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“Cyprus may be forced out of the euro and this would be dangerous” -Michalis Attalides

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Michalis Attalides

Michalis Attalides

Michalis Attalides is Rector of the University of Nicosia and holder of a Jean Monnet Chair at the University. He has been a lecturer in Sociology at the University of Leicester, a counterpart to the UNESCO Expert at the Cyprus Social Research Centre and a Guest Lecturer at the Free University of Berlin. He has represented the Republic of Cyprus as its Ambassador in a number of capitals, including Paris, London, and the European Union in Brussels, before being appointed Permanent Secretary of the Ministry of Foreign Affairs. He has also represented the Cyprus government in the European Convention.

Attalides graduated from the London School of Economics with a BSc in Economics, received an MA and, in 1966, a PhD in Sociology from Princeton University.

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In a speech delivered upon taking office, Nicos Anastasiades underlined that his first priority as President was to “reinstate Cyprus’ credibility,” to work closely with the country’s European partners and to fulfill, “to the outmost,” his country’s responsibilities. The president delivered that speech a little over a month ago. What happened? Why was Cyprus rushed to the brink?

It is indeed difficult to fully comprehend the behavior of our European partners. They had shown a great deal of patience with the previous, communist president of Cyprus, Demetris Christophias, who had exhibited many signs of being suspicious of the European Union and western institutions generally, and who had since March 2011, when Cyprus was pushed out of the money markets, consistently sought alternatives to a European Memorandum of Understanding.

When Nicos Anastasiades was elected, who is, together with his party, a committed European and a member of the European Peoples’ party, announcing that he would apply for membership of Partnership for Peace and seek closer relations with NATO, he was confronted with deadlines and pressure which were an extraordinary exhibition of lack of understanding and solidarity with a European Head of Government who had taken office two weeks previously, as well as with enormous economic problems, accumulated during the tenure of the previous government.

President Anastasiades characterized the Cyprus bail-in as an “experiment.” What is your assessment on such an experiment and its impact on the rest of the euro zone?

Clearly the formula used by the Euro Group and the Troika, the “bail-in”, through which bank depositors bear the cost of recapitalization of a failing bank is an experimental one, as it has never been used in Europe before to my knowledge, while it has apparently on occasion been used for failing banks in the United States.

The difference involved is in the degree of ruthlessness involved, both for depositors and for the economy of Cyprus. No matter what may be said about the responsibilities of depositors as quasi-lenders of banks, who need to shop around before they entrust their money, we must bear in mind that many of the depositors were not international investors, but small business people, who considered that their life-savings were safe in these banks. After all, the two largest banks in Cyprus had shortly before passed the EU stress tests. If the EU considered the banks sound then, how would a shop-keeper know that they were not?

Secondly, the difference between depositors becoming responsible for recapitalizing a bank in California and in Cyprus is that the Bank of Cyprus and the Laiki bank together represented 45 % of total deposits in Cyprus, and, according to some reports, 70% of business deposits. So the “resolution” of one bank, and the virtually 60% “haircut” of deposits, along with the freezing of 90% of deposits in the other bank, has virtually brought the whole economy to a standstill, and has the potential to suffocate it, forcing Cyprus out of the euro area. At the very least it will induce a recession of 10 to 15 % of GDP during this year, which is unprecedented except perhaps for Finland after the collapse of the Soviet Union.

I have the impression that the eventual Euro Group agreement reached may be better for the rest of Europe than the proposal which was rejected by the Cyprus House of Representatives, because, unlike the rejected proposal, it does not involve impounding part of the deposits of small, insured depositors with a total deposit of less than 100,000 euros. There seem to be two schools of thought about the consequences of the radical hair-cut to the large depositors of the Bank of Cyprus and the “resolution” of the Laiki bank.

One interpretation is that these unprecedented steps will create insecurity for depositors all over Europe (and perhaps further), creating doubt and causing weakening of banking systems, particularly in Southern Europe. It is also possible that the precedent may create an aversion of investors to banks in Europe generally.

There is a second, apparently more limited school of thought, presumably including the president of the Euro Group, Jeroen Djsselbloem, which considers that this harsh combination of measures could be the answer to the problem of the vicious circle of the link between bank indebtedness and government indebtedness.

As for the intention to change the economic model of Cyprus, this is an unprecedented and dangerous experiment in intervention in the affairs of a member country, which to my knowledge does not have backing in the European legal system.

There probably will be a change in the Cyprus economic model, but not just because of the intervention of the Euro Group, which was in any event not clearly thought out. Part of the stated intention was to drive Russian depositors out of Cyprus. Yet the formula used for the Bank of Cyprus will turn Russian depositors in the Bank of Cyprus into owners of the Bank of Cyprus, not a completely effective way of driving them out, which is quite fortunate for Cyprus.

