Cyprus bailout deal reached as long-term impact remains uncertain

European leaders Monday hailed a last-minute bailout for Cyprus as an important step in defending their unified currency, but some officials and analysts questioned whether the deal raised new problems that could still threaten the survival of the euro.

The arrangement will grant Cyprus $13 billion in emergency loans from an international group of lenders but will force the country to shutter its second-largest bank and will push massive losses on large depositors there. The deal effectively wipes out Cyprus’s appeal as an international banking haven but saves Europe from cutting off support to one of the 17 nations that use the euro currency.

Cypriot banks closed for a 10th day Monday and are not due to reopen until Thursday. With many depositors limited to withdrawing no more than $130 from an ATM, some analysts questioned whether the agreement would weaken faith in the currency union and whether a euro deposited in a Cypriot bank was worth as much as one deposited elsewhere.

The bailout set precedents — that European leaders will play hardball, bank accounts can be frozen, and deposits may be on the line in such a rescue package — that could exacerbate the possibility of bank runs in Spain, Italy and other vulnerable countries if the financial situation there deteriorates.

“Everybody in one way or another may emerge worse from the excruciating decision-making process we have been through,” said Sony Kapoor, managing director of Re-Define, an economic think tank. “There have been 10 days of insane uncertainty, which will have a serious long-term additional economic and financial cost.”

That uncertainty hit markets Monday after Dutch Finance Minister Jeroen Dijsselbloem, who leads a group of finance ministers for the European Union, suggested that future bank rescues on the continent might follow the Cyprus model and penalize large depositors.

Dijsselbloem’s comments, in an interview with Reuters and the Financial Times, damaged confidence in other European banks and sent stocks tumbling. He soon backtracked, issuing a statement that “Cyprus is a specific case with exceptional challenges” and that future rescue programs will be “tailor-made,” with “no models or templates” used. Nonetheless, the Dow Jones industrial average shed 64 points to close at 14,447.75, partly on concerns sparked by Dijsselbloem’s remarks.

The upheaval was a reminder that bank deposits are only as safe as the country in which they reside and showed how far Europe remains from ensuring that problems such as those in Cyprus do not escalate out of control. European leaders have been working on a unified banking system to help improve the resiliency of the currency union, which contains 300 million residents. The situation in Cyprus, a nation of about 840,000, may have weakened the broader project in the long run, some analysts said.

Bleary-eyed European finance officials who negotiated far into the wee hours of Monday emerged later in the day to say that they had stared down financial crisis and averted it. Many European leaders confronting furious electorates at home had been reluctant to use taxpayer money on a bailout of a country suspected of being a money-laundering hub for wealthy Russians.

“Europe is showing solidarity and will be showing solidarity. But we have to do away with the causes that lead to such crises,” German Finance Minister Wolfgang Schaeuble told reporters in Berlin on Monday. “The business model of Cyprus has not been successful.”

‘Avoided a disastrous exit’

Cypriot leaders, facing the prospect of a contraction in their economy that by some estimates could approach Depression-era levels over the next few years, were subdued. The Cypriot parliament last week rejected a proposal to seize a portion of all bank deposits in the country to pay for the bailout. The agreement reached Monday will protect deposits of up to $130,000, the legally mandated deposit insurance level, but the ordinary Cypriots who own those bank accounts are likely to face years of rising joblessness and a moribund economy.

“It’s not that we won a battle, but we really have avoided a disastrous exit from the euro zone,” said Cypriot Finance Minister Michalis Sarris.

The initial rescue proposal would have taken at least 6.75 percent from all bank deposits in the country to fund the $7.5 billion bailout contribution demanded by Europe and the International Monetary Fund. The decision to spare deposits of up to $130,000 eased fears that the principle of deposit insurance had been undermined in the currency bloc.

But the arrangement disrupted the notion that the euro zone creates a seamless financial system with the same rules for everyone.

“The fact is that, for the next few days, I cannot use the euros sitting in a bank account in Nicosia to buy anything. I also can’t take out more than 10,000 euros from the country,” said Simon Derrick, chief currency strategist at BNY Mellon. “They are, therefore, of less value than euros held elsewhere.”

The euro fell to $1.286 Monday, down from levels of more than $1.30 before the crisis flared 10 days ago.

The deal, which must be approved by several countries, will force large losses on those holding deposits of more than $130,000 in Cypriot banks, and it will split the country’s second-largest bank, Cyprus Popular, also known as Laiki, into two. Deposits of less than $130,000 will go into a “good” bank. Deposits above that level will go into a “bad” one, and depositors and bondholders may recover little or none of their money.

Cyprus also agreed to cut government spending, to privatize state assets and to drastically shrink the size of its banking system. As of the end of 2012, deposits in Cypriot banks were seven times the size of the country’s economy.

“The agreement reached today on Cyprus provides a comprehensive and credible plan to deal with the current economic challenges in the country,” IMF Managing Director Christine Lagarde said.

A banking haven no more

But the bailout puts an end to decades in which Cyprus had tried to diversify its economy beyond its warm Mediterranean beaches. Starting in the 1970s, the country set low corporate tax rates and emphasized its stability in a bid to attract companies. Its reputation was enhanced in 2004, when it joined the European Union, and even more in 2008, when it joined the euro zone, tightly binding the country to the far larger economic block on mainland Europe. Deposits poured in, and many companies routed transactions through Cyprus for tax reasons.

That reputation led Europe to take a hard line on any bailout, pushing for Cyprus’s wealthy depositors to be on the hook along with other European taxpayers. Last week, Cyprus urgently sought aid from Russia, hoping that the estimated $25 billion in Russian deposits in the country would help attract support. But Cypriot leaders left Moscow empty-­handed.

Russian Prime Minister Dmitri Medvedev on Monday compared the Cyprus deal to Vladimir Lenin’s expropriation of the wealth of the richest Russians in the early days of the Soviet Union.

“We need to understand what this story will finally lead to,” he said at a meeting of top Russian officials in Moscow, the Interfax news agency reported.

Neil Irwin in Washington contributed to this report.

Michael Birnbaum is The Post’s Moscow bureau chief. He previously served as the Berlin correspondent and an education reporter.
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