The Cyprus Solidarity Fund and bank restructuring - what's the latest?

Is this Plan B or Plan C? We’ve lost track. Maybe Plan B+.

Anyway, it seems that the Cypriot parliament is currently discussing the proposal for a ‘solidarity fund’ which the cabinet has reportedly unanimously approved. This idea originated yesterday and was rejected by the troika overnight – we assume (hope) that this version of the fund contains some additional proposals to smooth over the previous disagreements.

What is the solidarity fund and what does it include (click to enlarge)?

The solidarity fund is essentially an investment fund or sovereign wealth fund which will pool a series of assets to help provide the €5.8bn in cash required by the Cypriot government to agree the bailout.

This is a broad list (we have assessed many of the measures already) and not all of them are likely to be included.

Now, clearly, some of these assets are liquid and can provide a cash flow, while others are not. It has been suggested that this fund will be used to purchase government debt in order to fully monetise the assets and boost government coffers. This seems strange to us since it would only succeed in worsening Cyprus’ debt level. It is also very likely to be rejected by the Troika for just that reason.

We also don’t necessarily see the benefit of extending the Russian loan. It helps from a cash flow sense, interest payments are cut by 2.5% and repayment is delayed by five years. But in the end Cyprus will end up paying €160m more. The Troika usually frowns on this type of approach.

CDU MP Hans Michelbach has also raised questions over the fund and specifically suggested it falls around €1bn short of providing the €5.8bn needed.

Laiki bank restructuring

The Cypriot Central Bank just announced that the second largest bank in Cyprus, Laiki Bank (or Cyprus Popular Bank), will be restructured and separated into a good and bad bank. This had been rumoured throughout the afternoon and sparked long queues at cash machines particularly Laiki ones, while the protests outside the Cypriot parliament have swelled with nervous Laiki bank workers and customers. The level of withdrawals has also been restricted to €260, while (somewhat ironically) the Central Bank has confirmed all depositors up to €100,000 will be guaranteed - no word on those above (see below).

This seems a reasonable move and could save between €1bn and €2bn on bank recap costs but problems abound. The cost of financing and winding down the bad bank will be large, who will finance it? Some reports suggest it could be the uninsured depositors – this may work but is likely to cause outcry amongst foreign investors and some Cypriot businesses.

The bill on bank restructuring is in front of the parliament now, along with a bill on the solidarity fund and a bill which includes some form of capital controls. It seems that the restructuring bill and the capital controls bill has support from the eurozone, but it is not clear that the solidarity fund does or the plans to fund the bank recap (as @SpiegelPeter notes).

The eurogroup will hold a call on this proposal at 6pm GMT, with a statement due after.

It is not clear if a vote will take place on it tonight in the Cypriot parliament, but we imagine they will at least need to wait for approval of the eurogroup.

Beppe Grillo demands Five-Star Movement government and euro referendum

Remember Italy?

Looking unusually smart in his dark suit, Beppe Grillo, along with some of his Five-Star Movement colleagues, this morning opened the second day of talks with President Giorgio Napolitano on forming the new Italian government.

After the meeting, Grillo's parliamentary whips Vito Crimi and Roberta Lombardi (see picture) read a short declaration to the press. The following three points stood out:

• The Five-Star Movement's 20-point plan for government would include a referendum on Italy's membership of the euro. This now seems to have become official party policy; 

• The Five-Star Movement wants "a full mandate" to form a government of its own choosing;

• If the Five-Star Movement fails to obtain the mandate, it will request the chairmanship of two key parliamentary committees: COPASIR, which is in charge of supervising Italy's intelligence services; and the committee in charge of supervising Italy's public broadcaster RAI.

On his blog, Grillo has just ruled out supporting "political or pseudo-technocratic governments". This sounds very much like a definitive 'no' to any solution other than a cabinet led by the Five-Star Movement itself, and essentially leaves two options open:

• A national unity government backed by Silvio Berlusconi, centre-left leader Pier Luigi Bersani and possibly Mario Monti. Such a government could be led by either Bersani himself or someone from outside of politics. Incumbent Interior Minister Anna Maria Cancellieri and newly-elected Senate speaker Pietro Grasso (a former anti-mafia prosecutor) are the names doing the rounds in the Italian media at the moment;

• New elections. These could, however, only be called once the next Italian President takes office in mid-May (we explained why in our response to the Italian election results).

