The European Central Bank has given Cyprus until Monday to come up with a revised bailout plan. Earlier this week the Cypriot parliament rejected the original plan which required bank deposits to bear some of the cost of the program.
The government is now left with the challenging task of finding an alternative source of €5.8 billion in order to access the €10 billion from the troika of the European Commission, the ECB and the International Monetary Fund.
A new plan appears to be for a reduced levy of 5% on deposits of over €100,000 (previously 9.9%), no levy on deposits below that level (previously 6.75%). A range of other measures would need to be adopted to meet the shortfall including tapping the reserves of state pension funds, or possibly a further increase in the corporate tax rate beyond the proposed 12.5%.
Whatever plan the Government comes up with will need the endorsement of the troika. The ECBs ultimatum means that failure to get that agreement quickly will see the emergency liquidity measures to the Cypriot banks withdrawn, leading to their insolvency and a far greater loss for deposit holders.
I think some arrangement will be found. Russia , the source of a significant proportion of foreign deposits in the banks, could still yet play a greater role beyond the restructuring of interest payments on an existing loan to Cyprus.
Markets are understandably watching developments closely. Despite its small size (less than 0.25% of Euro zone GDP), the good folk who came up with this plan for Cyprus are the same folk that are in charge of previous and possibly future plans for euro zone countries in trouble.
I accept the argument that Cyprus is a special case and that bank deposit holders should share some of the burden of the bailout. The Cypriot banking sector is around twice the size of other EU in relation to GDP, with around a third of those deposits coming from off-shore. However, contagion fears and market pricing of those fears comes back to the extent to which markets also accept the argument.