The Pound to Euro exchange (GBP/EUR) rate opened 1.45 cents higher at 1.705 for the week as markets reacted to the Cyprus bailout 10% tax levy.
Over the weekend Cypriot President Nicos Anastasiades announced that in order to receive the €10 billion bailout package, that is vital to hold the country’s banking sector together, depositors will have to pay a one-off 9.9% tax levy on all savings above €100,000, and 6.75% on any money stored below that amount.
The controversial law breaches a previously accepted notion that depositors will be protected from losses during bailouts, and led to a run on Cypriot cashpoints over the weekend. Many automated tellers ran out of cash rapidly and electronic transfers were stopped. The deal, if passed by politicians later on today, will come into effect on Tuesday. However, because it is a bank holiday today in Cyprus, savers do not have the opportunity to transfer their funds. There is a €50,000 fine or a three year jail sentence for those who do not comply.
The most dangerous aspect of the ruling is the very real threat of contagion across other Eurozone member states. Although Eurozone leaders have described Cyprus as a unique case, by breaking a taboo that has ensured relative stability in the 17-nation bloc during a number of high profile sovereign bailouts, EZ Finance Ministers have opened the door to a possible run on the banks.
If depositors at Cypriot banks are forced to pay a levy on their savings, what’s to say that a similar law will not be passed in Greece, Spain, Italy, or Ireland? There’s no guarantee that future tax levies will be capped at 10%; the prospect of 15%, 25%, or even 40% levies could have a catastrophic effect on Eurozone banking stability as depositors look to safeguard their savings by withdrawing funds from the bank. With this levy, the levee of trust has been broken.
The argument in favour of the one-off tax payment in the Cyprus bailout is that unlike in Portugal, Ireland, or Greece – who have previously received sovereign aid packages – the Cypriot government cannot afford to pay for the bailout with taxpayers’ money because Cypriot GDP only accounts for an eighth of the debt ran up by its banks.
There is also the problem of alleged money laundering in Cyprus. European officials are concerned about using Eurozone taxpayers’ money to rescue what they believe to be large portions of Russian-owned money in the Cypriot banks.
With Eurozone officials, most notably German Finance Ministers, unwilling to dish out such a colossally large percentage of national output to shore up the country’s banks, the tax levy was seen as the only option.
Cypriot President Nicos Anastasiades acknowledged the severity of the decision, but claimed it was the only option for Cyprus to maintain solvency:
“We would either choose the catastrophic scenario of disorderly bankruptcy or the scenario of a painful but controlled management of the crisis”.
It remains to be seen how much of an impact the unique Cyprus bailout will have on the Eurozone debt crisis, but the threat of contagion as depositors lose trust in the banking system does not bode well for the Euro exchange rate. Bank-run fears are especially prevalent in the southern Eurozone states, but the currency bloc as a whole could feel the effects of this watershed moment.
If investors feel that their money is not safe in the 17-nation bloc, then it could lead to a nasty cycle of liquidity freezes and further bankruptcy. This would also have the knock-on effect of weakening the Euro exchange rate as savers look to havens from the crisis; the Pound, the US Dollar, and the Swiss Franc could be the strongest beneficiaries of this phenomenon.
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