SocGen's Post-Mortem On Cyprus' "Unique Stability Levy" A/K/A Deposit Confiscation

From SocGen:

Cyprus bailout with unique stability levy

In the early hours of Saturday, the Eurogroup agreed an adjustment programme of up to €10bn for Cyprus, the first under the ESM. Eurogroup President Dijsselbloem referred to the “exceptional nature” of the situation that required “unique measures”. In the special case of Cyprus, this is a upfront one-off “stability levy” of 6.75% on all bank deposits of 100K or less and 9.9% for deposits over 100K, with the aim to raise €5.8bn. A MoU will be finalised shortly. The national approval processes of the euro area member states will then be launched and final agreement should be reached in the second half of April. The IMF is also expected to offer financial support.

The package for Cyprus still comes with tough conditionality and the risk is that introducing a new “unique” bank levy measure – despite the many reassurances - could trigger renewed concerns.

Full conditionality of austerity and structural reform (again!)

The Eurogroup Statement on Cyprus reads that the programme for Cyprus will be based on “ambitious measures to ensure the stability of the financial sector, determined action to carry out the required fiscal adjustment and structural reforms to support competitiveness as well as sustainable and balanced growth, allowing for the unwinding of macroeconomic imbalances”. Cyprus has already progressed on measures amounting to 4.5% of GDP and stepped up efforts on privatisation. While privatisation is a medium-term positive for the economy, like structural reform it often comes with a J-curve effect in that layoffs could result from the process. The statement added that “Further measures concern the increase of the withholding tax on capital income, a restructuring and recapitalisation of banks, an increase of the statutory corporate income tax rate and a bail-in of junior bondholders”.

Conditionality is here to stay! Indeed, there appears to be no change in the economic policy model of austerity and structural reform that has characterised the euro crisis to date. More broadly speaking, this is also fully consistent with the message from the 14-15 March European Council that “growth-friendly fiscal consolidation” remains a top priority for the euro area. Once published, the reports supporting the MoU will allow detailed analysis; our focus will be on the growth assumptions. In the case of Greece, weaker-than-expected growth outcomes explain a significant chunk of the subsequent government debt overshot. In the case of Cyprus, the aim is for general government debt to reach 100% of GDP by 2020.

ECB Executive Board Member Joerg Asmussen noted that Cyprus is systemically relevant. He further indicated that once the recapitalisation of the Cypriot banking sector is complete, they will once again gain access to Euro-system’s monetary policy liquidity, until then ELA (Emergency Liquidity Assistance) will be available from the National Bank of Cyprus. No mention was made of OMT, but given what we understand to be full funding, this would not be relevant at present.

A new unique measure … this time a “stability levy” on bank depositors

Uniqueness has become something of a red flag word in the euro debt crisis. The unique situation in Greece led to PSI, in Cyprus it is the “stability level”. The levy of 6.75% will be applied to all bank deposits of 100K or less and 9.9% for deposits over 100K, with the aim to raise €5.8bn (just over 30% of GDP). The tax we be paid by both residents and non-residents. Unsurprisingly, the bulk of the questions at the press conference centred hereon.

On the question of whether a similar levy could be applied if Spain or Italy were to request bailout, Eurogroup President Dijsselbloem responded, “the situation in Cyprus with the specifics of the banking size and structure has led to this specific package and these instruments, full-stop.” Asked specifically whether he could rule out a deposit levy in a subsequent bailout in another country, Dijsselbloem replied, “It’s not being discussed at all, there is no reason to even discuss it, so I won’t discuss it or speculated on it. We have a very specific, very complex situation which we’ve had to deal with in a way that is leading to a very fair way of sharing the burden, and that’s the package that we have agreed here”.

On practical steps, Asmussen noted that the Cypriot authorities are taking immediate measures to ensure that the levy can be collected. He indicated that the levy would be frozen on accounts, but emphasised the rest of the deposits can be freely used by all the deposit holders. Asmussen also indicated that the Greek operations of the two largest Cypriot banks would be ring-fenced with the assets sold to a Greek institution with no additional cost on the Greek adjustment programme. The levy as we understand will not be levied on depositors with Cypriot banks in Greece.

Other sources of support … Russia … the IMF

On other sources of support, the comments at the press conference noted that Russia might extend maturity and lower interest payments on its existing loan package to Cyprus. These arrangements have yet to be finalised in talks and Russia was not involved in the discussions overnight at the Eurogroup meeting.

IMF Managing Director Lagarde indicated that the conditions for the IMF to offer financial support to the Cypriot adjustment programme are in place with; (1) a sustainable solution in the interest of the Cyprus economy, (2) a fully financed solution and (3) appropriate burden sharing. No indication of a possible amount was given, but based on past practices an amount of €1-3bn seems likely.

Adjustment for Portugal and Ireland

The Eurogroup overnight also confirmed agreement to extend the maturities of EFSF loans to Ireland and Portugal. Extension of EFSM loan maturities will be reviewed by ECOFIN. We expect this to be finalised in April.

It is worth recalling that according to its technical features (available on the ECB website), OMT “may also be considered for Member States currently under a macroeconomic adjustment programme when they will be regaining bond market access”. We understand the possibility to use OMT for Portugal and Ireland to be an on-going debate at the ECB.