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Small Mediterranean Country Seeks Gainful Employment – Anything Considered

Cyprus Faces Future Without Other People’s Money

by Frank Quin

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An advertisement in yesterday’s online edition of Haaretz, one of Israel’s leading dailies, rather said it all. The page in question was headlined ‘Cyprus crisis could affect Israeli deals there, but overall impact is limited’. The piece reported on the apparently low exposure of Israeli banks and suggested that the sector most likely to take a hit would be forex, with many Israeli-controlled agencies running accounts in Cyprus. And there, alongside the story, was an ad by a Hungarian business consultancy which read ‘From Cyprus to Hungary’, and underneath – ‘Move your company from Cyprus to Hungary, 10 % corporate tax’.

It’s not quite as simple as that of course – the newly-minted 10 percent Hungarian company tax rate only applies on taxable incomes up to €1.8 million per annum, beyond which the old rate of 19 percent still applies. But that’s to quibble: Hungary has deliberately followed Bulgaria and of course Cyprus in seeking to attract investment via the lowest tax rates in the EU. And this enterprising consultancy plainly sees the prospect of offshore companies scrambling to get out of Cyprus and into somewhere else, perhaps as early as next week.

Not so long ago, such a move by another EU member state would have prompted few, if any, offshore Cypriot companies to relocate from the haven. What Cyprus could offer in addition to the lowest tax rate going was its depth of experience in offshore company establishment and administration – a large and lucrative industry has been built on the provision of these and related services – and equally deep experience in facilitating cross-border currency flows and in funds warehousing, for pretty much anyone needing such services and not too many questions asked. Notwithstanding more rigorous bank regulation since joining the European Union in 2004, Cyprus – long a tax haven up there with the best of them – has continued since accession to present as destination of choice for foreign capital needing a home which appreciates the importance of discretion.

According to data provided by the Central Bank of Cyprus (CBC), as of December 2012 total non-bank deposits in Cypriot banks amounted to a staggering €70 billion, well over three times the size of the country’s GDP for the year. Of that total, a shade under 62 percent was recorded in the names of domestic depositors and a further 7.6 percent as ‘other euro area residents’. The balance of just over 30 percent - €21.5 billion – had been deposited by ‘residents of rest of the world’.

Of whom, by all accounts, a very great proportion are Russians. And indeed, Russians probably account for a sizeable chunk of the ‘domestic’ deposits also. Over the past decade or so, Cyprus has become the favoured home away from home for thousands of Russians, with 10,520 officially recorded in the 2011 census, mostly resident in Limassol – or ‘Limassolgrad’ as it’s known locally – and with anecdotally tens of thousands more flying under the radar. And for the most part they are from the ‘high-net worth’ end of the Russian economic spectrum, with deposits per capita in Cypriot banks way above the local average.

For its first six years of EU membership, the Republic of Cyprus – not to be confused with the rump Turkish Republic of Northern Cyprus, effectively quarantined by the Union – did spectacularly well out of the move. A happier union of elite Euro-club membership and savvy tax shelter status could hardly be imagined. The single and other hard currency poured into the island, with bank deposits growing by an average of 13.2 percent annually in the 2006-2010 calendar years (over 18 percent for ‘rest of the world’ deposits). Together with soaring tourism receipts, the revenues generated for the domestic economy by those billions in the banks, in bank charges and invoicing by the plethora of financial services enterprises, produced living standard growth for Cypriots unmatched pretty much anywhere else in the EU. According to World Bank data, 2011’s GDP per capita (PPP basis) at $32,254 was nearly 50 percent up on that in 2004, when Cyprus joined the EU.

And of course the Cypriot banks – some, such as the Bank of Cyprus, now with significant Russian ownership - were doing their level best to place this unprecedented fiscal largesse to best advantage in international money markets. Which to a very large extent meant the ‘mother country’ – Greece – and the folly of which is now all too painfully apparent.

As Cypriots go into their second consecutive weekend without banking services beyond the couple of hundred euros available – or not, as the case has often been this week – at automated teller machines, the huge fear is of what will happen if banks reopen on Tuesday, Monday being the celebration of Greek Independence Day, of all days, and no deal has been done with the Troika. And open they must if the country’s economy is not anyway to grind to a halt because cash only gets you so far and that commodity is anyway being squirreled away as fast as account-holders can pull it from the ATMs.

Absent a Troikan deal, or something of equivalent scale from Russia, say, there is only one plausible scenario. There will be a massive run on Cypriot banks, with neither they nor the central bank having anything remotely like the wherewithal to service the demand; they will start to default on settlement obligations across the financial spectrum – from multi-million euro commercial drafts currently frozen in transit to modest family savings accounts; and their doors will shut as quickly as they opened, only this time in at least some instances for good. And Cyprus will enter a financial meltdown from which there will be no way back – the Euro jettisoned, since it can’t be devalued, a new pound sinking like a lead weight within moments of its launch, and the ‘bail-in’ bailout so imperiously rejected by the Cypriot legislature during this past week seeming like manna from the heavens, if only it could still be had.

In such a dire strait, in the past, insolvent countries have had no choice but for their citizenry to get back to work and to work hard enough for long enough to start a recovery of sorts. A case in point being Argentina back in 2001-02. And they’re still at it, are the Argentines, though the worst of the country’s monetary collapse is now behind them.

But the Republic of Cyprus is no Argentina. It doesn’t have the population for one thing – with just 840,000 souls according to the 2011 census – and it doesn’t have the industry or the natural resources which Argentina has been able to turn to account in its journey back from the brink. Fact is that, when financial services and tourism are removed from the equation, Cyprus – like Greece, the font of all its woes – has virtually no way of making a living. And as the Greek experience also demonstrates, the first casualty of financial collapse is inbound tourism – you get whacked coming and going.

Of course, there is the prospect of vast amounts of natural gas being extracted from the seabed just off the coast of Cyprus. But an income stream from that source is likely to be years away and in any event matters will have to be resolved with the north of the island – the Turkish part - before anyone in their right mind will invest in the process.

What then for Cyprus’ future as an international financial centre, or tax shelter if you will? Without a bailout, there isn’t one – a lucrative national enterprise of long-standing and built on nous, trust, connections, discretion and the helpful accommodation of other people’s money will simply evaporate, leaving behind nothing but redundant office space in Nicosia’s central business district.

And, sadly, it’s possible without difficulty to find any number of commentators this week, and especially since rejection of the Troika deal mid-week, who believe that Cyprus is finished as a financial centre irrespective of whether some other deal is struck by Monday. Meltdown might be avoided, the process might be more orderly but sooner or later, according to this view of things, the Russian and other offshore billions will start to pack their bags and head for more agreeable climes.

Perhaps there’s a third scenario but it’s hard to spot it at the moment. Whatever happens over this long Cypriot weekend, it looks very likely that the country is going to have to find itself another job. Taking some constructive steps towards resolution of the south-north divide might not be a bad start to the process.

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