Cyprus slips a little closer to oblivion

The Mediterranean island faces years of severe hardship, writes Liz Alderman.

After a chaotic month in which Cyprus was pushed to the brink of default and a possible exit from the eurozone, Cypriots knew things would get bad. But not this bad.

A bleak assessment released on Thursday by its European partners, says the Cypriot economy will spiral downwards for at least the next two years, contracting by up to 12.5 per cent as the country cuts a banking sector that had ballooned to more than five times its gross domestic product.

And because the economy will do worse than expected, Cyprus must soon raise €13 billion - nearly twice the amount the government thought it would have to come up with just a month ago - in order to keep its debt and deficit from spinning out of control and to maintain a €10 billion ($12.4 billion) international bailout secured last month by the newly elected president, Nicos Anastasiades.

A shrinking economy means the country's budget deficits are likely to grow, so the government will need to raise more money to keep the deficits within limits set under its bailout agreement. Because the government has also committed to improving the health of its banks, it must come up with more money to ensure that the lenders have adequate capital, especially if their loan losses start to snowball as the economy slumps.

"In the short run, the economic outlook remains challenging," the European Commission said in the report, which details the conditions that the Cypriot government agreed to meet to obtain the financial lifeline from the so-called troika of the International Monetary Fund, the European Central Bank and the commission.

So hard pressed is Cyprus that it has agreed to sell off some of the family jewels to raise money. Chief among them are excess gold reserves held by the central bank.Cyprus had already agreed to sell €400 million worth of gold, or an estimated 10 tonnes from its 13 tonnes reserve.

Cyprus' coffers have run dry as it scrambles to keep its teetering banks from collapsing. On Tuesday, finance minister Harris Georgiades said that without the bailout, public funds would run out by the end of the month.

Cyprus is under pressure from the troika to speed development of the natural gas reserves that have been discovered off its coast. The hope is that the proceeds would be used to keep Cyprus' debt under control as the economy slumps. But this could set trigger geopolitical tensions. Turkey, to the north of Cyprus, last month challenged any move to speed exploration, especially if it means Russian involvement. Turkey warned that it may "act against such initiatives if necessary".

In the meantime, the commission described a bleak future for Cyprus, at least in the short term.

Under the terms of the bailout, it was required to fold part of its second-largest financial institution, Laiki Bank, also known as Cyprus Popular Bank, into the largest, the Bank of Cyprus. Numerous companies are likely to close as banks cut back on issuing credit.

Other lucrative businesses that fed off the bloated financial services industry are also likely to suffer. Real estate prices, which have already begun to fall as a building bubble collapses, are expected to deteriorate further. Companies registered even as a simple mailing address, are likely to look elsewhere as the corporate tax rises to 12.5 per cent from 10 per cent, even though that is still the lowest in the eurozone next to Ireland, The commission said in its report that people and businesses that held uninsured deposits at the two largest banks will see a "loss of wealth" as the government confiscates up to 60 per cent of their money to meet the terms of the bailout deal. That, combined with extraordinary restrictions on withdrawals to prevent a bank run, will cut down on consumption and business investment.