With plan to save Cyprus, EU bureaucrats prescribe long-term pain

Local and European leaders are expressing cautious optimism after having reached a last-minute deal on a bailout agreement for Cyprus. But independent analysts worry about the long-term economic consequences for the island.

"A long period of uncertainty and insecurity surrounding the Cyprus economy has ended," said Michael Sarris, the Cypriot finance minister.

“We've put an end to the uncertainty that has affected Cyprus and the euro area over the past week,” proclaimed Jeroen Dijsselbloem, who chairs the meetings of the 17-nation eurozone's finance ministers.

But many independent experts don’t quite see it that way. Although Cyprus secured the 10 billion euro ($13 billion) bailout that it wanted, in return it signed up for drastic and far-reaching measures that many say will cripple its vital financial services industry for years to come.

The deal reached by Cyprus may have averted short-term bankruptcy and a forced exit from the euro but it is likely to entail a massive restructuring of the Mediterranean island’s economy – leaving Cypriots worried about significant job losses, a deepening of the country’s recession, and a flight of foreign capital from their once lucrative banking sector.

A 'brutal hit'

Negotiations between the leaders of the indebted nation and international lenders in Brussels went right down to the wire – the accord was struck early Monday morning, just hours ahead of the deadline by which the European Central Bank said it would shut off emergency liquidity assistance for Cypriot banks.

The agreement safeguarded the bank deposits of small investors, with a guarantee for all holdings of 100,000 euros ($130,000) or less.

The country's second-largest bank – the Popular Bank of Cyprus, which is also known as Laiki – will be effectively shut down, with companies and individuals holding more than 100,000 euros in their accounts facing significant losses.

The bank’s thousands of employees are likely to lose their jobs and there will be knock-on effects for the consultants, accountants, and lawyers who make their living from the financial sector, which has attracted billions of dollars of foreign capital in recent years, including an estimated 20 billion euros ($26 billion) from Russia alone.

The sector employs around 25 to 30 percent of the workforce in Cyprus, which has a population of just 800,000 – significantly less than the state of Rhode Island.

“It has been hit very brutally,” says Stelios Platis, an economist at Cyprus International University of Management.

No confidence

Dr. Platis put the blame squarely on the Eurogroup, the gathering of the euro zone’s finance ministers, which granted Cyprus the bailout package. “The Eurogroup killed the most important ingredient in any banking sector – depositors’ and investors’ confidence."

“Now we don’t even know if Cyprus’s largest bank [the Bank of Cyprus] will survive," he says. "The financial services sector was the largest and most successful economic activity on the island and it’s been hit by an unprecedented blow. The real economy will inevitably be hit as well.”

Platis hesitated to estimate how badly the wider economy would be affected, but other analysts said there could be a contraction of up to 20 percent in the next two years and that unemployment could jump from 15 percent to 25 percent within 12 months.

Critics of Cyprus said it had become far too reliant on its financial services industry, which is worth around eight times the country’s gross domestic product of 18 billion euros.

Eurozone leaders were determined to enforce far-reaching reform of the sector, which has been accused of accepting money from sometimes shady investors with no questions asked.

The “economic shock” of the restructuring meant the Cyprus’s near future would be “very difficult,” said Olli Rehn, the European Union's commissioner for monetary affairs.

A slow, painful recovery?

Afxentis Afxentiou, a former governor of the Cyprus Central Bank, said the effects could last up to a decade. “Cyprus has suffered a big hit and our standard of living will spiral downward. Although the economy may be able to recover in two to three years, our standard of living will take at least 10 years to return,” he told state radio.

Open Europe, an independent think tank based in Brussels and London, said the bailout package would have a devastating effect on the tiny island, with the risk that it could become “a zombie economy,” overly dependent on euro zone funding while experiencing very low levels of growth.

“Cypriot GDP is likely to collapse in the wake of the deal, with possible capital controls hampering the functioning of the economy. The large loan from the eurozone will push debt up to unsustainable levels while the austerity accompanying it will increase unemployment and cause social tension,” the think tank said in a statement.

The uncertainty of the past weeks, and the paralysis of the banking system, has already had a big impact on small businesses.

“In the last week, all our suppliers have been demanding cash, they won’t take checks or credit,” says Nicholas Lartides, who runs a convenience shop in Nicosia. “Businesses are going to start laying off employees. I think it’s going to take five or six years to recover from this.”