But it would be foolish to forget about Cyprus. Despite the $13 billion bailout, the small Mediterranean island is edging toward a euro exit. Quitting the single currency would devastate wealth, fuel inflation, lead to default and leave Cyprus friendless in a troubled neighborhood. Even so, the longer capital controls continue, the louder will grow the voices that call for bringing back the Cypriot pound.
The president, Nicos Anastasiades, is against Cyprus’s leaving the euro. But the main opposition, the Communist Party, wants to pull out. A smaller opposition group wants to stay in the euro but kick out the so-called troika of creditors — the European Commission, the European Central Bank and the International Monetary Fund. The country’s influential archbishop is also critical of the troika.
The president can hold the line for now. After all, he has just been elected and the Constitution gives him huge power. What is more, there are strong arguments for staying inside the single currency — not the least of which is that otherwise, Cyprus would lose the €10 billion (or nearly 60 percent of its gross domestic product) in bailout money.
If Nicosia brought back the Cypriot pound, it would plummet in value. Nobody knows how much, but economists guess it might be as much as 50 percent. Cypriots are complaining about the large losses suffered by big depositors at their two largest banks, Bank of Cyprus and Laiki. Such a devaluation would savage the wealth of all other depositors.
Meanwhile, devaluation would fuel inflation. Cyprus is a small, open economy. All the oil is imported. More than 80 percent of the textiles, chemicals, electronics, machinery and automotive vehicles are imported, too, according to Alexander Apostolides, a lecturer in economics at the European University Cyprus.
Cyprus also relies on low-cost immigrant labor in its agricultural and tourism industries. After a devaluation, their cost in local currency would rise. All this would mean the erosion of any gain in competitiveness.
The island’s economy would suffer a further shock because it is running a current account deficit of about 5 percent of G.D.P. Given that Cyprus has minimal hard currency reserves, this deficit would have to vanish overnight. Imports would slump. But so would domestic production, given its reliance on imports.
In such a scenario, Nicosia would not be able to avoid defaulting on its debts. Following a 50 percent devaluation, these would be double their current value when expressed in local currency. The debts come in two forms: the government’s own €15 billion in borrowings; and the central bank’s €10 billion in emergency liquidity assistance to the banks.
Default might seem to be an attractive option because Nicosia would suddenly shrug off a vast debt load. But it would not be that simple. The government would face many lawsuits. And if the central bank defaulted on its provision of the emergency assistance, the E.C.B. would take the hit. The euro zone would not be happy and would, at a minimum, insist on some sort of staged repayment plan.
Cyprus could, of course, refuse to pay point blank. But it is not Argentina. Its small size makes it vulnerable to being pushed around. If it tried to play hardball with its euro zone partners, it would probably find them playing hardball with it. They might even find a way to kick Cyprus out of the European Union.
Exit from the Union would be another blow for Cyprus. Its best trading opportunities are within the Union. Most of the rest of the neighborhood — like Syria and Egypt — is not in great shape. And Turkey is out of bounds until and unless some way can be found to resolve the dispute between Nicosia and Ankara over the latter’s occupation of the northern part of the island.
Cyprus would also struggle to exploit its offshore natural gas reserves if it quit the European Union. Turkey, which is already trying to stop that development, would find it easier, if Nicosia were friendless.
Apart from all this, the country would have to decide how to run monetary policy.
A responsible government would want to contain inflation by either linking the Cypriot pound to another currency, like the British pound, or running a tight but independent monetary policy. In either case, Nicosia would have to keep interest rates high and curb its budget deficit. Given its small foreign exchange reserves, it might also need to maintain capital controls.
Such an austerity program would be worse than that demanded by the troika. It would then be hard to avoid the temptation to print money. But that way lies hyperinflation.
So quitting the euro would not be a good choice. But staying is not a great one either. G.D.P. could plunge about 20 percent over the next two years, according to the latest guesses. And the longer capital controls are in place, the more the Cypriot people will feel they are not in the single currency zone anyway — as a euro in Cyprus is not equal to one in the rest of the world.
The troika should help lift the controls as soon as possible. Otherwise, Cyprus may well quit the euro and, small though it is, that could destabilize the zone.
Hugo Dixon is editor at large of Reuters News.
Article source: http://www.nytimes.com/2013/04/08/business/global/quitting-the-euro-wouldnt-be-a-good-choice-for-cyprus.html?partner=rss&emc=rss
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