Bersani is due to meet President Napolitano this evening at 5pm (GMT). The prevailing view in the Italian media is that the President may announce the name of the (first) person tasked with forming the new government by tomorrow evening, or Saturday morning at the latest.

We'll keep you posted with real-time Twitter updates from Italy. Follow us @OpenEurope or @LondonerVince.     

Why is the ECB threatening to pull the plug on Cyprus? And how would it work?

The ECB - which holds the key to Cyprus' future inside the euro by virtue of funding the country's banks - this morning issued a statement which essentially set Monday as the deadline for a Cypriot bailout deal. It said:

The Governing Council of the European Central Bank decided to maintain the current level of Emergency Liquidity Assistance (ELA) until Monday, 25 March 2013. Thereafter, Emergency Liquidity Assistance (ELA) could only be considered if an EU/IMF programme is in place that would ensure the solvency of the concerned banks.

Short but not sweet. It''s clear that Cypriot banks cannot survive without this liquidity. There either needs to be an EU/IMF bailout deal agreed by Monday or some deal with Russia to prop up Cypriot banks (although the political implications of this would be significant). Remember the four scenarios that we set out on Tuesday night following the No vote in the Cypriot parliament (which now many other analysts are echoing).

 In our flash analysis, we questioned whether the ECB might do this. We noted:

Would the ECB really pull the plug on liquidity to Cypriot banks?  

The key turning point here will be whether the ECB cuts off Cypriot banks...To pull the plug on ELA the ECB needs a 2/3 majority (15 out of 23 votes) at the ECB Governing Council. Although the Bundesbank and maybe the Dutch and Finnish central banks might vote to turn off the ELA a 2/3 majority is not certain. In fact since Mario Draghi took over the ECB it has not been particularly hawkish. Bloomberg reports that the ECB said after the vote: “The ECB reaffirms its commitment to provide liquidity as needed within the existing rules”. The crisis has shown so far that the rules of the ECB are incredibly malleable, so what exactly that statement means is unclear, but the vote could certainly go either way.

But why has the ECB taken such a tough line with Cyprus? Below we outline a few potential reasons behind its thinking (some of which were touched upon by @KarlWhelan on twitter yesterday):

• ECB rules clearly state that ELA must be provided only to solvent but illiquid banks - without recapitalisation (under a bailout deal) Cypriot banks would certainly be insolvent.
• Continuing to provide liquidity to Cypriot banks could also amount to a huge transfer of risk from depositors and investors to the ECB.
• Even if a deal is reached there are likely to be huge deposit outflows particularly from foreign depositors (even more so if the banks open without a clear deal).
• Cypriot bank ELA is currently around €9bn. Russian deposits total between €15bn and €20bn. If Russian depositors are hit hard, much of these deposits could be withdrawn.
• At almost 30% of all deposits, this would bring the solvency of Cypriot banks into question. The ECB would have to extend ELA massively to keep banks afloat – possibly by another €10bn to €15bn.
• This liquidity would therefore indirectly help fund outflows of deposits.
• Even increasing the ELA would not be sufficient if this turns into a full deposit run. This means the banks could still collapse and Cyprus could leave the eurozone. In this scenario, the Cypriot Central bank would default on its Target 2 imbalance with the Eurosystem (currently €7.5bn but it could double if the outflows are significant) leaving the ECB with a loss.
• Financially this loss would be bearable but it would hit ECB credibility hard and break the taboo of the ECB not suffering losses in the eurozone crisis, a No-No for Germany.
• If the banks collapsed but Cyprus stayed within the eurozone, the eurozone would likely have to stump up further funds to keep the country afloat. 
• Any losses from the ELA are the responsibility of the Cypriot Central Bank (and the Cypriot state which backs it), so they would not become a Eurosystem/ECB issue directly. That said, with Cyprus under a bailout programme the burden will likely fall on the eurozone since the Cypriot state would be unable to backstop the central bank alone.

So, extending the ELA without a clear deal could lead to a significant transfer of risk towards the ECB and questions over its credibility. This would be a particularly poisonous debate in Germany, something which neither the ECB nor the German government would want ahead of the German elections in September.

With this in mind, it is possible to see why the ECB has taken such a strict line here. That said, it certainly ramps up the pressure over the next few days.

