European Union member Cyprus urgently needs outside aid to prevent bankruptcy. The International Monetary Fund (IMF) and the EU are considering their options, but other problems have now surfaced.
Cyprus is one of the EU's smallest members, yet saving the island from bankruptcy could prove to be complicated and politically charged. First of all, there are disputes about the sum required. Cypriot Finance Minister Vassos Shiarly said the loans required would amount to a good 17 billion euros ($23 billion).
In absolute terms that's very little compared to the bailouts for Greece, Portugal and Ireland. But in relation to Cyprus' economic output, it is an enormous amount: equal to its annual gross domestic product. The EU has never before taken on such a large share of financial responsibility for a country.
But now, perhaps an even bigger problem has surfaced. A report in the German daily "Süddeutsche Zeitung" suggests the IMF is demanding the Europeans give private creditors a haircut.
If they don't, Cyprus wouldn't be able to handle its debt burden, despite all its austerity and reform efforts. But the IMF will not contribute to a bailout package for Cyprus, the newspaper wrote, without the island slashing its debt.
There has only been one haircut: for Greece at the beginning of the year, and that only following wearying negotiations with the banks. EU governments did not tire of repeating that Greece was a particularly difficult case - which was why there won't be another debt cut. Some politicians have since called this course of action a mistake, because they were afraid of scaring away investors.
If this promise were now broken and creditors had to forgo debt claims again, much of the painstakingly built confidence in the monetary union could be lost. Investors would then perhaps fear losses on investments in other, much bigger countries, such as Spain.
But IMF involvement is especially important to stability-oriented countries such as Germany and the Netherlands. They believe that the IMF - with its strict criteria that applies worldwide - will ensure greater discipline, as Europeans tend not to look too closely when it comes to helping each other out. The mere threat of an IMF exit in Cyprus could significantly increase the pressure to solve the problems that led to the difficulties in the first place.
A recent warning from a high official in the Cyprus Ministry of Finance shows how close to the brink the country already is. Christos Patsalides told the parliament in Nicosia that if the country did not receive 250 to 300 million euros "in the coming days," it would no longer be able to service its debt. Although that may be an exaggeration, to put pressure on donors.
Even so, it will take weeks before a single euro reaches the island. At present, the troika of the EU Commission, the European Central Bank and the IMF are discussing the situation in Cyprus. And in late January, euro group finance ministers will present their position on the assistance request. It is by no means certain that all will come to an agreement.
Another political difficulty for the European bailout is that Cyprus used low taxes to build a huge banking sector, which then fell into trouble in the wake of the financial and debt crisis. This Cypriot business model has continually been a thorn in the side of other countries with higher taxes. There have also long been allegations of money laundering.
For the lender countries, saving Cypriot banks would now mean using taxpayer money to keep competitors afloat. But if they let the island's banks fail, they run the risk that Cyprus' economy will lose its most important pillar. High unemployment and a recession would follow. No matter how the EU decides, it is not in the least bit easy.
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