What if the Cypriot parliament votes against the deposit levy?

This is the question which is now holding global financial markets on the edge - could it really happen and what would it mean, we assess the possible scenarios below.

Could the Cypriot parliament vote against the levy?

According to Reuters, Cypriot government spokesman Christos Stylianides told state radio that the vote “looks like it won’t pass”. Meanwhile, via Zerohedge:

• CYPRUS PRESIDENT: PARLIAMENT BELIEVES BAILOUT PLAN UNJUST, GOVERNMENT MAKING OTHER PLANS.
• CYPRUS PRESIDENT: PARLIAMENT WILL REJECT BAILOUT PLAN

As we were tweeting yesterday, the DIKO party (junior coalition member with 8 MPs) had said it would not vote for the deal without some improvements, although we suspect reducing the burden on small depositors could help convince them. The European Party (2 MPs) had previously said it would not support he levy, however, according to CYBC, it has now said it would support the levy if depositors are compensated with interest bearing government bonds (we assume linked to gas revenues, something which the government has already offered).

That said, according to the Cypriot press, the latest proposal sees deposits below €20,000 exempt, deposits between €20,000 and €100,000 taxed at 6.75% and deposits over €100,000 taxed at 9.9% - this is unlikely to satisfy demands to exempt smaller depositors. It also seems unlikely to raise the required €5.8bn, not least because it applies the same rate as the original to a smaller pool of deposits.

Separately, there are conflicting reports this morning on whether the vote will be delayed again. The government is unlikely to put this to a vote until it is almost near certain of getting it through.

What would the fallout be?

The fallout of voting down the package could be explosive and we can only speculate about what could happen next, but its eurozone membership would likely be brought into doubt. As we noted in our flash analysis, there are few other alternatives for Cyprus to raise the necessary cash, while the eurozone has made it clear it cannot foot the entire bill (such an option would make Cypriot debt unsustainable anyway).

The eurozone would likely give Cyprus a few days either to change its mind or come up with an alternative way of financing the €5.8bn. Another parliamentary vote could be held (the EU of course has form when it comes to demanding the 'correct' vote).

The ECB has already reportedly warned that rejecting a levy would have dire consequences. Specifically, the two largest Cypriot banks would go without recapitalisation and could see their liquidity from the ELA (sanctioned by the ECB via the Bank of Cyprus) cut off, leading to them becoming insolvent and collapsing – putting their €30bn of deposits at risk, since the government obviously cannot guarantee them. This would likely bring down most if not the entire Cypriot financial system.

With the financial sector close to or in the process of collapsing and no support forthcoming from the eurozone or ECB, since Cyprus rejected their terms, Cyprus could even be forced to leave the eurozone and begin printing its own new currency, one that would have little international trust and could lead to a spiral of hyperinflation, etc, etc (i.e. a very nasty scenario).

There is, of course, a chance that if faced with the prospect of Cyprus leaving the euro, the rest of the eurozone could blink and find an alternative way to bailout Cyprus but the politics of such a scenario would get very ugly indeed. The ECB may not follow through on its threat to withdraw liquidity for Cypriot banks but this would only be a temporary reprieve. The Cypriot government will run out of cash at the start of June when it needs to pay off a €1.4bn bond, while the banks' position could be worsened by the likely deposit outflows once banks open, even if the tax is not applied.

What are these “other plans”?

It’s not clear exactly what Cypriot President Nicos Anastasiades meant when he suggested the government is making 'other plans'. We have long noted that deeper connections to Russia remain a viable option for Cyprus. With Russia angry at the eurozone for trying to burn some of its depositors, some more financial support could be forthcoming (but maybe only for Cyprus outside the eurozone) – with significant geopolitical implications as we noted here.

Other options which have been bandied around include: a financial transaction tax and the recent proposal from Lee C. Buchheit and Mitu Gulati (the men partly behind the Greek restructuring) to convert deposits into deposit certificates with fixed long term maturities. However, the former has been widely rejected by Cyprus and may not yield sufficient funding. The latter is an interesting proposal but may only offer liquidity support rather than solvency, while the banks would still remain under-capitalised. Such a proposal would still require significant backing from the eurozone and Russia – both of which are likely to come with onerous terms – and present similar obstacles to a deal.

So, all in all a 'No' vote, however tempting to Cypriot MPs, only leaves more drastic alternatives, hence it remains a possible but not probable outcome.

How might a revised Cypriot bailout deal look?