Lastly, although the ECB is taking the decision based on technical considerations, it's clear the good folks in Frankfurt are now deeply embroiled in a highly political debate - precisely what the ECB wants to avoid at all costs.

Is reducing the tax on beer but not wine legal under EU law?

Cheaper beer but is it legal?

Delivering the budget today Chancellor George Osborne announced the reduction in beer duty by 1p per pint. However he did not do the same for wine. We have been wondering if the Treasury has cleared this with their lawyers as this could potentially infringe EU law - a point raised by Geoffrey Clifton-Brown MP in the debate. Hopefully it is legal but we thought we might remind them of an old case.

Under EU law you can not discriminate against another state's products. As the UK does not produce (much) wine the EU could argue that this breaks EU law. They have done it once before.

In the  1983 case "European Communities v United Kingdom of Great Britain and Northern Ireland. - Tax arrangements applying to wine. - Case 170/78." The Court found that:

ON THOSE GROUNDS ,

THE COURT

HEREBY :

1 . DECLARES THAT , BY LEVYING EXCISE DUTY ON STILL LIGHT WINES MADE FROM FRESH GRAPES AT A HIGHER RATE , IN RELATIVE TERMS , THAN ON BEER , THE UNITED KINGDOM OF GREAT BRITAIN AND NORTHERN IRELAND HAS FAILED TO FULFIL ITS OBLIGATIONS UNDER THE SECOND PARAGRAPH OF ARTICLE 95 OF THE EEC TREATY .

Before people get their spirits up (pun intended) we just hope the Treasury's lawyers were consulted.... And if it is legal then there is nothing stopping France putting up its tax on beer...

Osborne says UK is £3.5bn better off after Cameron's EU budget deal. Is he right?

Coverage of the budget today will understandably focus predominantly on the wider debate about sticking to 'Plan A', and of course the inadvertent 'leaking' of the budget on the front page of the Evening Standard.

However, being the EU obsessives that we are, it is always interesting to look at the latest estimates for the UK's contributions to the EU budget, particulalry in the wake of last month's deal on the long-term budget.

During his statement in the Commons, George Osborne said that as a result of the deal struck by David Cameron in February, the UK would be better off to the tune of £3.5bn by 2017-18. This is repeated in the main budget document (page 23).

So is he right? Well, yes and no.

First, it's definitely the case that the UK government has secured a decent deal compared to previous long-term EU budget periods (at least in terms of absolute cash, not so much on content), for which it should be given credit. The EU budget is always complicated because the UK contribution is presented in several different ways. But the underlying data from the OBR (pages 138-9) does indeed show that due to the reduction in the long-term budget agreed last month, the UK is due to save £3.5bn by 2017-18 compared to the estimates made in the OBR's December forecast - this is the row labelled "New Multi-annual Fiscal Framework deal" in the table below.

However, the OBR figures also show that the UK will lose out due to two other factors: the change in the projected exchange rate, which will see the UK contribute roughly £1.2bn more up to 2017/18, and assumed increases of £0.7bn to the UK's contributions to the 2012 and 2013 annual budgets. It isn't clear what the row "other" refers to, but apparently it will reduce the UK contribution by £0.4bn up to 2017/18. 

We would also speculate that the OBR may have to revise its figure for the 2013 annual budget upwards again because the European Parliament has made its agreement to the long-term budget deal conditional on any funding shortfalls for 2012 and 2013 being financed with new funds rather than from future budgets - there are rumours the Commission is set to table another so-called "amending budget" to top up the 2012 budget, which would mean greater UK contributions.

But notwithstanding all of these intricacies, the OBR's figures illustrate that Cameron's deal on the budget will serve to limit the UK's gross contributions to the EU. But, as we've said before, this may not be the case for the UK's net contributions for several reasons, including changes to the UK rebate.

NB. It is important to note that the UK's actual contributions to the EU are higher than the figures presented above. This OBR table only deals with the UK's so-called gross GNI contribution, which is the largest share, but doesn't include the extra cash from VAT and customs duties that the UK also hands to the EU. It also doesn't reflect changes to payments the UK receives from the EU budget.

All at sea – What does the 'No' vote mean for Cyprus and the eurozone?

