The Cyprus Crisis and the Road Ahead

For such a small country, Cyprus certainly carries enormous implications as an indicator of the overall stability of the European Union. Since the island nation’s sharp economic decline at the turn of the 2012-2013 year, Cyprus has witnessed widespread panic and fiscal chaos. In March of 2013, after weeks of disorder, the European Union stepped in to salvage the ailing country with a bailout package of 10bn euros. But can any bailout carry enough weight to lift Cyprus out of danger?

The answer is not an easily calculable one, despite the IMF’s best attempts at economic foresight. According to the IMF, Cyprus’ economy will likely drop by 9% this year, followed by a 4% decrease next year[1]. While these numbers are undoubtedly formidable, the IMF’s estimation history suggests that they may actually be quite reserved. Indeed, when the IMF forecasted Greece’s future in 2009, it reported that the country’s economy would shrink by 5.5%–a striking underestimation compared to the 17% reduction that actually occurred[2]. Of course, the IMF would have a very valid reason for downplaying the Greece’s (and maybe Cyprus’) potential losses. After all, if the international monetary organization were to diagnose Cyprus’ economy as terminally ill, the resultant panic would certainly see to the downfall of the country’s economy.

Four months later, it is clear that the March bailout did little more than mask the signs of a failing economy. An important indicator of this situation can be found in the differentiated value of the euro in Cyprus versus that of the euro in, for example, Germany. Despite the fact that Cyprus and Germany operate under the same currency—and despite the fact that the Maastricht Treaty explicitly requires the free movement of capital—the March bailout package requires that euros in Cyprus cannot be transferred and used in other countries in the European Union[3]. The reasoning behind this decision is understandable enough; if the bailout money intended for Cyprus does not remain in Cyprus, the entire package would be rendered ineffective. Still, the consequences are such capital controls are enormously significant. As one Cyprus businessman declared, “A Cyprus euro is a second-class euro.”[4] Thus, the euro itself is now effectively divided, raising profound questions about the true stability of the European Union as a whole.

But of all the issues facing Cyprus, the intangible factors are possibly the most disconcerting. Bailouts may keep the country afloat, but no bailout can rebuild the trust that is essential for the maintenance of foreign investors.[5] This basic level of public confidence in the banking and government sectors are difficult to measure, but they are essential to Cyprus’ recovery. In order to demonstrate its commitment to rebuilding trust and establishing a system of effective self-regulation, Cyprus must make good on its promises for strict austerity measures. Nonetheless, even if Cyprus manages to improve its condition significantly throughout the coming years, the doubts raised by this year’s crisis will likely haunt its economy for quite some time.

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