The Pound to Euro exchange rate rose by around 0.15 cents yesterday to 1.1745 as fears surrounding the sustainability of Cyprus’ recent bailout package led to a slight drop in demand for the single currency.
A leaked report on Cyprus’ debt sustainability showed that the cost of the Mediterranean island nation’s bailout package has now risen from €17 billion to €23 billion. The large majority of the €6 billion shortfall will be funded by the large-scale restructuring of Cyprus’ two largest banks. Jonathan Loynes of Capital Economics said:
“The biggest burden of the increase in the bailout will fall on depositors and bank bond-holders, whose combined contribution will rise from an expected €5.8 billion to €10.6 billion”.
Cyprus aims to agree on a relaxation of its €2.5 billion loan from Russia, in order to help the fiscal consolidation progress run a little bit smoother. Restructuring the calamitous banking sector will raise the largest chunk of the package – €10.6 billion – as the soon-to-be wound down Laiki bank absorbs all of the bad loans, and uninsured large depositors take a significant hit. A further €600 million will be collected through enhanced rates of tax for corporations and capital income. Pending legal approval, the clear-out of the Cypriot Central Bank’s gold reserves will fetch around €400 million. And the final €1.4 billion will be resolved through a series of privitisations across the Cypriot economy.
The report suggests that Cypriot GDP will shrink by -8.7% this year and -3.9% in 2014. However, with exports likely to shrink by far more than the -5.0% predicted, and domestic demand likely to suffer tremendously due to the huge losses imposed on wealthy depositors, it is prudent to assume that this, already disastrous, GDP target will not be met. Historically initial estimates have been revised lower with the mechanical precision of a metronome on a quarterly, and sometimes monthly, basis.
The optimistic projection – if that word is applicable to a GDP estimate of -8.7% – even drew caution from those who compiled it:
“There is a non-negligible risk of a cycle of household and corporate defaults propagating through the economy, leading to further banking sector losses, worsening of labour market conditions, stronger-than-expected falls in house prices and a prolonged loss of business and consumer confidence…Although difficult to quantify, downside risks appear dominant”.
The official debt-to-GDP ratio figures foresee Cyprus peaking at around 128% in 2015. But, like the GDP estimates, there is a strong possibility that adverse economic factors will lead to a significantly higher fiscal deficit. Additional austerity measures, leading to further deteriorations in growth, leave the entirely feasible possibility that Cyprus’ debt-to-GDP ratio will hit a highpoint of 134% in 2015, and remain well-above 110% by 2020.
The Pound to Euro exchange rate (GBP/EUR) did not benefit too much in response to these downbeat developments, as the inaccuracy of initial growth targets and fiscal consolidation efforts is widely understood among markets. It seems that the potential infallibility of Cyprus’ uphill struggle, towards redemption following the unprecedented tax levy on its depositors, has already been priced-in to the Sterling/Euro exchange rate.
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