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Cyprus may be the EU's next domino to fall

Pedestrians walk through the 'no man's land' in the heart of the divided Cypriot capital Nicosia's Old City in this 2008 photo.


Which European Union country will be next to sue for a bailout? If you guessed Italy or Spain, you might be wrong. It's likely to be Cyprus.

While Europe is focused on saving Italy and the other debt-whacked countries for the sake of the euro, the Greek-Turkish island in the Eastern Mediterranean is going through its own hell.

On Monday, Athanasios Orphanides, Cyprus's central bank governor and member of the European Central Bank's governing council, said the country is showing "intense signs of recession" and that access to the international capital market has been lost. "It's very positive that the critical nature of this situation has been acknowledged," he told parliament.

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Cyprus is the third-smallest EU country, after Malta and Estonia. It has big financial problems. Tourism has fallen off and its banks are in serious trouble. The country's banks are cruelly exposed to ailing Greek sovereign debt and have to raise capital -- a potentially impossible task -- on their own. The waning flow of credit to small- and medium-sized businesses, the backbone of the economy, is pushing Cyprus into recession.

Cyprus's own credit rating was dropped two levels, to Baa3, by Moody's last month. S&P lowered its Cyprus rating the month before. The yield on 10-year Cyprus bonds has climbed into the low double-digit levels, a worrisome sign. Greece, Ireland and Portugal each received bailouts shortly after their yields breached 7 per cent.

In response, the Cypriot government is rolling out austerity programs. A two-year package, worth about €500-million, looks set to be approved later this month. It may not be enough prevent a bailout because of the high cost of the bloated civil service. The finance ministry said that overall public-sector costs are projected to rise to €2.7-billion this year, up by a quarter from 2008, the last boom year, according to a Bloomberg report. Incredibly, the annual gross salary of the average civil servant in 2009 was almost €47,000, well more than double that of private sector workers, according to former Cypriot president George Vassiliou.

Add in a 6 per cent budget deficit and €2-billion of maturing debt next year and things do not look good for the sunny island. Some fund managers think a bailout is inevitable. It would not cost a lot, by Greek standards. But a fourth bailout of an EU country is something the reeling EU does not need.

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About the Author
European Columnist

Eric Reguly is the European columnist for The Globe and Mail and is based in Rome. Since 2007, when he moved to Europe, he has primarily covered economic and financial stories, ranging from the euro zone crisis and the bank bailouts to the rise and fall of Russia's oligarchs and the merger of Fiat and Chrysler. More

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