Economic Interests

If you owe the bank £100, that's your problem. If you owe the bank £100 million, that's the banks problem.

Archive for the tag “bailout”

The next EU Bailout?


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The Euro Crisis has died down in 2013 after a turbulent 2012. This was not because of a lack of effort by Europe’s trouble makers; Italy ground to a halt when trying to decide a government, while Cyrpus were the latest government to need a bailout. Yet the cost of borrowing for many EU countries has been decreasing gradually regardless. This has mainly been down to the statement made last year by the head of the European Central Bank to “do whatever it takes” to save the euro, hinting at the bank finally becoming a lender of last resort to the rest of the eurozone.

But tricky times lie ahead for Europe. The Euro area declined on averaged by 1% in the first quarter of the year and unemployment has reached a record 12.1%. Protests and riots have been more common in recent years (with even Sweden now experiencing public unrest) leading to many extreme parties getting more public attention, campaigning largely on their respective countries leaving the EU.

So a big question remains; who will be the next country to request a bailout?

One likely candidate is Slovenia. With a budget deficit over 5% of their GDP, their finances are in disarray. The economy retracted by over 15% in 2008/09 and is not set to return to growth until at least 2015. The largely state owned banking sector, saddled with debt, has grown to 140% of GDP, with an estimated 20% of loans considered non-performing (extremely late repayments). The public debt is still rather low at around 60% of GDP compared to much of Europe, but the interest levels Slovenia have to pay for borrowing are rather high at near 6%, if that rises much higher in the coming months they may lose access to the international markets and require external help (i.e. a bailout). Much of Slovenia’s problems come down to the credit crunch, where easy credit fuelled a construction boom similar to that in Spain that promptly burst. Another problem was the size of the state, which kept a tight grip on the bigger markets, crowding out private competition and stopping innovation. With the government now employing austerity measures, the growth of these industries have stalled, with potential buyers now a lot harder to find in a recession hit EU.

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Slovenia’s prime minister has announced a brave rejection of any bailout talks, instead talking of important reforms to the banking sector (a creation of a bad bank for the worst debts) and budget balancing austerity measures including: cuts to school subsidies, a recent 5% cut in nominal public sector wages and a new higher marginal personal income tax. Their crisis resembles more Ireland’s than Cyprus and some strong leadership is giving the country a fighting chance of avoiding an international bailout.

So if not Slovenia, who then?

Two countries that resemble Cyprus (the latest bailout victim) more closely are Malta and Luxembourg. Both are small countries with massively outsized banking sectors. Malta’s banking sector is nearly 800% of its GDP making it impossible for the government to bailout out the sector by itself if needed, while the government already has high public debt of around 70% of GDP. But Malta has relatively low unemployment and a controllable budget. Its banking sector is rather different in nature to Cyprus’s as well; instead of two big local banks full of dodgy russian money and heavily exposed to the volatile Greek economy, Malta banks are actually subsidiaries of foreign banks, with high capital ratios and profits. Luxembourg also has a large banking sector, roughly 23 times its GDP. But once again the banks are large foreign owned, differentiating it from Cyprus. The economy is also very strong; experiencing low growth in 2012 when the surrounding countries were in deep recession, holding low public debt and unemployment and possessing one of the large current account surpluses in the region. If that weren’t enough, the small country has the highest GDP per capita ratio in Europe, meaning its people enjoy a very high standard of living. Both countries are over reliant upon their financial sectors and are very exposed to shocks in the market, but neither are realistically on the brink of a bailout.

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Rather more worryingly, a much bigger economy is at risk, one which has already had to accept a bailout for its banking sector. Spain withdrew around €40 billion from European Stability Mechanism to help recapitalize their banks (a EU organism set up to offer up to €100 billion in bailout funds to member states). Yet many believe this wasn’t enough and that problems remain in the troubled Spanish banking system. Spain has had to nationalise one of its largest banks Bankia, while most others have had to make large cuts to their balance sheets. If this wasn’t enough, the economy is in serious trouble. Spaniards are seeing a deep decline in their national output, likely to fall for an eighth consecutive quarter and unlikely to see growth until after 2015. Unemployment is at a record high of 27% of the population, nearly 60% for the young. The budget remains heavily unbalanced, with a deficit of 7% of GDP, leaving public debt high (though not as high as private debt). A construction crash has lost many young spaniard an entry into the work force and has caused a lot of bad debts in the banking sector. When times were bad for the EU, Spain and Italy have faced some of the highest borrowing costs. Many see Spain as the weakest member of the big club, and any serious bailout of the economy would cause massive fractures in the EU and could possibly cause a domino effect on the likes of Italy and so forth. Fortunately, the political scene is stable, with the government in power for the foreseeable future and elected on a mandate of budget balancing and reform. Such reforms and austerity are already under way, with labours cost having dropped in contrast to rises in Frances and Germanys and a 4% drop having been achieved in the budget deficit since 2009. Progress is being made, but it needs a stable environment and a strong recovery in europe wide demand for Spain to really recover and see of the need for a bailout. That is a big ask in a continent that has become synonymous with the word crisis. A bailout for Spain is largely not talked of, precisely because of the implications it could have for the future of the EU. Yet it probably remains more likely than a bailout for Luxembourg and Malta.

