Perspectives

Rescue me – Is Cyprus Still in Trouble?

Kenneth A. Orchard, CFA
Portfolio Manager, European Fixed Income
July 2013

In our January 2013 outlook, we stated: “The most obvious candidate for an IMF-EU rescue program is Cyprus.” Cyprus was indeed rescued. The banking system collapsed and two of the country’s largest banks were restructured. Initially, we were very surprised that all depositors were to be bailed in. This decision was quickly reversed and, in the end, only non-guaranteed depositors (with €100,000) were included.

In addition, the government secured €10 billion of loans from the European Stability Mechanism to cover deficit financing and some debt repayments. Capital controls were put in place to prevent capital flight. They are officially prohibited by the EU Treaty, but there is sufficient flexibility in the treaty to allow capital controls in extreme circumstances.

The issue of capital controls raises concerns. As of today, there are still restrictions on cash withdrawals and international payments out of Cyprus. Although there has been little reaction in other countries, and we do not expect this to be repeated in other countries’ rescue programs (for example, if Spain entered a rescue program), it sets a dangerous precedent. It makes other periphery countries more fragile, as depositors could rush to withdraw funds from banks if they feared such controls being enacted in their country.

Is Cyprus a template for other eurozone countries? Yes and no. No, because Cypriot banks were unique in that they were very large compared with the size of the economy, and most of their liabilities were in the form of deposits. Yes, because there is increasing reluctance to spend taxpayers’ money to bail out banks. Bank creditors, including sub-and senior debt holders, will have to start taking some losses.

The risk of Spain entering a rescue program has declined this year, but over the long run, we believe that additional support will be required from the IMF and European Union.

 

Important Information

This material is provided for information purposes only and is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities, T. Rowe Price products or investment services. Past performance cannot guarantee future results. Information contained herein is based upon sources we consider to be reliable; we do not however guarantee its accuracy. This article provides opinions and commentary that do not take into account the investment objectives or financial situation of any particular investors or class of investor. Investors will need to consider their own circumstances before making an investment decision. The views contained herein are as of June 2013 and may have changed since that time.