Cyprus Financial Crisis Essay

I. Introduction With a population of only 1 million and no more than half a percent of Euro zone economy, it is surprising to find out that the financial crisis in a tiny country called â€Å"Cyprus† has enormous global implications (Long 2013). It cannot be also denied that the â€Å"Subprime Mortgage Crisis† of the US in 2008 has its downbeat domino effect to the world including European Union and Cyprus. In this report, not only the most critical reasons but also the aftermath of Cyprus financial crisis and possible alternatives which could have been done to ease such economic downturn will be carefully examined. II. Body 1. Main Reasons The root of the crisis lies when Cyprus experienced a terrible recession in 2009 when the country’s economy was diminished by 1.67% including significant reduction in tourism and shipping which obviously caused high unemployment rate (CIA 2013). Since then, the country’s economy worsen and with the 30% decline of the real estate market has put enormous pressure on a rise in non-performing loans of banking system (The World Bank 2013). Therefore, the banks ended up with Greek Private Sector debt of Euro 22 billion and accumulated $120 billion inclusive of $60 billion from Russia according to Jolly and Castle (2012). Furthermore, it is the direct result of the crisis in Greece known as Greek Debt Crisis where the second biggest retail bank in Cyprus over-invested in Greek Bonds and as a result of this, Cyprus failed on its recapitalisation where the Government is left with limited time and option as mentioned in Aljazeera news podcast (2012). Besides, Hans Humes pointed out during an interview conducted on 21 February 2012 that one of the significant reasons that led to a threat in collapse of the Cyprus Banks is 50% haircut in 2011 during Greek Crisis. Next, Cypriot Banking system is in shortage of at least 10 billion Euros in new capital plus 8 billion to satisfy public debts (Long 2013) and to make matter worse, the government has not got enough money to help out as it is impossible to raise money in bond market due to high level of borrowing rates. The country’s credit rating was rated CCC by Standard & Poor’s in September (Bases 2013) and this left the country with no benefits but high rise in percentage of yields on long term bond. This can be added as a reason to confirm that the country is not in the position to calm down its banking sector. They also made a wrong step in refusing UN’s plan for uniting their island which clearly annoyed their E.U partners and caused weak strategic position (Dixon 2013).The country’s economy could be a lot healthier if it had restructured the banks. 2. Consequences The consequences of the Cyprus financial crisis has had a surprising impact on the eurozone and raised concerns about the euro currency in the market. The two main financial institutions in Cyprus were both effected by the Greek financial crisis due to their operation heavily in the Greek Government Bond & the Greek Debt. The two largest banks in Cyprus, the Bank of Cyprus and Laiki Bank were both heavily impacted by the Greek financial crisis through exposures to their own operations in Greece and to Greek sovereign debt. According to the latest confirmation of GDP data, Cyprus is gliding deeper into recession and no sign of financial stress in economy is abating (Ernst & Young 2013). The Cyprus financial crisis have had helped driving the value of the euro currency to fall down from $1.36 at Feb to $1.28 at the end of March and lead to rising unemployment caused industrial unrest. Many workers struggle against wage cuts. However, the unemployment rate will likely continue to rise and wages fall, contributing to reduced consumption in the next few years (Ernst & Young 2013). To resolve the nation debt a solution was introduced by the government to force depositors and savers to scarify 10% of their life savings. As part of the Government’s austerity program, the VAT rate was raised from 17% to 18% in January 2013. The Inflation rate under impact of higher VAT was also increased from 1.5% in December to 2% in January (Ernst & Young 2013). That decision let Cypriots themselves furious and they have responded by trying to clear out their accounts and that will negatively impact on the deposit security or stability. Apart from any possible instability in deposit base, Eurozone banks may see their ability to rise unsecured funding deteriorate. Cyprus became the first ever Eurozone country to apply capital controls with limits on credit card transactions, daily cash withdrawals, foreign money transfers and cashing cheques. This is a clear indication of the severity of the situation and, effectively, at least temporarily devalues Euros located in Cyprus as they are now less easy to transfer. More than a thousand bank employees marched in the capital Nicosia on Saturday, angry that their jobs could be lost in the forced restructure of the island’s economy — and that the government had proposed to nationalise pensions in order to fund the bailout. That option was later rejected. Some protests to express Cypriots’ indignation happened on the street, while parliament voted overwhelmingly to reject the tax on bank accounts. Furthermore, Banks have been closed for more than a week, to prevent depositors moving their money off the island, which would have caused the banks to collapse and made the entire situation worse. However, ATMs were still opened, and they were quickly ran out of money as everyone tried to withdraw as much as possible (Ghostagenda 