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The reality is that many member states could require a bailout if matters turned for the worst, with Portugal another possibility after the rejection of austerity measures by the national courts. The lack of a proper system in place and the reluctance by the ECB to really put its money wheres it mouth is, means rich and stable countries like Germany will continue to fund the mistakes of poorer economies. A more united Europe could solve this, with the spreading of some of the debt between the member states an attractive idea, ending the vicious circle of national debts being inflated by bailouts and increasing the need for further bailouts. Politically it remains a tough sell, especially for Germany, but it would also show a strong and united Europe, something most national leaders would secretly like to see.

Slovenia are the strongest possibility for a next bailout, with markets lacking confidence in the economy and increasing the costs of borrowing to perhaps unstable levels. But a spreading of at least some of the debt  through Euro Bonds could greatly decrease the need for this guessing game.

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Cyprus’s Choice: A Failing EU Or Corrupt Kremlin?


The pillars of Cyprus’s economy could be crumbling.

A small country that sometimes slips under the radar is now facing serious problems. Cyprus’s economy is intertwined with that of Greece and the country is now in need of a bailout. But while the other countries in the eurozone have been acquiring these funds from the EU, Cyprus has been taking from the hand of Russia. Last year Russia issued a €2.5 billion emergency loan to help out the country and is now rumoured to provide another loan of €5 billion. This would account for a quarter of Cyprus’s GDP and will help save its troubled banks, which are heavily exposed to the messy Greek banking system. It has been estimated that if Greece were to exit from the euro, the Cypriot banks would require a capital increase of around €9 billion or in other terms 50% of their GDP.  In total the Cypriot banks owe around €152 billion, roughly eight times the country’s GDP, and this will need to be brought down over time.

Cyprus is in a tough situation as it can no longer borrow freely from the markets after it was given “junk” credit status, with long term government bond yields currently at 7%.  This means the island now relies on loans from either the EU or Russia, but which is the better option?

Most would probably argue the EU is the safer option, and makes more sense as Cyprus is part of the eurozone. But the government is wary of the tight austerity measures the EU have placed on the other members that have asked for bailouts, something a Russian loan does not include. The country would almost certainly be forced to lose its low corporation tax, currently at 10% (compared to the UK’s at 24%) which has helped Cyprus become a tax haven for companies. So the country could turn to Russia again, with the Russians having a vested interest in the safety of the Cypriot economy. A lot of Russian money is currently in the tax haven that is Cyprus, while newly found natural gas resources have been found off the south coast, an appealing thought for Russian companies. But this only masks the real problems; Cyprus cannot avoid the economic reforms that the EU proposes forever. Taking a Russian loan just prolongs the process of returning to the markets, it’s not like Russia will provide loans every year for Cyprus to run its country.

2010 levels of Corporation tax in the EU. Cyprus possess one of the lowest tax levels. 

The country has other problems to deal with as well. The economy is expected to decline by around 1% this year after slow growth of just 0.5% last year. The slow growth was partly explained by the Evangelos Florakis naval base explosion, which was reported to have cost the country up to €3 billion (17% of GDP). Unemployment in the country remains high at around 10% and youth unemployment even higher at near 30% of the population, a worrying statistic for a country so small. On top of this the Cypriot government had to cut their budget by €120 million to get its deficit under its intended target of 2.5% of GDP, which have seen cuts in public worker salaries and an increase in the VAT. This is to help tackle the huge debt the country possesses, currently over 70% of GDP. This isn’t to mention the divide that runs through the island, separating Greek-Cypriots and Turkish-Cypriots, which disrupts the country’s economy. Talks have been ongoing but a lack of compromise from Turkey means tensions are as high as ever.

The no-mans land separating Northern and Southern Cyprus.  

Things aren’t all gloomy for the country however. They remain part of the EU, which still largely benefits them more than it hinders them. Without such protection, their currency could have proved very volatile to changes in the market, while the EU will continue to offer help to the county accepted or not. The fears of the country’s economy imploding are also not as dangerous as some would think, the costs sound high, but with a bailout fund of nearly €500 billion, the EU could afford to rescue such a small economy.  The real danger is that whatever causes Cyprus’s economy to fail (e.g. Greek exit) might cause a country like Spain or Italy to fall, which would crash the whole European market. In these circumstances Cyprus could be forgotten in all the uproar and its people left in a country with no working economy. Such a nightmare scenario remains rare, with the hopes that Angela Merkel and the other European leaders will finally agree on a path out of these worrying times.

Can the major leaders of Europe agree a solution?

For Cyprus, the big question right now is whether they should borrow from Russia or the EU. One promises short-term relief while the other would help concentrate the government on fixing the economy. Let’s hope the Cyprian government makes the right choice, but something tells me the Russian money will win out for now.

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