Cypriot comeuppance and regional repercussions

THE expected impact of the crisis in Cyprus is huge locally, everyone agrees. Economists now expect the Cypriot economy to contact by 10 percent or more this year. Depositors with balances in excess of (100,000) euros are expected to lose nearly 40 percent of their money. Making depositors responsible for the bailout is a novel approach in the euro zone, applied for the first time in Cyprus.
To limit capital flight, Cypriot authorities put stringent capital restrictions, also unprecedented in the euro zone. Depositors will be allowed to withdraw no more than 300 euros from their accounts. Credit or debit card transactions will be unlimited within Cyprus. However, transactions out of the country may not exceed 5,000 euros a month per person.
In the meantime, ownership of Cypriot banks — those that survive the crisis — will witness some major changes. Under terms of the bailout, depositors who are required to take the 40 percent haircut are expected to become shareholders in the banks where they kept their accounts: Their ownership will be proportional to how much they had to pay in taxes. We may see Russian and other foreign depositors reluctantly owning big chunks of Cypriot banking real estate. Some of those depositors may not relish that responsibility or the publicity, considering the sources of their wealth.
Cypriot bank depositors are of course the biggest losers, but they are not the only ones. Banks there too will lose big, as depositors may shun the hitherto supposed security of well-known banks. The whole banking system will come under a cloud of mistrust, where banks may find difficult to attract local and foreign clients, who may fear another painful haircut.
But does the crisis really matter globally? What does it mean to Gulf banks and their clients?
The initial market reactions were low key. After all, Cyprus was not the first to go through this type of crisis. The euro zone has witnessed greater events in the past two years, in Greece, Italy, Ireland, Spain and Portugal. It seems more worried this week about Italy’s new government, and the possibility that rating agencies may further downgrade its debt, below Moody’s Baa2 (of last July).
However, the mild reaction to Cyprus troubles may prove to be a bad omen. In a comment on the crisis, the credit rating agency Moody’s said the lack of a global strong reaction to Cyprus may make policymakers even more willing to go after bank creditors in the rest of Europe. In Cyprus, Moody’s said, “policymakers seem to have concluded that spillover effects to other banking systems, including the periphery, will be limited or can be contained. We think the market’s relatively muted reaction so far to these developments may embolden policymakers in the future should they feel contagion risks can be contained.”
There was one area where market reaction was felt strongly. European banking stocks (outside Cyprus) tumbled, in Greece, Italy, Spain, even Germany. Some bank shares lost as much as 30 percent, others 45 percent. The sellout is indicative that shareholders are beginning to have serious doubts about the value of their banking stocks.
The crisis also revealed that Europeans are no longer ready to bail out every struggling member. They will demand that troubled economies to pay to full cost of any rescue package, as in the Cypriot example, even if they have to transfer the cost to taxpayers and bank depositors.
As if these crises were not bad enough, a report came out last week expecting Europe to lose out in the recovery. According to this report by the Organization for Economic Cooperation and Development (OECD), the global economy is beginning to rebound, but Europe is lagging behind and unemployment rates, even in countries starting to see growth, are still too high. It expects growth to accelerate in Japan and the United States in the first half of 2013. And though Germany will bounce back strongly, it says other countries that use the euro will contract or only grow slowly. It believes that the European Central Bank needs to do more to encourage banks to lend and economies to grow.
What does this all mean to GCC markets? Strictly speaking, there will be little direct effects of the Cypriot crisis on GCC banks and financial markets. After all, the Cypriot GDP is no more than $ 25 billion, compared to a GCC combined GDP of $ 1.5 trillion. Any exposure would be of limited impact on the GCC.
However, if the Cypriot crisis leads to a wider crisis in the euro zone, that could have serious repercussions. After all, the EU is still the number one trading partner of the GCC. Any further weakness in that economy would have noticeable effects on some GCC markets.

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