must start accepting losses.

“There have been too many bailouts in Europe; it’s time to remove the air bags,” said Stephen Jen, a former economist at the International Monetary Fund who runs a hedge fund based in London. “This is not a Lehman,” he said, referring to the disastrous chain reaction triggered by the collapse of Lehman Brothers in 2008.

With Cyprus, “the links are psychological, not mechanical,” Mr. Jen said. “In Greece the links were both mechanical and psychological.”

Eric Dor is a French economist who has studied in detail the mechanics of how a country might remove itself from monetary union. By his calculations, the euro zone — via its central banking system and its national banks — has just €27 billion in outstanding credit exposure to Cyprus. That is a mere rounding error compared with the overall euro zone G.D.P. of €9.4 trillion.

Estimates of the potential cost if Greece had been forced into a disorderly euro exit have ranged from €200 billion to €800 billion, given the much larger exposure that the E.C.B. and European banks had to the country.

“This explains why Germany and others are putting so much pressure on Cyprus,” said Mr. Dor, head of research at the Iéseg School of Management in Lille, France. “They are saying we can take the risk of pushing Cyprus out of the euro zone, and that Europe can take the losses without going broke.”

Mr. Dor notes that the current euro zone-wide system of insuring bank deposits up to €100,000 was put in place following the financial panic that followed the Lehman collapse. Those deposits are supposed to be insured by national governments.

So when the president of Cyprus admitted this week that his country did not have the funds to backstop the €30 billion of guaranteed bank deposits — a figure greater than the Cypriot economy itself — a crucial bond of trust between a government and its citizens was snapped.

“It is the first time ever that the leader of a euro zone country has admitted that he could not afford to pay the guarantee,” Mr. Dor said.

By that reckoning, whatever grievances the Cypriot people have toward the euro zone finance ministers might be better directed toward their own national leaders who have failed to protect their savings.

Article source: http://www.nytimes.com/2013/03/22/business/global/a-cyprexit-might-not-hurt-euro-zone-much.html?partner=rss&emc=rss