De Facto Loss of Sovereignty: Cyprus Makes Big Concessions for Bailout

By Christian Reiermann and

Cyprus wants help from the European Union's bailout fund. But the price for the billions in emergency aid money is high. The country will effectively lose its sovereignty.

A Cypriot euro coin. The president has called the bailout terms a "necessary evil." Zoom
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A Cypriot euro coin. The president has called the bailout terms a "necessary evil."

Dimitris Christofias had a serious look on his face as he turned to the cameras and spoke of what a "gut-wrenching" decision it was, but added that it was also a "necessary evil." The Cypriot president was not giving his people good news.

His staff realized how bad it would be when Christofias, in his televised address last Tuesday, reminded viewers of his country's darkest hour, the Turkish invasion of northern Cyprus in 1974.

Although Cyprus is not about to suffer the same fate, it is already clear that in return for billions of euros for the debt-ridden country from the European bailout fund, the "troika," made up of the European Commission, the European Central Bank (ECB) and the International Monetary Fund (IMF), will essentialy take control of the Mediterranean island.

The Cypriot government and representatives of the troika negotiated for almost five months over the terms of a bailout package, worth at least €17.5 billion ($22.8 billion). The negotiations produced the draft version of a 30-page Memorandum of Understanding (MoU), in which the troika dictates to Cyprus what steps it will have to take in the coming years, down to the smallest detail.

Under the deal, civil servants and politicians, including cabinet ministers, will have to fly in economy class when traveling within Europe in the future. Exceptions apply to the president of the country and the president of the parliament. Spending on foreign trips will be trimmed. The privilege senior bureaucrats have to buy cars duty-free will be eliminated. And the salaries of civil servants and lawmakers will be frozen until 2016.

Blaming the Banks

When representatives of the troika get down to the nitty-gritty of imposing rules, no detail is too small for them. For instance, they have prescribed new hours of operation for government offices. In the future, public offices will open punctually at 8 a.m. Starting Sept. 1, 2013, public servants and other government employees will work within a regulated flextime program. According to the MoU draft document, this will be "37 1/2 hours per week, 7 1/2 hours per day."

The euro rescuers also addressed government revenues. The tax on fine-cut tobacco will go up drastically from €60 to €150 per kilogram, while the beer tax will increase to €6 per degree of alcohol and hectoliter. The troika also believes that a tax increase of 7 cents per liter is appropriate for diesel fuel and gasoline.

Citizens will be especially hard-hit by the planned 2-percent increase in the value-added tax, bringing it up to 19 percent. The troika is also calling for cuts in the healthcare sector, as well as reduced pensions.

Christofias left no doubt as to who he blames for the disaster, saying: "It's true that the decisions of bank executives and the miserable control by the Cypriot central bank have cost Cyprus billions of euros." The amount of the aid package corresponds almost to the country's entire economic output in a year. According to the troika's plan, by 2016 Cyprus's national budget will be cleaned up enough that the country can hopefully make do without new debt.

Creditors to Take Losses First

Cypriot banks are also expected to make a contribution. Crisis-ridden institutions will no longer be supported solely by injections of cash from the European bailout fund. This time, the banks' creditors are also expected to pay up. "With the goal of minimizing the cost to taxpayers, bank shareholders and junior debt holders will take losses before state-aid measures are granted," the MoU draft reads. This means that creditors of Cypriot banks won't just be able to withdraw their money. Instead, their claims will be converted into bank shares.

In taking this step, the troika is avoiding a potential embarrassment. Substantial sums of Russian capital are deposited into Cypriot banks, and some of it is probably of dubious origin. It would be difficult to explain to the European public why its taxes are being used to rescue wealthy oligarchs. Now, people who had previously invested their wealth into yachts, cars and football clubs will be forcibly turned into bank owners.

At the same time, Cyprus will have to rebuild its financial sector in the coming years, along with drastically improving regulations and intensifying the fight against money laundering and tax evasion.

But on Tuesday, the president wasn't willing to end his address without giving his fellow Cypriots at least some words of comfort and hope. After the Turkish invasion, he said, the country was rebuilt. And today, he added, Cyprus can hope for a new "economic miracle."

Translated from the German by Christopher Sultan

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