2013). Many businesses are refusing to take credit cards. Retailers have faced cash-on-delivery demands from suppliers, the Cyprus Mail reported, and shelves are emptying. Some are running out of coffee, cigarettes, alcohol and soft drinks. European governments rejected taking money from depositors in order to pay for necessary bailout packages. The fact created a panic, led to emergency negotiations. For example, the discussion happened between the Cypriot government and the troika in an attempt to reach a deal which was successfully achieved that managed to save the country from bankruptcy at the 11th hour (Ghostagenda 2013). Nobody doubts that, after such this financial crisis Cyprus will be pushed into a harsh recession. According to forecast in the troika’s source, GDP will shrink by about 10% before any hope of recovery. 3. Strategies In order to overcome the current financial crisis, focusing on the economic itself is not enough. Policymakers should include the full range of factors which interact the country’s financial situation- such as economic security policies, investment, interest rate, inflation, employment, etc. (The Star, 2009). In general, developed countries need to save their incomes more and consume less; developing countries, in contrast, have to boost their domestic demand as well as export. However, Mohsen, Abdulla & Jalal (2011) states that it is much easier said than done in the real circumstance. Iqbal (2010) suggests some strategies to overcome such difficult situation and avoid this particular issue in the future: †¢ The existing financial structure of related countries is required to modify. †¢ Creating and monitoring an effective exchange rate policy. †¢ The accounting standards need to be customised to fix the global economic situation, for instance: the convergence of United State and international accounting standards in terms of changing from fair value measurement back to historical value measurement. †¢ Globally coordinated and huge fiscal stimulus †¢ More transparency in the operation of financial institutions. Application in real situation of Cyprus: The Cyprus’s banking system has done a huge number of works in order to reduce the impact of financial crisis on its economy. Encouraging international investors to invest in Cyprus is one of its most effective policies which were proved to boost its economy. By providing â€Å"attractive† policies and tax, more and more Chinese investors are interested in putting their money into this market in many different sectors, for example: shipping, construction and energy industry. They also offer the opportunity to become a permanent resident to foreigners who purchase  £300,000+ in value of property. According to the Cypriot embassy in Beijing, more than 500 properties had sold to Chinese investors so far (Shengnan, 2013). Cypriot government is also seeking the financial assistance to solve their current debt crisis, primarily happened as a result of over-invested in Greek banks. European Union (EU) is a main target which Cyprus considers as its assistance for such an issue. On 25/3/2013, Greek-Cyprus government and EU singed a commitment which stated that EU would provide â‚ ¬ 10 billion bailout fund associated with some conditions: reducing money laundering, increasing the corporate tax and the one-off tax on bank deposits (Burgin, 2013). This was planned to catch â‚ ¬5.8 billion contribution for the bailout packages from internal resources. The Cypriot government has also declaredspecial fiscal measures with the aim of improvement the investment into their main industries such as tourism and construction. However, there is no empirical evidence on how it worked for their own circumstance (The Economist Intelligence Unit Limited, 2009). In addition, government also boost the guarantee on deposit to â‚ ¬100,000. This action encourages foreign investors to deposit in Cyprus banks as the EU guarantee was only â‚ ¬50,000 (7/10/2008). Furthermore, the It is estimated that Gas revenues will be an important factor in solving Cyprus’s the economic malaise forecast for the next few years. The Government agreed to set up a resource fund to cope with the expenditure from gas exploitation. They hope that Cyprus can start exporting the natural gas in 2019. This should contribute to stronger growth in the medium term (Ernst & Young 2013). III. Conclusion To conclude, this is a difficult stage for Cyprus. There is still some argument on how will affect government debt sustainability when this country borrow under the economic adjustment programme and how the government debt burden can be reduce from the income of natural gas exploration and exploitation. However, the agreement was reached with the troika is a significant step in restoring the country’s economy. Everyone has shown understanding, consensus, readiness and elasticity to adopt a programme of financial reform, fiscal and structural amendment in accordance with the needs of the country. In the future, it is estimate that the Cyprus economy as well as its financial sector will overcome the current crisis and become stronger than before. The economic reform program is seen as an effective way to strengthen and stabilize the macro economy and the domestic financial. It also contributes to the revival of private economic activity, promotes economic growth and creates more jobs for labors. Moreover, in longer term, Cyprus may have good prospects for growth in the shape of its offshore gas reserves, which could help lower the debt burden of future generations (Central bank 2013).