Monday, 1 August 2011

Holidays in Euro-hell

Later this week, I am going on holiday. To Cyprus.

Yes, Cyprus - which is shaping up nicely not just as the next Eurozone domino, but also as perhaps the first which no-one except Greece really has an overpowering incentive to rescue, and which may even be allowed to fail spectacularly 'pour encourager les autres'.

Where to start? The easy stuff first: Cyprus' collapsing Communist government is running a fiscal deficit of 5.3% of GDP, and that is contributing to a current account deficit running at 7.8% of GDP.

From these numbers, we can tell that its private sector is running a savings deficit of 2.5% of GDP. Which in turn means that the island's banking system must be consistently finding cash with which to keep the private sector's economy running.

So let's have a look at its banking system. Let's start with the loan/deposit position of the banks with Cyprus residents - by June this year it had hit 116%, up from 108% a year ago (as the savings deficit dictates).  But that's only the slightly  bad news.  We need to consider the total size of the banking system, which right now has deposit liabilities equivalent to just over 5X Cyprus' GDP, and has loans outstanding to residents of just under 4X GDP.

You will have spotted, of course, that these sorts of multiples and cashflows dictate Cyprus' banks are funded by a large net foreign liabilities position. Now, the Central Bank of Cyprus isn't publishing data on the banking system's net external bond liabilities, but from what is published, we can discover that the banking system is carrying more foreign deposits than its making foreign loans - a funding mismatch currently worth around 31% of GDP.  Very clearly, the real net foreign liability mismatch will be larger.

Additionally, we simply don't know how much of Cyprus' bank assets are, in fact, Greek 'assets'. However,  the Greek commercial and cultural presence in (South) Cyprus is obvious and omnipresent, so it would be something of a surprise if it turned out Cyprus' banks haven't been lending money to their Greek compatriots. Press reports say the banks have around Eu 5 billion of Greek sovereign debt - that's equivalent to just under 30% of GDP.

And then there's the economy itself, which as a result of being shackled to the Euro, is overpriced for tourists (I'm going there because it's where my parents-in-law live, for now) and sluggish. During 1Q11 it managed nominal GDP growth of 2.6% YoY, which didn't keep pace with the muted 2.9% YoY growth of its capital stock. In other words, return on capital is falling, and as a consequence, so is investment (it fell 2% YoY in 1Q).   Since 2Q nominal GDP will certainly be slower, we can be sure that all these ROC numbers and trends have not yet bottomed.

But in fact, the economy's in much worse shape even than that. For Cyprus is reeling from a catastrophe which, though utterly avoidable, is truly disastrous. Two years ago, Cyprus intercepted and impounded a shipment of high explosives originating from Iran making its way to Gaza. Britain offered its technical aid to help Cyprus store it safely, but this offer was not taken up. Rather, the high explosive was stacked up in 98 containers next to the island's largest power station, which generates about half of Cyprus' electricity. Now, Cyprus is a near-desert island, subject to brush fires during the summer. So the inevitable duly happened:  two weeks ago, the brush fire ignited the high explosives, which took out half of Cyprus' electricity-generating capacity. So we can add power cuts and brownouts to the list of woes.

How will the tourists like that? (And it matters, since the Eu3.8 billion in services surplus is the biggest offset to Cyprus' Eu 4.7 billion trade deficit).  More to the point, who in their right minds would pick  Cyprus as their destination right now - except perhaps for disaster-hunting economists?

I shall be taking a computer, and fear I may find myself reporting from the front line. Damn!

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