Cyprus has become the fifth Eurozone country to apply to Brussels for an emergency bailout, after similar calls for help from Portugal, Ireland, Greece and Spain. Heavy dependence on the Greek economy has pushed Cyprus into this corner. The Cypriot banking sector is oversized for a country with only one million residents and it suffered badly from significant write-downs on Greek sovereign bonds. Cyprus hasn’t been able to access the debt markets since 2011 since being downgraded to ‘junk’ status by Moody’s and S&P, Fitch’s move to follow suit yesterday provided the final push to force the country into a bailout request.
In the very short-term, €1.8bn (around 10% of its domestic output) is required to recapitalise its second largest bank, Cyprus Popular Bank, while its largest bank, Bank of Cyprus has reportedly called for aid of around €500 million. Plenty more will be required for state financing and the country really requires a buffer from any further spillover effects from Greece.
The bailout is expected to amount to approximately €10 billion, which is equal to over half of the Cypriot GDP, currently standing at €17.3 billion. Along with the Spanish application for bailout funds for its banks, Cyprus’ bailout application has today been formally accepted by the Eurogroup. The funds will come from either the European Financial Stability Facility (EFSF) or the European Stability Mechanism (ESM) when it becomes active. This comes after controversial but ultimately unsuccessful bailout negotiations with Russia and China. Dimitris Christofias, the Cypriot president, had expressed his wariness of the strict conditions that would come with an EU bailout. In particular, Cyprus’ rock bottom (10%) corporate tax threshold may be a cost of the bailout request. The terms of the bailout will surface in the coming weeks.
In terms of the impact on overall sentiment towards the eurozone, the Cypriot request for a bailout will not in itself weigh too heavily. Whilst it is another worrying example of debt contagion and does build on increasingly negative eurozone sentiment, Cyprus is the eurozone’s third smallest economy and this bailout request been a long time coming. Market nerves at the moment are more firmly fixed on the eurozone’s fourth-largest economy- Spain. The euro is posting significant losses across the board; the key EUR/USD pair looks likely to retest its multi-month lows of $1.2285 in the near future.
Adam Highfield
Analyst – Caxton FX
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