The markets rallied Monday morning as Cyprus found an 11-th
hour solution to its crisis that protects deposits below the
European Union-guaranteed 100,000 euros ($130,000) limit but
takes a bigger chunk of those above that amount, but fell in
the afternoon as the risks became obvious.
The bailout creates a dangerous precedent and does nothing to
eliminate risks of contagion and
loss of confidence, various strategists said.
Monday morning, stock markets rallied across the globe, with
the Emerging Markets MSCI index up more than 1%, while the FTSE
100 and the DAX rose nearly 1% and France's CAC-40 advanced by
1.5% in mid-morning London time.
They fell back in the afternoon following remarks by Eurogroup
head Jeroen Dijsselbloem, who is the Dutch Minister of Finance,
in which he suggested that the approach taken on bailing out
Cyprus could be repeated for other countries.
"If there is a risk in a bank, our first question should be
'Okay, what are you in the bank going to do about that? What
can you do to recapitalise yourself?'. If the bank can't do it,
then we'll talk to the shareholders and the bondholders, we'll
ask them to contribute in recapitalising the bank, and if
necessary the uninsured deposit holders," Dijsselbloem said,
quoted by Reuters.
The solution found for Cyprus involves winding down its
second-largest bank, Laiki, with deposits under 100,000 euros
moved to Bank of Cyprus, the largest bank.
According to various press reports, depositors with over
100,000 euros stand to lose something like 30% of anything they
have above that level. No official figure for the haircut for
depositors was available.
"The agreement reached today on Cyprus provides a comprehensive
and credible plan to deal with the current economic challenges
in the country," Christine Lagarde, Managing Director of the
International Monetary Fund (IMF), said in a statement after
the Cypriot authorities announced their decision.
"This agreement provides the basis for restoring trust in the
banking system, which is key to supporting growth," Lagarde
But some analysts disagree, saying the hardships not just for
Cyprus but for other countries are just beginning.
Flows into emerging markets fell in both fixed income and
equity asset classes last week, when developments in Cyprus
deteriorated, strategists at RBS noted.
Michala Marcussen, an analyst with Societe Generale, said that
the reaction in Cyprus over the coming days will be "important
"For Cyprus, the tumultuous events of last week have deepened
the economic shock. For the euro area, this has not done much
for confidence in its ability to resolve crises," Marcussen
She noted that as part of the agreement, the Cypriot financial
sector roughly 7 times the country's gross domestic
product - will be cut to match the EU average by 2018, an
independent evaluation will be carried out on the
implementation of anti-money laundering framework and capital
income tax and the corporate tax will be increased.
Even though Cyprus is too small to matter too much to the
eurozone from an economical point of view, "contagion remains a
risk," she added.
The first risk that Marcussen sees is that of a "depression for
Cyprus," with a drop of 20% in GDP by 2017 and the country
needing further financial assistance.
Another risk, this time broader than just for Cyprus, is that
of a "loss of trust," because events in Cyprus "will have given
food for thought" to depositors with over 100,000
"Just how much trust has been lost will in our opinion only
really be put to the test if another country were to request an
adjustment program." Marcussen said.
Yet another risk that she sees is the fact that there is "more
appetite for bail-in," with the tough stance taken by leaders
in the eurozone showing that their patience is wearing thin
when it comes to negotiating conditionality.
AUSTERITY STILL PREFERRED
The fact that "conditionality remains tough" is also a risk, as
the program for Cyprus came with the same harsh conditionality
seen in previous programs, despite repeated calls from various
leaders in the eurozone and from the IMF to favor growth rather
"The view that a painful diet of austerity and deep-rooted
structural reform ultimately delivers the right results is
alive and well," Marcussen wrote in a market note.
Danske Bank chief analyst Allan von Mehren believes that the
crisis is not over, although the fact that a deal was reached
is a positive feature that calms markets over the short
The solution found for Cyprus sets "a very dangerous" precedent
in the areas of capital control and losses on deposits above
the deposit guarantee, von Mehren wrote in a market
"Savers in Greece and Spain will most likely react much faster
and pull their money out if new negotiations with the EU become
necessary at some point," he said.
"A flight of deposits above the 100,000 euros guarantee could
already take place in these countries in the short term as
these savers feel less secure about their deposits."
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