Unsustainable Debt Load

A rift has emerged between the eurocracy and the IMF over the pending bailout of Cyprus. The EU's bailout mechanism ESM stipulates that the IMF must agree that a country applying for help will achieve debt sustainability under the proposed bailout plan. The intent behind this stipulation is clear: it allows the eurocracy to point to the IMF's demands when the austerity measures demanded from an aid recipient are deemed too harsh. In addition, the IMF has well-established procedures and trained teams that enable it to exercise a reasonable amount of control over such programs.

The IMF is however not overly happy with being involved in the euro area's bailouts. For one thing, Europe is seen as rich enough to handle these problems on its own. For another, the ironclad determination to keep everyone a member of the euro area is so pronounced that even complete basket cases like Greece keep getting bailed out no matter what.


Apparently the IMF fears that Cyprus could become a similar case.

Der Spiegel reports:

“When euro-zone finance ministers meet in Brussels on Monday, a welcome guest will be missing. Christine Lagarde, 57, the French managing director of the International Monetary Fund (IMF), is currently unwilling to discuss giving aid money to ailing euro-zone member Cyprus. For some time now, the Americans in particular have been eyeing the IMF's involvement in Europe with suspicion, causing the Frenchwoman to hit the brakes time and again. "I have no mandate for that" is a statement that the euro-zone finance ministers have heard only too often from Lagarde.

As such, it remains to be seen whether the IMF will ultimately participate in a loan program for Cyprus. A number of countries, Germany first and foremost, have said that IMF participation is crucial. The statutes of the European Stability Mechanism (ESM), the euro zone's €700 billion ($931 billion) permanent backstop fund, stipulate that the IMF must rubber stamp a country's debt sustainability before any cash can flow.

But this time around, the IMF is hesitating. A member of the troika which is currently negotiating the bailout deal with the Cypriot government, the IMF has an entirely different notion as to how the program should look.

In particular, there are differing points of view over whether the Mediterranean island nation will ever be able to repay its debts. According to current forecasts, the Cypriot debt load will grow to 140 percent of its gross domestic product (GDP) by the year 2014. The IMF believes that such a sovereign-debt level is unsustainable over the long term.”


(Emphasis added)

Evidently it is indeed doubtful whether Cyprus will ever be able to repay its debts.


Bank Recapitalization

Moreover, the IMF thinks that the bailout of the country's banks should be handled separately, by means of an ESM recapitalization. Then the ESM would share the risks of the bank rescue – which would make the sovereign debt problem look commensurately smaller.

The euro-group doesn't want that because the mooted European banking regulator hasn't been established yet. The IMF also insists – rightly – that both junior and senior bondholders and even depositors should bear losses. This however would mean that the Greek 'PSI deal' was not so 'unique' after all, which would create a quandary for the EU.

Keep in mind here that one of the main reasons why the Cypriot banks are insolvent is that they held Greek sovereign debt which they had to write off twice. The money-laundering allegations are also a bone of contention, with the IMF surprisingly concluding that they are largely a load of hooey, something the Northern euro-zone countries apparently don't want to believe.


“Another issue has also caused an air of mistrust to creep in between the IMF and a number of member states. Germany, Austria, Finland and the Netherlands don't trust the findings reached by a team of IMF experts last autumn with regard to Cypriot money laundering activities. The experts from Washington came to the conclusion that Cyprus is largely playing by the book and only minor legislative amendments are required.

This doesn't go far enough for the northern countries in the euro zone. They don't just want to know whether Cypriot laws meet international standards — they want to find out whether they are actually applied. Schäuble and his counterparts from the other donor countries intend to put forward an initiative to address these concerns at Monday's Euro Group meeting. They realize that it could take months to answer these questions, but that doesn't deter them.”


(emphasis added)

Of course the main concern isn't really 'money laundering' anyway. That is just  a pretext. To be a 'Russian oligarch' is not a crime, per se. The fact that rich Russians seek out overseas havens to deposit some of their money in is mainly a function of political risk perceptions in Russia – there is no reason to assume a nefarious motive.

In reality, the EU centralizers want to put pressure on Cyprus to raise its taxes.  The government of Cyprus meanwhile is living from hand to mouth, by borrowing money from the state-owned electric utility.



Cyprus financing needs

The size of the putative Cyprus bailout relative to the country's GDP. The problem is that the banks are very large relative to the economy (chart via Der Spiegel).




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