x Abu Dhabi, UAEWednesday 17 January 2018

Cyprus forced to dig deeper as bailout cost swells to €23bn

The cost of bailing out Cyprus has swollen to €23bn (Dh110bn), with the crisis-hit country having to take on the lion's share of the measures needed to avoid bankruptcy, according to a draft document by the country's international creditors.

BRUSSELS // The cost of bailing out Cyprus has swollen to €23bn (Dh110bn), with the crisis-hit country having to take on the lion's share of the measures needed to avoid bankruptcy, according to a draft document by the country's international creditors.

The draft document says the country will have to find €13bn – an increase on the €7bn contribution agreed during the country's chaotic bailout talks last month. The money will be raised by imposing heavy losses on large bank deposits, levying additional taxes, privatisations and a part-sale of the central bank's gold reserves.

The so-called troika of international creditors – the European Commission, the European Central Bank and the International Monetary Fund – are set to grant the Mediterranean island nation a €10bn rescue loan package to recapitalise Cyprus's shaky banking system and keep the government afloat.

As part of the original deal, Cyprus agreed to overhaul its bloated banking industry by breaking up its second-largest bank, Laiki, and imposing losses on savers who have more than €100,000 in another lender, the Bank of Cyprus.

In the latest draft document, the troika has revised the cost of bailing out Cyprus amid a gloomier economic outlook, adding an extra €6bn to the bill.

"The sheer size of the increase has underlined the extent of the enormous challenges facing Cyprus itself," Jonathan Loynes of Capital Economics said in an analyst note.

The document also shows that the troika expects the break-up of Laiki to raise €10.6bn. Those funds will be used to prop up the Bank of Cyprus.

Cyprus will also have to sell off parts of its gold reserves – a measure that is expected to net another €400 million – a first for a bailed-out European country.

The measures in the draft document highlight how Europe's financially more stable creditor countries are becoming increasingly impatient with bailing out their southern neighbors and are inflicting harsher terms on countries in need of assistance. Cyprus is the fifth eurozone country to receive bailout loans.

The eurozone's 17 finance ministers are gathering on Friday at a meeting in Dublin where, they are expected to discuss the documents spelling out the details of the assistance package for Cyprus.

The troika had sought to keep its contribution down to €10bn, putting the onus for finding the missing funds on Nicosia. However, there are concerns among analysts that the hit to Cyprus's economy from the terms of the bail-out deal may be too much for the country to bear.

Cyprus is expected to gain €1.4bn from privatisations over the next few years. However, similar demands on Greece, which has received €240bn in bailout loans so far, had to be revised downward several times as selling state assets in the midst of a dire recession has proven tricky.

The creditors' underlying growth assumptions for Cyprus are also raising concerns: If the reality will be worse than the forecast, another bailout or additional revenue raising measures might be necessary to plug the resulting shortfall.

Cyprus's tiny economy of about €18bn – or less than 0.2 per cent of the eurozone total – is expected to plunge by 8.7 per cent this year, and another 3.9 per cent in 2014, according to another official document by the creditors.

Several analysts, however, have cautioned that Cyprus's economy might shrink by more than 10 per cent this year alone in the wake of the harsh banking restructuring and the other measures required to qualify for the eurozone bailout.

"If everything goes according to plan, the growth figures might at least be in a realistic range, if too optimistic," said Christoph Weil of Germany's Commerzbank. "If there are any problems – and there are significant downside risks – then it could be much worse, and a combined contraction of 20 per cent is within the range of the possible," he said.

In 2015, the country is forecast to return to growth of 1.1 per cent. Such a relatively quick turnaround might prove quite optimistic if Greece is any guideline – the country is in its sixth year of a protracted recession and sees unemployment hovering at around 27 per cent.

"I don't think this is realistic. The country must go through a painful and wide-ranging restructuring of its economy, with half of its banking sector evaporating, I think it will take at least three years for the economy to bottom out," said Weil.

The rescue loans will further increase Cyprus's debt burden, which is set to peak at 126 per cent of GDP in 2015, according to the documents. That would be one of Europe's highest debt burdens, putting a serious question mark on the feasibility of returning to the markets to refinance its debt in the following years.

Capital Economics' Loynes said the economic projections contain "a considerable degree of optimism" given the uncertainties of unwinding the banking sector and tightening the government's budget.

"This could force Cyprus to undertake further fiscal tightening to meet its borrowing targets and casting doubt over the sustainability of the bail-out," he said.