Its not just Cypriots who were worried about the possible imposition of a whopping tax on bank deposits. Analysts and economists were also concerned that the tax will set a bad precedence for the Eurozone as a whole.
But how did a small island with a GDP of a relatively meager $23 billion gain the spotlight to the extent that it has once again put question marks over the strength of the Eurozone and revived interest in safer investments like gold? The dilemma can be traced all the way to Athens.
Remember how private bondholders in Greece had to take a haircut loss on their holdings to help save a bankrupt Greece? Banks in Cyprus also ended up losing money as a consequence, and asked for a bailout from the Government. Needless to say, the Government approached the EU to save it from the crisis. Talk about recessionary vicious cycles.
As to how a haircut loss could affect an entire national economy; its noteworthy that the financial sector in Cyprus is mammoth-sized relative to the size of the economy - the banking sector being five times the size of the GDP. And the islands public debt is expected to reach about 100 percent of GDP by 2020.
So a loss to banks due to the haircut to bail out Greece did take quite a toll on the economy to warrant a bailout from the EU.
But the EU decided not to keep it easy this time; not the usual austerity measures in exchange for much-coveted bailout monies. And you can really blame them after looking either at the poor implementation of austerity measures by predecessor countries, or at the civil unrest that follows from so much as discussions of spending cuts.
But a 9.9 percent tax on deposits of over euro 100,000, and 6.75 percent on smaller deposits is a tad too harsh. It was hoped, however, that the levy will help reduce the bailout price tag roughly equivalent to the countrys GDP. To avoid the kind of frenzy seen at ATM machines after this announcement, banks are closed in the country till Thursday.
In a twist of climax, lawmakers rejected the bank levy in exchange for bailout money, raising questions about how the small island economy will survive. In fact, a bank run and cut off of financing from the European Central Bank (ECB) for Cypriot banks is an expected outcome.
The rejection of the condition aside, the very fact that such a condition was imposed in the first place did open quite a few discomforting possibilities for eurozone countries. For once, depositors in other economically-unwell countries will wonder if putting money in banks will be a good idea for fear of it being taxed by the eurozone in exchange for bailout money later on. Needless to say, banking systems will bear the brunt of this anticipation.
"What happens if we
e back at Spain, Portugal or Italy at some point six months from now, and the same set of issues arises? There is less confidence and greater probability of instability because of this," said Tim Adams, Managing Director of the Institute of International Finance (IIF).
Yet, any Eurozone assistance will come with strings attached, and some tough calls will be required if countries have to be prevented from going bust. In the case of Cyprus, the conditions see a tad too harsh. Perhaps the EU did want to set precedence for other countries, after all.
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