Not, in fact, a statement on the tourist denizens of Agia Napa.
There’s one thing you should know about Cypriot sovereign debt entering a full-blown crisis (S&P had just downgraded to BBB+ at pixel time, following Moody’s). There isn’t actually a lot of debt about, and what is, isn’t in bonds, but in bills, commercial paper and also medium-term notes.
Big problem though!
There’s around €11.5bn in total — which is a mere 145 times less than Italy’s outstanding debt. But considering Italy itself is going illiquid on its own terms these days…
Second thing – illiquid as the debt is, because of the crisis Cyprus needs domestic banks purchasing more of it. A crisis with banks smack-bang in the middle. It’s a miniature sovereign-bank loop.
The explosion of the Vasilikos power plant in July only makes that worse, because it’s sent fiscal adjustment way off course. Therefore it is looking like more debt will have to be sold.
So, FT Alphaville thinks that the basic issue here is still the way Cyprus is hugely leveraged, first to its banks (assets 640-650 per cent of GDP, 925 per cent if counting subsidiaries of foreign banks) and via them, to the Greek sovereign. Maybe it isn’t so much about Cypriot bank holdings of Greek government bonds. Obviously if these were written down by half or more, it’s probably going to require recapitalisation from government funds.
But it’s also about the state of Cypriot bank deposits. This is where it dovetails with Cypriot sovereign debt issuance, too.
Time to reprise two Brockhouse Cooper charts we first posted in June:
Essentially, Cyprus is Greece’s Uruguay. Argentines put money in Uruguayan banks, then took it out at speed to escape Argentine capital controls. That brought down Uruguayan banks – then the central bank and the currency, when it used reserves to provide liquidity. The resulting depreciation saw debt to GDP balloon just as Uruguay faced a sovereign refinancing hurdle. That led to a debt restructuring, not just a bailout.
So, it’s interesting to note the formidable refinancing schedule for Cypriot debt, however meagre the total stock:
And it’s also interesting to note that the Cypriot finance minister reassured his public this month that of €2.4bn gross issuance of obligations in 2012 (€1.7bn of that to refinance old obligations), domestic investors are expected to buy up 61 per cent. Foreign ownership of Cypriot debt would be intriguing to break down. It’s mostly focused on medium-term notes, which are often privately placed, or credit lines with banks. Domestic holders tend to be in treasury bills or commercial paper.
This is not the stuff that liquid sovereign debt is made of, but our main point is that from this point on, if Cyprus doesn’t take official financing, most Cypriot debt would be domestic-held and therefore vulnerable to a negative feedback loop anyway. Banks could take Cypriot sovereign debt and pledge it at the ECB to replace the lost deposit funding, though it all depends on Cypriot depositor reaction to events in Greece.
Thus it’s also interesting to note that the value of the government’s depositor insurance scheme amounts to 120 per cent of GDP. A reader might be forgiven here for forgetting Ireland’s famous “bluff”. It’s worth noting that a big part of depositor inflows comes via Russian oil producers, making use of Cypriot offshore taxation leniency to transfer revenue between subsidiaries. The levels of deposit are therefore usually sensitive to oil prices, but it should be clear that this isn’t a loyal depositor base.
Given that depositor flight, sovereign-bank loops and sovereign liquidity have all been themes of the euro crisis, this will be one worth watching. Not least because Cyprus is politically illiquid to quite a degree by now. Stuart Thomson, chief economist at Ignis Asset Management put it well on Friday:
Cyprus is a small butterfly in economic terms but as Benjamin Franklin noted “beware the little expenses, a small leak will sink a great ship”. Last week’s proposed changes to the European Financial Stability Fund will allow the organisation to provide funds to countries to recapitalise their banking system. The country could become the first protectorate of the fund. Much more likely will be a small bailout from the EFSF. More importantly, will be the likely imposition of economic governance from Brussels. This would be consistent with German Finance Minister’s recent comments that countries that seek funding from other Eurozone members will need to surrender some sovereignty. Cyprus will be an obvious test case of this new hardline policy…
You can see why we might be thinking of another old British possession at this point.
Related link:
Cyprus dissolves cabinet as crisis grows – FT