Eurozone worries continue as Cyprus, the smallest EU member, is next in line to apply for financial assistance from the EU bailout fund.
An estimated sum of around 10 billion euros ($12.4 billion) is needed to sustain Cyprus’s troubled finances. It may seem surprising that, all of the sudden, Cyprus—which is considered a relatively stable small country known for its excellent vacation spots and beaches—is in trouble.
The underlining cause is that Cyprus placed most of its national investments into Greece before the crisis and, as a result, has lost around 74 percent of its investments in Greek government bond holdings. That effectively caused Cyprus’s credit rating to be cut to junk status by two of the major rating agencies.
Practically speaking, carrying the junk label on its rating means that Cyprus must pay 14 percent interest on new 10-year bonds—a price too high to pay for any country. It has, therefore, few options to look for money and one of them is the EU bailout fund.
“Certainly, I don’t take it as a given that we will negotiate our induction into the support mechanism. But I don’t want to exclude it entirely,” said Dimitris Christofias who has been Cyprus’s president since 2008.
The most affected of the banks is the Cyprus Popular Bank, which invested heavily in Greek bonds and has suffered great losses as a result.
“Cyprus is starting to feel the effects of the Greek crisis and may have no other recourse but to ask for European aid,” Alex Apostolides, an economics professor at Nicosia’s European University, told the Wall Street Journal. “There has been a narrowing of all other options that were available, to the point where going to the EFSF [European Financial Stability Facility] looks increasingly likely, almost inevitable,” he added.
Besides investing in Greece, Cyprus’s entire economy and culture is tightly interwoven with Greece’s. Not only does Cyprus share the same language with Greece, but also Greece is its biggest trading partner. The disastrous effects of Greece’s financial crisis have strong reverberations in Cyprus, as it hopes that Greece will accept the austerity measures and continue to stay in the eurozone. The reintroduction of the drachma currency in Greece would make things more complicated for Cyprus, as it would cause further losses, since Greece would not be able to pay back the remaining loans or continue to do business with its devalued currency.
Cyprus Looks for Backup Plan
At the end of last year, Cyprus borrowed 2.5 billion euros from Russia with a relatively low interest rate, well below the market rate if it would borrow today. However, this money will not be enough to compensate for the 74 percent loss Cyprus encountered with its investments in Greece. At the moment Cyprus is trying to get similarly cheap loans from China.
Besides borrowing from Russia and applying for a loan from the EU bailout fund, Cyprus is willing to introduce austerity measures to cut its budget deficit to 2.5 percent. Next month, President Christofias plans to announce concrete measures.
Cyprus entered the eurozone in 2008. Its total GDP is 23 billion euros, out of which 17.3 billion is exposed to Greece due to trade and other effects. It has a population of only 1 million people and an area of 3,572 square miles (about the half of the size of New Jersey).