September 23, 2020

News Analysis: Effect of Cyprus Exit From Euro Seen as Limited

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

And that, economists and investors contend, is why Germany and its Dutch stalking horse, Jeroen Dijsselbloem, the president of the Eurogroup of finance ministers, were so adamant that depositors — large and small, Cypriot and Russian — contribute 5.8 billion euros ($7.5 billion) toward the 10 billion euro 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 a signal must be sent that citizens and investors must start accepting losses for the euro zone to survive in the long run.

“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 in London. “This is not a Lehman,” he said, referring to the disastrous chain reaction touched off by the collapse of Lehman Brothers in 2008.

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

Estimates of the potential cost if Greece had been forced into a disorderly euro exit have ranged from 200 billion euros to 800 billion euros, given the larger exposure that the European Central Bank 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 zonewide system of insuring bank deposits up to 100,000 euros was put in place after 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 money to backstop the 30 billion euros 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.

A hasty expulsion from the euro zone would make the savings of the Cypriot people all the more evanescent, once they are converted back into Cypriot pounds, the currency Cyprus used before adopting the euro in 2007.

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