Cyprus: There is no “once upon a time” in this story…

by Markella Toumaniou. Originally published on 2014/02/06

Cyprus has been characterized as the newest “victim” in the unveiling of the Eurozone crisis. The financial environment in Cyprus had nothing to fear at the beginning of the international financial crisis. The economic indicators at that time showed that the GDP was moving on an upward trend, positive percentage changes were characterizing the real GDP growth rates and there were conditions of full employment. However, the services-based Cypriot economy was affected in 2011 when the government bonds were downgraded as much as to cut off the island from the international markets.

The milestone month was March 2013 when an unexpected Eurogroup decision shook the economic and financial landscape of the island. The causes were both, exogenous and endogenous. Firstly, Cyprus-based banks were highly exposed in Greece in terms of private loans and government bonds. The total exposure was estimated to worth 160% of Cyprus’ GDP . Under a 70% “haircut” suffered by investors of Greek bonds, Cypriot banks were found with a huge amount of debt that was impossible to be covered by own means. The “haircut” revealed some of the gaps in the risk management and illustrated the process of prudent banking that was followed for the last couple of years by the major banks in Cyprus. Secondly, the size of the banking sector compared to the size of the economy is considered to be another major cause. Representative can be that in 2010 the total assets count as 896% of GDP . Finally, the enormously large banking sector was a channel for Russian depositors and investors who favoured the domestic tax system. Although in the majority of cases these deposits were legally entering in Cyprus, Eurozone leaders were supporting exactly the opposite, by characterizing Cyprus as a “money-laundering” state.

On March 16 the newly elected government in Cyprus, just a week after the elections, agreed on a rescue package in a Eurogroup meeting. It was an unexpected agreement since the lenders requested that in order to offer 10€ billion assistance, the Cypriot government would have to raise 6€ billion by its own means. The agreement involved a bank levy. All deposits up to 100.000€ were to forcibly contribute 6.75% while for more than 100.000€ the levy would be 9.9%. These provisions were in fact the biggest threat of the Deposit Insurance Scheme (DIS) according to which all deposits up to 100.000€ per customer and per bank would be guaranteed. Almost three weeks after this decision was made, the so-called “Troika” came up with a second plan according to which all deposits falling under the DIS would not suffer a levy. However, the haircut on the rest of the deposits was around 47.5% . Then an unexpected parameter came in.

The discovery of natural resources seems to be very optimistic news for Cyprus. The gas discovery in the southern part of the Exclusive Economic Zone (EEZ) of Cyprus has the potential to contribute billions to the economy. According to a report published by the Massachusetts Institute of Technology (MIT), the value of the gas in the first of the 12 marine gas fields is estimated between USD 80 – 100 billion. The benefits for the economy will be very significant, such as reducing the cost of electricity and the cost of energy per unit of GDP.

Besides the construction of gas liquefaction warehouses and ports may as well result in increased foreign investment and improve the labour market prospects of the country. Apart from this, the positive effect on the country’s GDP will be significant if one considers that GDP now stands at USD 24 billion and the deposit has 5.4 times greater value. With the discovery of gas resources, Cyprus is viewed a lot differently from its European partners and regional neighbours .

The second announcement of Noble Energy Inc. for a second drilling in August 2013 helped restore the confidence, first and foremost, of the Cyprus stock exchange. The international lenders and bond market were also pleased with this movement. Some months later, the government licensed Total, Eni and Kogas as well. These developments have helped in restoring the confidence among bank depositors (mainly Russians) who support island’s the tax-friendly environment.

In addition to the economic benefits, geopolitics also comes into play. Companies from four out of the five permanent members of UN Security Council (Russia, France, Great Britain., and U.S.A.) have already shown interest for drilling in the region. The Government of Cyprus will try to use the different political formations created in “isolating” Turkey in conjunction with the efforts made to solve the Cyprus Issue. The geopolitical equilibrium in the whole region is now changing due to the gas diplomacy that these states follow. Leading example is USA often asking Turkey to throw tons in relation to the developments taking place in the Cypriot EEZ and the drilling of US-based Company Noble Energy. At the same time, Russia expressed a clear position in favour of Cyprus.

Despite the positive developments and general optimism, there are those who support that the discovery of natural resources is sometimes not a de facto blessing. From my point of view, I strongly support that the discovery is more or less a curse and can be seen as the “Pandoras’ box” for Cyprus. Natural resources not only do they affect the economic growth in a country, but are also able to cause a number of problems, including unequal income distribution, high levels of poverty and corruption. The discovery of natural gas in Cyprus is posing the same question: is it a curse or a blessing for people? Many Cypriots are celebrating nature’s abundant blessing – through the financial hardships, while politicians are under strains on how to take advantage of them. Is it going to be a story with a happy ending?