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Salmon: Cyprus' Bad Haircut Day

NEW YORK (Reuters Blogs) -- As The Wall Street Journal reports, Cyprus has said όχι to the idea of taxing deposits: good for them. And the parliament did so decisively, as well: 36 "no" votes, 19 abstentions, and (as FT Alphaville notes) zero "yes" votes. Even the president, who initially said in an official statement that Cyprus had no choice but to say yes, was already moving on the Plan B before the vote was even taken (as ekathimerini.com notes), although no one yet is entirely clear what exactly Plan B entails.

One very big hint comes from the fact that the Cypriot finance minister, Michael Sarris, is in Moscow Tuesday (where, according to Reuters, he's denying via text message reports that he has resigned). Russia accounts for the lion's share of Cyprus' uninsured deposits, and president Vladimir Putin has said, according to The Associated Press, that even a 9.9% tax on those deposits would be "unjust, unprofessional and dangerous." Given that the only way that Cypriot president Nicos Anastasiades kept the tax to less than 10% was by taxing the insured depositors at an unacceptable 6.75%, there is obviously a lot of appetite within Russia to help Cyprus find a way out of this mess.

One way to do that would be for Gazprom, the Russian energy giant, to spend a few billion euros (see Greece.GreekReporter.com) on rights to Cyprus' natural gas resources; another, according to Storify would be for the Russians to buy a bank or two (see this Financial Times article), leaving Cyprus to raid local pension schemes for extra liquidity until natural-gas revenues come on stream. Or, of course, there's always the Buchheit-Gulati option, I recently wrote about. The thing they all have in common is the idea that they're basically trying to provide a bridge to the point at which Cyprus starts getting lots of money from its natural gas. Of course, the gas might not exist at all, or (according to the Guardian), it might take a decade before it actually starts seeing revenues, so there's risk here. But the point is that in Cyprus, uniquely, kicking the can down the road actually makes sense: If you get far enough down the road, there's a real chance that everybody could end up being paid off in full, or making a substantial profit.

It's not clear that Greece's parliament will grok the distinction, however, which makes this particular game very dangerous for the Eurogroup. For the time being, the EU and IMF -- and, crucially, the ECB (according to Reuters) -- are keeping the lines open to Nicosia: The idea seems to be that so long as they don't need to cough up any more than the 10 billion euros they've already agreed to, they'll let Cyprus find the balance of the needed cash any way it wants. But here's the rub: If Cyprus gets to reject the Troika and largely set its own terms, then everybody else (read: the Greek parliament) will want to be able to do that as well. And no one in Europe's centers of power really wants the Mediterranean periphery getting too uppity.

The best-case scenario here is that the vote by the Cypriot parliament is a "phoney war," in Dan Davies's words in a Twitter post: "A vote on which the government abstains is like opening with two hearts at bridge. It's a bidding convention, not a serious plan." Cyprus and the EU will go back for another round of negotiations, with Cyprus trying to front that it has a great offer from the Russians, and the two sides will come to a compromise that doesn't involve taxing insured depositors. The banks will then reopen, the Russians will pull a large chunk of their remaining money out of the country, the ECB will provide all the liquidity that the Cypriot banks need, and Cyprus will muddle through in an austere kind of way.

The worst-case scenario -- call it CypriOut -- is that talks just break down entirely, with no plan acceptable to both the Eurogroup and the Cypriot parliament, while the Russians ultimately decide that they don't want to throw good money after bad. In that event, Cyprus ends up with a chaotic default and devaluation -- think Argentina 2002, only on an island that Wikipedia notes is already fractured along intractable ethnic lines.

The cost of CypriOut to the ECB and to Europe as a whole would be substantial, both in euros and in precedent. If you think that taxing deposits is a bad precedent, just wait until you see what happens when the world learns that a country can leave the eurozone after all. So a lot of people are going to spend a lot of effort trying to avoid it. And judging by recent European history, some last-minute deal will manage to get cobbled together somehow. But this whole situation is horribly messy -- it reminds me of the Argentine political chaos (see this Euromoney article) in March 2001, a few months before the country defaulted.

The big problem here is that there's no overarching strategy on the part of the EU. An interviewer from Greek TV asked me yesterday whether the agreement with Cyprus represented an important change in the Eurogroup's attitude towards peripheral countries. I had to say that it didn't, just because that would imply that the Eurogroup has an attitude towards peripheral countries, which can change. Instead, it's all tactic and no strategy, and the tactic is a dreadful one: wait until the last possible minute, and then do whatever's most politically expedient at the time. It'll probably work, somehow, in Cyprus. But it won't work forever.

-- Written by Felix Salmon in New York.

Read more of Felix's blogs at Reuters.

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