Update 11:00 GMT 18/03/2013

Sources told Spanish news agency EFE that the Cypriot government and the Troika have agreed to cut the levy on depositors with less than €100,000 to 3% and and increased the levy on those with more than that to 12.5%, but we haven't seen this confirmed by anyone else so treat with care.

Update 09:15 GMT 18/03/2013:

The WSJ is reporting that Cyprus could seek a further division amongst uninsured depositors (which @MatinaStevis tweeted already yesterday). According to the paper, the Cypriot government is pushing for 3% on below €100,000, 10% on between €100,000 to €500,000 and 15% on €500,000+. There are no clear figures on how much each individual levy will raise, although Germany is said to be open to the idea as long as the total of €5.8bn remains.

The Cypriot parliament will vote on the deal at 2pm GMT, with eurozone finance ministers due to have a teleconference at some point later this afternoon.

Original post

As we reported yesterday, the Cypriot government is now scrambling to renegotiate the deal which has created such an outcry in Cyprus. Germany and the IMF will not budge on the headline figure or that the money must come from a deposit levy (the only option to raise this sort of cash anyway), however, they do not mind which depositors pay it or at what rates.

This has led to suggestions that the rates could be adjusted to increase the cost on large uninsured depositors and reduce the impact on smaller insured depositors – this would probably be both legally and politically more acceptable.

So how could it be structured? Well, Cyprus has around €30bn in insured deposits below €100,000 and €38bn of uninsured deposits above €100,000. See table below for potential structures (click to enlarge):

Option 1 seems to be what is currently under discussion. Option 2 might be politically popular, although the impact on business and investment could be significant. One thing that is clear, as we have repeated over the weekend, is that this deal remains in flux.

Is there any chance Cyprus could secure a better deal?

UPDATE 22:00 

According to Reuters, German Finance Minister  Wolfgang Schäuble claimed today that it was indeed the Cypriot govenrment's  decision to go for smaller depositors - not Germany's. 

Speaking to public broadcaster ARD he said, 

"It was the position of the German government and the International Monetary Fund that we must get a considerable part of the funds that are necessary for restructuring the banks from the banks owners and creditors - that means the investors."

"But we would obviously have respected the deposit guarantee for accounts up to € 100,000...But those who did not want a bail-in were the Cypriot government, also the European Commission and the ECB, they decided on this solution and they now must explain this to the Cypriot people."

 Let the finger-pointing begin...

ORIGINAL POST

As we have pointed out, the bailout deal and deposit tax are still subject to Cypriot parliament approval, which is far from assured but looks likely.

In any case, questions are arising of whether there is scope to adjust the level or structure of the tax, with reports claiming that the Cypriot government is currently in talks with EU partners to revise the deal, possibly shifting a greater share of the burden to larger depositors. This would make the deal far more politically palatable.

Much of the outcry has been against the 6.75% tax on depositors below €100,000 – mostly 'ordinary' Cypriot savers. The perception is that EU leaders and the IMF imposed this on Cyprus. The question is, if the parliament rejected the deal - or with the threat of it rejecting the deal (still unclear whether there will be a majority for it in the Parliament) - could they perhaps push for the 9.9% rate for depositors over €100,000 to be increased, with a corresponding lower share for the lower end depositors? And are there possible progressive arrangements, involving several different depositor 'brackets'?

It is possible, since technical details are still being ironed out (for example if you have €100,000+ will it all be taxed at 9.9% or part at 6.75%). However, the important point to note is that, although Germany was the driving force behind the tax itself, it seems that the Cypriot government played a role in designing it. Mainly, reports suggest that the Cypriot President Nicos Anastasiades was reluctant to return with a double digit tax on higher deposits as this would anger Cypriot businesses and investors as well as scare of foreign investors. In other words, Cyprus worried that this would kill the country's position as an 'offshore' financial centre.

It has of course been reported that Germany and the IMF were pushing for a double digit tax initially – but on whom? Think about the maths for a second. The current structure raises almost €6bn. The max which the Eurozone was trying to cut of the bailout was €7.5bn. So, with €1.4bn in privatisations the target is reached. Logically this must mean the higher rate would have raised the same amount and therefore been applied to fewer depositors. This simple calculation suggests that the negotiations moved from a higher double digit tax on a specific group to a broader lower tax.

In any case, the important point to note is that the structure of the deal and the decision to hit ordinary depositors may not have been entirely a Eurozone one.

Whether the Cypriot government can or will change its position remains to be seen, but all of this suggests there should be some scope for a revised deal, though it would be far from ideal to keep the details unclear when markets open.