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Eurozone (debt) crisis: Country Profile Cyprus

Economic Comment

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To the Eurzone (debt) crisis overview page 

  • The severe economic problems Cyprus faced were to large extent a private sector debt problem. The country‚Äôs huge banking sector was hit by several shocks.
  • A central element of the crisis response in Cyprus was the concept of bail-in. The economy has started to recover and fiscal performance has been above expectations, but the crisis leaves deep scars. 

Diagnosis

The severe economic problems Cyprus faced in 2012-2013 were to large extent a private sector debt (banking) problem. 

Partially thanks to its position as a safe haven for Russian capital, the Cypriot banking sector had grown to enormous proportions relative to the size of the Cypriot economy (in 2012 this sector accounted for about 700% of GDP). The sector was hit by its exposure to Greek sovereign and private sector debt, local property developers and Cypriot government debt (especially after this debt got junk status). The need for a bail-out became already visible in the course of 2011, but the communist government of Cyprus was very reluctant to ask for external assistance, even as Cyprus faced a very sizeable refinancing requirement. In the summer of 2012, Cyprus finally requested eurozone aid. However, due to difficult negotiations an agreement could only be reached in early 2013.

Crisis response

A central element of the crisis response in Cyprus was the concept of bail-in. Given the huge size (relative to Cypriot GDP at least) of the financial sector and the already very high level of public debt, a bail-out of banks by the government was not a viable option. The fact that wealthy Russians accounted for a sizeable share of deposit holders also reduced the appeal of using public (European) money for bank bail-outs.  Instead, shareholders, holders of deposits of more than EUR 100,000 and other creditors of two large banks had to absorb the capital shortfalls in the form of a bail-in. To allow this bail-in to take place, capital controls were imposed. Meanwhile, the Cypriot government received financial support and was forced to raise its corporate tax rates and to implement a number of privatisations. Besides, the country had to reduce government spending strongly and had to undertake healthcare and pension spending cuts. The Cypriot economy contracted sharply in 2013 and negative growth continued throughout 2014, though the contraction was less severe than expected. In the first quarter of 2015, the economy started to grow again. Fiscal performance has also been above expectations. A new debt restructuring framework was implemented in the first half of 2015, which allowed Cyprus to re-access external assistance.  

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