Following the dramatic vote by the Cypriot parliament tonight to reject the bailout deal, here is our flash analysis of the situation:

The Cypriot parliament tonight voted against a bill to introduce a tax on bank deposits, in return for a €10bn bailout offered to the country by Germany and other eurozone governments. Not a single Cypriot MP voted for the deal. The structure of the tax in the bill is shown in the table below. The vote leaves Cyprus’ place in the eurozone hanging in the balance and threatens the escalation of the crisis to a new level, though the most likely outcome is that the Cypriot parliament votes a second time, on a revised deal.

Results of the vote (click to enlarge)

The governing party (DISY) abstained (with one member absent), while the junior coalition partner (DIKO) voted against – this signifies the huge political divisions at work in Cyprus. Even if a bailout deal is eventually approved the government’s position continues to look untenable.

What does the vote against the deposit levy mean?

As we have noted before, this has the potential to be a very serious twist in the eurozone crisis. Previously, Germany and the eurozone have stressed that Cyprus has no alternatives to the deposit levy. Now, all eurozone partners are forced back into difficult negotiations.

What timeline are Cyprus and the eurozone working on?

Cyprus will run out of cash on 3 June, when it has to repay a €1.4bn international bond. However, the decision will need to be taken long before that. Cypriot banks cannot stay closed for long but they cannot be reopened until a decision is taken, otherwise there will almost certainly be a deposit run. While people can reportedly withdraw up to €700 per day from ATMs, businesses, large and small, cannot function without banks being open. We would expect some decision would need to be taken by early next week before the lack of liquidity and lack of economic activity begins to severely harm the Cypriot economy.

Would the ECB really pull the plug on liquidity to Cypriot banks?

The key turning point here will be whether the ECB cuts off Cypriot banks. It is to some extent the vital difference between option 2 and 4, while keeping liquidity on could help facilitate option 1. To pull the plug on ELA the ECB needs a 2/3 majority (15 out of 23 votes) at the ECB Governing Council. Although the Bundesbank and maybe the Dutch and Finnish central banks might vote to turn off the ELA a 2/3 majority is not certain. In fact since Mario Draghi took over the ECB it has not been particularly hawkish. Bloomberg reports that the ECB said after the vote: “The ECB reaffirms its commitment to provide liquidity as needed within the existing rules”. The crisis has shown so far that the rules of the ECB are incredibly malleable, so what exactly that statement means is unclear, but the vote could certainly go either way.

Click here to read our analysis in full, including four potential scenarios.

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.

Eurogroup distances itself from decision to tax small depositors in Cyprus

At some point yesterday, it became clear that Cypriot President Nicos Anastastasiades would not have sufficient support to push the deal on the deposit tax through parliament – at least not in its current form.

That led to an extension of the bank holiday to at least Thursday, the parliamentary vote being moved to 4pm GMT today (from yesterday) and the Eurogroup holding a teleconference yesterday evening.

The result of the conference was this statement, the key part being:

The Eurogroup continues to be of the view that small depositors should be treated differently from large depositors and reaffirms the importance of fully guaranteeing deposits below EUR 100.000. The Cypriot authorities will introduce more progressivity in the one-off levy compared to what was agreed on 16 March, provided that it continues yielding the targeted reduction of the financing envelope and, hence, not impact the overall amount of financial assistance up to EUR 10bn.

The statement seems to be more of a hand washing exercise than a definitive end to the issues plaguing the Cypriot bailout – i.e. do whatever you need to in order to raise the €5.8bn but don’t blame us for your political troubles.

Ultimately, it is not clear that deposits below €100,000 will not be taxed. The two options on the table remain:

-          Depositors with up to €100,000, taxed at 3%; those with €100,000 to €500,000 taxed at 10%; and those with over €500,000 taxed at 15%. (This could also include an exemption of deposits below €20,000).

-          Tax deposits over €100,000 at 15.2% and exempt deposits below €100,000.

How much difference will this move make?

Well, removing the burden on smaller depositors would be a positive one, as we have suggested. That said, with the cat out of the bag as it were, this is unlikely to dial down frustrations or concerns significantly. This option is now on the table and the political divisions it has exposed are unlikely to be easily papered over.

Despite the fact that it seems the Cypriot government played a large role in the decision to structure the tax to hit smaller depositors in the first place, the anti-German feeling seems to be rising. Meanwhile, we still believe that the position of the government – which was elected on the basis of ruling out losses for any (large or small, foreign or domestic) depositors – remains precarious.

