Small country, so what’s the big deal?

Small country, so what’s the big deal?

This past Tuesday (March 19th), the German-led Eurozone finance ministers and International Monetary Fund (IMF) offered Cyprus a €10 billion bail-out package. The catch is, this plan requires Cyprus to raise approximately €5.8 billion (almost one-third of Cyprus’ GDP) as its share of the bailout, by Monday (March 25th). Cyprus is a small player in the Eurozone, and in a lot of trouble – could the costs of keeping Cyprus in the Eurozone outweigh the benefits?

To remain part of the Euro, the Cypriot Parliament will need to reach a compromise with the EU and IMF, or find sufficient funding from elsewhere, before trading starts Monday morning. Little time has been wasted, with nine bills approved by late Friday night, regarding the restructuring of their struggling banks, restricting of financial transactions and creation of a “solidarity fund” aimed at facilitating the flow of investments and contributions. However, should they be unable to come up with the €5.8 billion or reach a compromise, the European Central Bank has warned it could cut emergency funding to Cypriot banks on Monday morning, almost certainly leading to a banking crisis and probable exit from the Euro; the first exit in EU history.

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If Cyprus was a bigger economy, like Greece, the EU market would be a lot more volatile to its exit. Greece was almost too big to fail, but Cyprus doesn’t have that problem. It is the third-smallest country in the Eurozone, with fewer people than Adelaide.  Cyprus’ GDP is €17.5 billion, and its current debt (including bank liabilities) amounts to 145% of its GDP. To put this into perspective, Australia’s GDP in 2012 was $1.542 trillion. Here’s the clincher – Cyprus creates less than 0.5% of the Eurozone’s total GDP. Some believe that Cyprus’ banking collapse could actually mean minimal losses for the European financial systems.

That being said, there are some serious risks and repercussions associated with Cyprus’ exit from the EU. Firstly, it will signal to global investors that the Eurozone is not yet stable to the point of progressing towards a durable solution. Cyprus’ exit could threaten the legitimacy of the EU, and show the Eurozone’s tendency toward contagion. After all, Cyprus banks didn’t crash because of Marcos Baghdatis’ sliding form and niggling injuries; more so from the billions lost on bad Greek debt. If it wasn’t for Greece’s woeful economic state, Cyprus would not be in such a predicament now. Furthermore, the risk of ‘speculative attacks’ and ‘deposit runs’ would increase, begging the question: if this could happen to Cyprus, what’s stopping it from happening to other countries in the Eurozone?

Six Euro-zone countries have unemployment rates between 15 – 25%, and youth unemployment rates (at historic highs) between 30 – 60%. The 2011 euro crises were fuelled by fearful markets. Today, it seems the crises are driven by volatile and unstable politics, arguably more dangerous. Above and beyond Cyprus, we can see this in Italy, where an anti-euro zone comedian won more votes than the leaders of either major party.

Either way, whether Cyprus remains within the EU or not, the cost and burden would lie with the citizens of Cyprus, who are already the most indebted in the Eurozone. As an example, one of the bills approved on Friday night impose a tax of approximately 1% on all bank deposits. With banks closed and streets crowded, tensions are high. The money to save Cyprus is likely to come out of their pockets.

Cyprus is a small fish in a big European pond, but problems in the Eurozone, now more than ever before, have global repercussions. Apart from Baghdatis winning an upcoming tournament, Cyprus can only hope that their attempts to raise funds locally, along with the financial plans of the Eurozone financial ministers and IMF, are enough to get them over the line.

ESSA Poll: Will Cyprus foreshadow the future of the Eurozone?