A bailout of Cyprus wouldn't cost much for the country's creditors, but concerns about moral hazard have stalled its approval. Withholding the aid for a few months makes sense. But a longer delay could be risky – and not only for the tiny Mediterranean state.
Hit by the euro zone crisis and its exposure to Greece, the Cypriot economy is in bad shape. The small island needs roughly €17.5-billion ($23-billion) to recapitalize its banks, refinance debt and fund its budget deficit. A bailout this size is nearly equivalent to Cyrpus's gross domestic product and will catapult debt to more than 140 per cent of GDP – levels clearly unsustainable.
Restructuring would be tricky. The euro zone and the IMF have sworn that Greece would be the only country allowed to inflict pain on its creditors. Furthermore, state-owned enterprises and domestic banks would be the biggest losers.
Most of the mooted bailout would go to the island's banks, which need some €10-billion of capital. Bailing in their creditors would be difficult because the system is mostly funded by deposits – which amount to more than four times GDP. The unease of European governments, notably Germany, stems from the fact that non-euro zone depositors – predominantly from Russia – have €21-billion of their cash in Cypriot banks. The fear is that saving Cyprus would amount to bailing out oligarchs while turning a blind eye to the banking system's less-than-transparent practices.
Such reservations are justified. But official findings show Cyprus scores better on compliance with OECD money-laundering standards than many of its peers, including Germany. Granted, there is still room for improvement in supervision and law enforcement. But withholding the bailout will do little to tackle dodgy practices. Instead, it could push Cyprus closer to Russia and cause a greater political headache given the island's geopolitical position and its growing energy significance.
Cypriot MPs have already backed austerity measures. The pro-reform centre-right opposition party is expected to win the upcoming presidential election and favours more privatizations and compromises. Delaying a deal until a new leadership takes over is prudent, and the extra time can be used to pressure Cyprus to enforce tougher transparency standards. But waiting for too long would risk setting a euro-exit precedent, endangering cash-strapped Cyprus and its peers.