While everyone is speculating about contagion to other eurozone countries: What are the Italian and Spanish press actually saying about the Cypriot bailout?

Analysts - led by Anglo-Saxon ones - have lined up to say that, following the deposit levy as part of the Cypriot bailout, a bank run on the rest of the Mediterranean is now a near certainty.

New York Times columnist Paul Krugman went the furthest, arguing that

It’s as if the Europeans are holding up a neon sign, written in Greek and Italian, saying “time to stage a run on your banks!”

But for all these speculations, very few analysts have actually bothered to properly assess the mood and immediate reaction in Italy and Spain - whose depositors are meant to be lining up outside banks and cash machines to withdraw all their savings. Surely, the response and tone in the media of these countries on the day following the deal will give a pretty strong indicator as to whether Italian and Spanish depositors will perceive themselves as being 'next in line', or whether, in fact, they consider the Cypriot situation unique.

As Mats Persson argued on his Telegraph blog yesterday,

Fears of deposit-led contagion to other parts of the eurozone should definitely not be be overstated...viewed with a depositor's eyes from Barcelona or Bilbao, Spain may have very little in common with Cyprus.

Of course, this is all very hard to predict and if talks about a bailout kicks of in Spain and Italy, will depositors trust what politicians are telling them? But what do governments and pundits actually say in these two countries? Put differently, what did Spanish and Italians depositors actually hear when they woke up to the news that their Cypriot counterparts will now see their savings taxed?

Here's a summary.

Italy  

Italy has some relatively fresh memories of a deposit levy: the 0.6% prelievo forzoso from all Italian bank accounts enacted by the government led by Giuliano Amato in 1992, when Italian public finances were facing an "extraordinary emergency". So one would expect the Italian media - and Italians themselves - to make a pretty big deal of the Cypriot bailout.

Not quite.  Although Italy's borrowing costs have inevitably been driven up a bit by the news coming from Cyprus, the media is surprisingly relaxed (and certainly no queues outside ATMs). Of the largest Italian papers, only La Repubblica and La Stampa made some room for Cyprus on the front page of today's print edition. Pope Francis and Italy's own political troubles continue to dominate. However, some Italian commentators did flag up the risks involved in the Cypriot bailout for the rest of the eurozone.

Vittorio Da Rold of Il Sole 24 Ore calls the Cypriot bailout "a dangerous precedent which undermines confidence" in the eurozone.

Italian economist Giulio Sapelli put it more bluntly,

Stuff like this can generate bank panic throughout the EU. [European leaders] are crazy.

Ferruccio de Bortoli, editor of Il Corriere della Sera, has tweeted that Cyprus's deposit levy "risks creating uncertainty and fears".

Unsurprisingly, the authorities' reaction was targeted at being a lot more reassuring. Giuseppe Vegas, head of Italy's financial markets watchdog Consob, said,

There are no similarities between Cyprus and Italy...The markets are obviously nervous [over Cyprus], but I wouldn't dramatise.

Spain

Several Spanish dailies ran with Cyprus as front page story today (see here). The most common reference in the Spanish press is to Argentina's corralito - when Argentinians' accounts were frozen to prevent a bank run in the country at the end of 2001.

As in Italy, there are no signs of Spanish depositors taking to the cash points - but the interest rate on Spain's ten-year bonds has reached above 5% this morning. As in Italy, authorities have moved quickly to reassure the citizens that there is no risk of contagion spreading to Spain.

There has been some concern over contagion in the press, though, with Carlos Segovia, Economics Editor of El Mundo, writing,

Analysts from around the world start to doubt that Cyprus’s precedent may one day end up being applicable to other Southern European countries, even partially.

Under the headline, "We are a German colony", the paper's Washington correspondent Pablo Pardo goes all out,

The 'bailout' imposed by the EU [on Cyprus] is the closest thing to an armed robbery against that country's savers.

Spanish economist José Carlos Díez is not happy either. He writes in El País,

The Cypriot bailout deal confirms that there are no signs of intelligent life in Europe.

Spanish business daily El Economista is a bit more relaxed, saying in an editorial that a Cypriot-style corralito is "unthinkable" in bigger eurozone countries like Spain, Portugal or Italy. But the paper also notes,

A haircut should have been applied to bondholders before applying [the deposit levy], which now comes out as an inconsistent measure.

