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Greece exit from Eurozone would hit Cyprus hard

GREECE leaving the Eurozone would be a nightmare for Cyprus, and it won’t matter much what steps the government is currently taking to save the banks or the economy, experts agree.

On Friday parliament approved legislation that could part-nationalise the Popular Bank, the island’s second-largest lender and heavily exposed to Greek debt, in a bond-for-equity swap if attempts to raise €1.8 billion privately fail by a mid-year deadline.

It followed efforts by the bank itself to find investors who were however discouraged by the lender’s exposure to Greece and the uncertainty in the country.

The bank’s chairman Michalis Sarris said approval of the bill gave the lender room to “do what needs to be done to put the banking system back on a healthy base.”

However, whatever Cyprus does may not mean anything if Greece leaves the Eurozone in a disorderly manner, dragging down with it other weak economies like Spain and Portugal and of course Cyprus.

Experts warn that such a development would be followed by chaos – banks and businesses will go bankrupt in Greece, unemployment going through the roof, shortage of basic commodities, to name but a few.

The real problem for Cypriot banks is not their exposure to sovereign debt but the loans given out to Greek businesses and households.

The three big banks have around €24 billion on their Greek loan books – Popular has €13 billion, followed by the Bank of Cyprus with €10 billion.

Thinking the unthinkable

A Greek exit – dubbed Grexit – and a return to the drachma – dubbed Drachmageddon – is expected to hit Cyprus hard, if it happens, and reports on Friday said the EU was now ‘thinking about the unthinkable’ on that score.

“We are now looking at the possibility that the large portfolio we have in Greece could become doubtful,” Sarris told BBC’s HARDtalk. He did say a Greek exit was not inevitable but “it is a clear possibility.”  “I think the Europeans are quite firm that they need Greece to stick to the adjustment plan, tough as it is.”

Sarris said the Greeks seem to think there is a way to stay in the Eurozone without implementing the measures they have to in exchange for the EU’s support.

“Now unless somebody blinks, this is the kind of situation that could lead to an unpleasant outcome but Greece has a history of going to the brink of disaster and then pulling back,” Sarris said.

His belief is that a way will be found for the country to remain in the Eurozone with perhaps some changes to the programme “in ways that the result can still be what is expected but perhaps some of the pain can be spread over a longer period.”

The worst case scenario for Cyprus would be Greece exiting the euro and returning to the drachma, which would certainly be devalued.

For the banks, it would mean a substantial loss of value on their assets, prompting the government to seek a bailout.

We are bound to end up in an EU bailout

“We are bound to end up in an EU bailout,” said Fiona Mullen, director of Sapienta Economics. “Basically we are faced with a second (banking) capital crisis.”

One way to avoid this is by isolating the banks’ operations in Greece.

An effort towards this has been undertaken by the Popular Bank but with no result, so far at least.

If this is unsuccessful, Mullen suggests going to the EU and asking them to bail out the banks in the event of a Greek exit in order to restore confidence.

“So we need a provisional EU bailout. It will come with tough conditions but probably conditions that the government has not had the courage to implement itself,” Mullen added.

Cyprus must also seek to dispel any suggestions that it would be following Greece out of the Eurozone as it has been reported recently.

“The government seems to have done the right thing by moving quickly on Laiki (Popular) this week but it also needs to start saying very loudly that we are not leaving the euro,” to prevent any jitters, Mullen said.

The extent of effects of a Greek exit on Cyprus or the Eurozone for that matter, are difficult to predict, though the consensus is they will be very negative. More so for Cyprus, which prefers the exit to come later rather than sooner – if it comes – so that it has more time to sort out the Greek loans issue.

Economist Symeon Matsis expects the whole Eurozone to be affected, forcing the EU to take measures that will of course include Cyprus.

“They will be forced to bolster the support fund or create a new one,” Matsis said. “It’s not just Cyprus.”

Matsis expects such a development to plunge the island into a deeper recession, pushing back recovery by a couple of years.

“It is clear we will have a lot of negative effects. And considering that the Cypriot economy is already in recession, you understand what this thing means.”

Sacrifices will have to be made

“We will be talking about sacrifices from the entire population,” Matsis said, noting that the government – possibly with the exception of the decision to support Popular – has not yet taken the necessary measures that will allow it to intervene. “We’ll be forced to lower salaries to subsistence level so that we can become competitive and be able to re-enter international markets.”

EU policymakers insist they want Greece to remain in the Eurozone but EU trade commissioner Karel De Gucht said the European Commission and the European Central Bank were working on scenarios in case it has to leave.

“A year and a half ago there maybe was a risk of a domino effect,” De Gucht told Belgium’s Dutch-language newspaper De Standaard.

“But today there are in the European Central Bank, as well as in the Commission, services working on emergency scenarios if Greece shouldn’t make it. A Greek exit does not mean the end of the euro, as some claim.”

Speculation about such planning has been rife, but de Gucht’s comments appeared to be the first time an EU official has acknowledged the existence of contingencies being drawn up.

But the European Commission’s top economics official, Olli Rehn, later dismissed De Gucht’s comments.

“Karl De Gucht is responsible for trade. I am responsible for financial and economic affairs and relations with the European Central Bank.” Rehn said. “We are not working on the scenario of a Greek exit. We are working on the basis of a scenario of Greece staying in.”

Germany making plans for Greek exit

Germany said on Friday that it had started making plans for a possible Greek exit.

“For the last two years we have been doing everything possible to keep Greece in the Eurozone… We have a programme and we stand by this. Greece must also stick by this. Everyone is prepared to go forward with it. Brussels has also emphasised this,” a German finance ministry spokeswoman said.

But she added: “The German government naturally has the responsibility to its citizens to be prepared for any eventuality,” she said without elaborating.

She was echoed by the head of the International Monetary Fund Christine Lagarde who said it is their job to be “technically prepared for anything.”

Lagarde stressed that this was not the desirable solution.

“I think what we should look at is the optimal scenario where the country has the political resolve to actually observe the commitment, comply with the undertaking, stay within the zone, which seems to be the desire of the population,” Lagarde told the BBC. “But it goes with the effort to abide by the program, which has been put in place.”

German Chancellor Angela Merkel meanwhile spoke with Greek President Karolos Papoulias on Friday and told him of Germany’s hope for a functioning government in Greece.

“She repeated the German government’s position that we are waiting for the new elections and it is our wish and that of all European partners to see a new, functioning government,” a spokesman for Merkel said.

This hope is certainly shared by Cypriot officials who are anxiously watching developments in Greece.

Speaking in parliament after approval of the bill to support the Popular Bank, Finance Minister Vassos Shiarly urged Greek politicians to display the same level of unity and responsibility shown by Cypriot MPs.

“We hope that logic will prevail at the end of the day and what would happen in Greece is something like what you saw [in parliament] – politicians uniting and putting the country’s interest before anything else,” Shiarly said. “If Greek politicians also show the same responsibility … I believe they will succeed and not drag our country into more difficult times”.