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Cyprus Desperate for Bailout

Finance Ministers to Meet


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By Erik Neilson
Thursday, March 14th, 2013

Cyprus may be getting a bit of financial help in the near future, as discussion of a bailout for the island is on the horizon.

According to Reuters, the Eurozone’s 17 financial ministers will be meeting Friday in Brussels to discuss a bailout of the island of Cyprus, which has helped to raise expectations that the Eurozone will finally be delivering on the aid package that Cyprus asked for in June.

The meeting comes after a summit of EU leaders and a mission by the troika of international lenders to Cyprus. The island has been hurt by its exposure to the Greek economy and requires funding in order to recapitalize its banks and finance its government, Reuters reports.

Cyprus will likely need aid three years of aid in order to recover. Without this, the island runs the risk of default, which could dramatically affect the credibility of the Eurozone and once again put it in bad favor with investors.

According to Reuters, initial estimates of the scope of the bailout have reached as far as what Cyprus’ economy is able to produce in a given year: 17 billion euros, or $22 billion.

Understandably, this has raised doubts as to whether or not Cyprus would ever be able to pay back such a large amount of money, which has officials on every end nervous. If Cyprus is able to raise a sizeable amount of money taxes and deposits, Reuters reports, it may require a smaller bailout in order to reach its financial goals.

One thing lenders are discussing in order to help Cyprus reach its goals is the possibility of raising the island’s tax rate from 10% to 12.5%, a hike of 2.5 points. They are also encouraging a tax on financial transactions, though the island has strongly opposed this in the past and likely still does.

Cyprus has been trying to get Moscow, a long-time ally, to agree to a 5-year payment extension with low interest rates. It also tried—and failed—last year to secure a 5 billion euro ($6.5 billion) loan from Russia.

Eurozone officials are hoping for a decision before the end of March. A “bail-in” is also a possibility, which would involve forcing losses on depositors in Cypriot banks, as Reuters reports. While this is a divisive issue, it’s something that could potentially help Cyprus to reach its economic goals and get back on track.

It could also spark a quick withdrawal of funds from Cyprus and completely undermine the island’s banking system, however, which would likely do nothing but make matters worse. Add to this the fact that Berlin is concerned Cyprus has become a conduit for money-laundering, and it makes sense why the option of a bail-in could perhaps cause more problems than it is worth.

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Even though Cyprus is a relatively small economy, a default could have a systemic risk that would affect the Eurozone in a very negative way. Since the Eurozone has worked diligently to improve debt issues in the recent past, a hit such as this could be monumental, and officials are doing everything they can to make sure it doesn’t happen.

The longer the negotiations continue, the the more uncertainty there is about the future of Cyprus’ economy. Fears that result from this issue could easily cause depositors to pull cash out of the island’s banks, which will do nothing but make things even worse.

A key question on Friday will be how to improve the island’s shortfall by striking a compromise between what Cyprus truly needs and what the troika is willing to offer them.

The future of Cyprus’ economy is quite uncertain, although tomorrow’s talks should bring to light new possibilities in helping the island recover. Officials are stressing that the sooner decisions can be made, the better the island’s chance of recovering.

 

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