Trouble spreads

Cyprus is the latest to be hit by the Eurozone contagion which has wobbled bigger countries like  Greece, Italy and Spain.

Though the island has a small economy, the problems it faces have the potential to psychologically and even substantially damage the web of financial arrangements in the European Union. A bailout package has now been prepared, as earlier in the case of the  bigger economies, but it again involves unconventional means and might result in a lot to hardship  to many stake-holders. Cyprus has a special situation in which its banks have deposits which are about eight times its GDP. The 10 billion euro package which has now been offered is contingent on restoring the financial stability of banks through freezing deposits above a cut-off  limit. There was an earlier plan to impose a 10 per cent uniform tax on all deposits. But this created an outrage  and was rejected by parliament. Banking business is shut down in the country now and the impact of the new proposal will be known only in the course of time.

Cyprus’ problems rose mainly from its being a tax haven, inviting money flows which were too huge for its small economy. The country had imagined that by keeping the rules soft and tax rates low, it could develop its financial sector. But much of the funds that came were tainted money from other countries, especially from Russians who made fast bucks in the privatization wave in the post-Soviet era. Most such depositors now stand to lose a good part of their wealth. But ordinary Cypriots have also come to pay a price. Even if the bailout package works and there is recapitalisation of banks, it will impose a heavy debt burden on the country. The EU has to keep Cyprus within the common currency zone because dropping out of a country, will have a major negative impact.

The troubles in Cyprus have turned international attention to other tax havens too, which are banking hubs and attract funds from other countries. Much of these are ill-gotten money being laundered outside their place of origin. The Mauritius route is well-known in India. One lesson from the Cyprus experience is that such funds stashed way abroad are not as safe as presumed. They might evaporate with the collapse of the host economies.