'Much Worse than Greece': IMF Demands Partial Default for Cyprus
Euro-zone member state Cyprus badly needs a bailout, but the International Monetary Fund is demanding a debt haircut first, according to media reports. The resulting standoff with Europe has delayed the country's badly needed aid package. To ward off insolvency, Nicosia has raided the pension funds of state-owned companies.
Cyprus did its part on Wednesday night. The country's parliament approved a 2013 budget which included far-reaching austerity measures so as to satisfy the conditions for the impending bailout of the debt-stricken country. While aimed at significantly reducing the country's budget deficit, the spending cuts and tax hikes are likely to result in a 3.5 percent shrinkage of the economy in 2013 along with an uptick in unemployment.
Citing anonymous sources familiar with the negotiations, the Süddeutsche writes that the IMF is concerned that, despite the austerity measures the country has now adopted, it still wouldn't be able to shoulder the interest payments due on its debt. Several European countries agree with the IMF. Others, however, believe that such a default could be dangerous. After all, when private creditors were pressured to write down a portion of their Greek debt holdings, the euro zone went to great lengths to present the move as one that would not be repeated. Should such a default now be applied to Cyprus, it could severely undermine investor trust in the euro zone.
"The situation in Cyprus is much worse than it is in Greece," one high-ranking EU official told the paper.
Days Away from Insolvency
It is hard to argue. This week, the country was forced to borrow 250 million ($330 million) from the pension funds of state-owned companies just to be able to pay the holiday salaries of civil servants. The move came on the heels of a high-level Finance Ministry official saying that Nicosia was just days away from insolvency.
More to the point, however, the country is massively exposed to Greek debt and its banking sector is struggling mightily as a result. Furthermore, the size of the banking sector dwarfs the size of the Cypriot gross domestic product. Whereas the country's banks have assets of some 150 billion, the GDP was just under 18 billion in 2011.
The troika of international lenders, made up of the European Central Bank, the European Commission and the IMF, are looking at an aid package of 17 billion for the country. As a percentage of GDP, it would be the largest bailout yet of a euro-zone member state. Fully 10 billion of that would go towards propping up the country's wobbly banking sector.
Not Entirely Aboveboard
What's more, many are also skeptical of the IMF partial default plan for economic reasons as well. Whereas many foreign banks held Greek debt when the debt haircut was engineered in March of this year, most Cypriot bonds are held by Cypriot banks. Should they be forced to write down part of that debt, their situation will only worsen, requiring more bailout help and driving up Cypriot debt. The net result would be largely neutral.
A final decision on the deal is set to be made in the coming weeks with the goal of sending the initial tranche of emergency aid in February. Until then, the pension funds of state-owned firms will have to do.
cgh -- with wire reports
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