So critical and concerned about precedent set, but no "panic spreads amongst savers" type headlines that we have seen in certain other countries. We certainly do not play down the precedent, or defend the deal, but one should not exaggerate either.

There's no way this [the deposit levy] will be repeated in Spain or Italy, so it's not clear when the great bank run is supposed to take place - not that bank runs are impossible by any stretch of the imagination in these economies, but a deposit tax or even the precedent set here is not likely to be the cause. That said, a real question remains over whether this will hamper future bailouts, future funding from the eurozone or even the fledgling moves towards greater eurozone integration. But that is a slightly different discussion.

The Great Cypriot Game - How important is gas to Cyprus' economic and geopolitical future?

Update 12:00 18/03/13:

Russian Finance Minister Anton Siluanov has had some interesting things to say on the deposit levy (via Reuters):

"We had an agreement with colleagues from the euro zone that we'll coordinate our actions."

"It turns out that the euro zone actions on the introduction of the deposit levy took place without discussions with Russia, so we will consider the issue of restructurisation of the (Cyprus) loan taking into account our participation in the joint actions with the European Union to help Cyprus."

It seems Russia is none too happy with the eurozone approach, unsurprisingly. If it does refuse to ease the terms of the €2.5bn bailout loan it previously gave Cyprus, it could hit Cypriot funding requirements, although probably not by a substantial amount. Still it could result in eurozone bailout funds being used to pay off a Russian loan in the near future - something which may not sit well with German taxpayers. Again, the interesting fall out will be to see how this impacts Russia's approach to Cyprus and the EU more broadly.

***************** Original post ********************************

In the middle ages, Cyprus was a key battle ground between great powers seeking dominance in the region. Well, the country - which, remember, only accounts for 0.2% of eurozone GDP - could become a hotspot once more (though we shouldn't be over-excited about this).

According Greek Reporter, Gazprom made an offer over the weekend to the Cypriot government to fund the bank restructuring planned under the Cypriot bailout (which is set to cost up to €10bn) in exchange for exclusive exploration rights for Cypriot territorial waters. How reliable this story is remains to be seen, but it does hint at the geopolitical tension which we have been warning about.

Gazprom is known to be very close to the Russian government and despite Russian President Vladimir Putin overtly slamming the deposit tax - calling it "unfair, unprofessional and dangerous" -  it is unlikely that they would let this opportunity pass untouched. Fortunately, the Cypriot government is said to have rejected the deal off the bat, but if displeasure towards the eurozone and the EU grows, the Russian option may become increasingly appealing.

So how important is the gas element for Cyprus' economic and geopolitical future? Well, there is no denying that Cyprus could potentially be sitting on top of gas reserves worth many times its GDP. However, as a revenue stream it is far from a sure thing. Here is how we put it in our flash analysis released on Friday:

Recent exploration has suggested Cyprus may have between €18.5bn and €29.5bn (103% - 163% of GDP) in untapped gas reserves lying in its territorial waters (according to Deutsche Bank). There have been rumours that this future revenue stream could be incorporated or used to backstop the bailout somehow. Although an appealing idea, there is still a huge amount of uncertainty around the real value of these reserves and how soon they can begin producing revenue

So far, one field has been explored (known as Block 12) and estimates of its potential value go as high as €100bn. See below for a useful diagram (via Baker Tilley):

However, there are a few key points to remember when considering the impact of this on the Cypriot bailout:

• Exports from the gas fields are not expected to begin until 2019 at the earliest. Cyprus runs out of cash in June this year, a short and medium term solution is needed now. Tapping the further reserves (beyond Block 12) will take even longer.
• There needs to be significant investment, potentially up to $4bn to begin extracting the gas – the Cypriot government certainly cannot afford this. Although there is sizeable interest in the exploration rights, the FT’s Nick Butler notes that Noble Energy (which explored Block 12) is not bidding for further rights, which raises some concerns.
• Furthermore, Turkey is still contesting Cyprus’ ownership of these reserves. Although Cyprus currently has the backing of the international community, this dispute could further hold up progress in tapping these reserves. Many of the energy companies looking into Cyprus also have interests in Turkey and may not want to put those at risk.

To us then, the offer by the Cypriot government to provide Cypriot depositors with bonds linked to gas revenues sounds like a nice idea, but will not compensate these depositors for some years, at best.

But, remember with a view to Moscow, this is definitely one to watch.

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.