Cyprus Goes to the Eurozone Well

The government of Cyprus has requested a bailout from other members of the Eurozone through the European Financial Stability Fund (EFSF) or the European Stability Mechanism (ESM) which together have been capitalized to the tune of €750 billion. The government statement reportedly asked for assistance to mitigate the risk to the country’s economy due to the exposure of Cypriot banks to the economic troubles in Greece.

The country’s sovereign debt rating was cut to junk status this morning by Fitch Ratings, the last of the three major ratings agencies to issue such a rating to Cypriot debt. As long as one ratings agency maintained an investment grade rating on Cypriot sovereign debt the country was able to borrow from the European Central Bank (ECB). That is now no longer an option.

The country’s second largest bank, Cyprus Popular Bank, needs a recapitalization of €1.8 billion by the end of this month, according to a report in the Financial Times. The government wants to follow Spain’s lead in recapitalizing its banks, which would require less from the country’s citizens in the way of austerity measures. That may not be possible, though, because Cyprus’s plan does not include the kind of fiscal measures proposed by Spain in its bailout request.

In addition to the immediate need for €1.8 billion, Fitch reckons that Cyprus will need another €4 billion fully to recapitalize its banks. The country’s banks hold about €22 billion in Greek private sector debt according to the FT. Cyprus has already borrowed €2.5 billion from Russia.

Cyprus now joins Greece, Ireland, Portugal, and Spain in the quest for funds from the EFSF or the EXM. The amount the country seeks is relatively small, but is equal to about a quarter its GDP. And even though the request for aid comes at virtually the last minute, the ECB pretty much has no choice but to agree to the bailout. If it doesn’t, the world will get a preview of what could happen in Greece or Spain, and the ECB certainly wants to avoid that.

Paul Ausick