I believe that the Cyprus government representatives at the first Euro Group meeting were under the impression that they were going to a friendly European meeting.

Is there anything the Cypriot government could have done differently at the negotiating table?

Well, of course I was not present at the negotiating table, so I can only speculate. But a Government that has repeatedly said that it did not consider the “haircut” as being a serious intention or even a possibility, as the Cyprus Government had done, cannot have been well prepared for a negotiation along precisely these lines.

But this says more about the transformation of the attitudes and atmosphere in European institutions than about the Cyprus government, as I believe that the Cyprus government representatives at the first Euro Group meeting were under the impression that they were going to a friendly European meeting, intended to assist Cyprus, rather than to a hostile environment in which the economic stability and welfare of the country would be challenged.

This was a government that had after all, taken office two weeks previously, believing that it would negotiate the Cyprus economic issues leading to an MoU in a friendly environment.

However, I also believe that the procedures for handing over power from one Government to the next in our country needs to be reviewed and radically improved, so eventualities of this kind are not faced in the future.

The question that arises is whether the activities of the Cyprus government resulted in improvement for Cyprus between the first and third Euro Group.

It is true that there was almost universal criticism of the intention to tax insured depositors at the first Euro Group, and that the change in this element was of universal value, and virtually universally applauded.

But I do not know whether the eventuality was explored of taxing only uninsured depositors in all banks, rather than the extremely harsh penalization of depositors in two banks, causing some ordinary people to lose their entire life savings.

The near-unanimous rejection of the first deal by the Cyprus House of Representatives and the failed attempt to find an alternative to a European solution in Russia may have hardened some attitudes in Europe.

What do you think of the other Euro Group members’ attitude during the negotiations?

I will quote from a written account by the Foreign Minister of Malta, Edward Sicluna, who was present at the meeting.

Sicluna says that the Ministers insisted on three aims being achieved, “Firstly, that creditor countries, including us, would ensure they got their money back. Secondly that an equal effort is seen to be made by both creditor and debtor countries […] Thirdly, that all the past sources of irritation which went unheeded by the country concerned are finally and forcefully settled with the now all-powerful creditor countries…

“In the case of Cyprus, it was the Russians, with the implication of being recognized as a tax haven with abundant stories of gross money laundering activities…

“All […] was agreed to by the Cypriot government representative who, with a pistol to the head, was naturally unusually co-operative.

“But it took nearly 10 long hours before the Cypriot minister’s body and soul became exhausted enough for him to assent to this accord. As soon as that happened Schäuble demanded that all wire transfers to and from the Cypriot banks would cease forthwith.”

If the accusation is that there are large Russian businesses and depositors who are based in Cyprus, then the question is why such a presence is not allowed in Cyprus, whereas it seems to be approved of in other EU members.

Cyprus’ bail-in is also being portrayed as a way to rid the country from money launderers and an over-sized banking sector.

International efforts to eliminate laundering of money derived from criminal activities, or intended for use in criminal activities, or terrorism, are of course essential and need to be implemented with the greatest vigor. However Cyprus has taken all the measures and undergone all the inspections available in the international system and had been considered as having as strong measures in place against money launderers as any other jurisdiction, and stronger ones than some other European countries.

Those who, at the time when it had a pressing need for an international bailout, accused Cyprus of allowing money laundering, actually had a duty to have raised the issue before, if they had such evidence or such suspicions, which was not the case. Even after the Euro Group meeting, I am not aware of any specific case that has been raised by another government (there have been some general references in the press ), or any evidence put forward, other than a reference to, as far as I know, undisclosed evidence in the hands of the German secret services.

Nevertheless, if the Cyprus Government agrees to further inspection by relevant international bodies, it is assumed that any weaknesses identified will be rectified.

If the accusation is that there are large Russian businesses and depositors who are based in Cyprus, then the question is why such a presence is not allowed in Cyprus, whereas it seems to be approved of in other EU members.

Finally, the size of the banking sector in Cyprus is proportionally smaller than that in Malta, and much smaller than that in Luxembourg. The fact is that nothing in the Treaties dictates what kind of economic activity should be conducted in each EU country. Clearly Cyprus cannot have heavy industry, a motor industry, or an arms industry, so that it has over the years, painstakingly developed an economy based on services, including banking, legal and accounting services.

It is true that unlike other European countries with a large banking sector, Cyprus had to ask the other Euro Zone countries for a bailout, and clearly it would not have arrived in this state had its governments and banks not committed serious errors.

More understanding was expected from our partners, particularly as the main impetus sending Cyprus into economic insolvency came from an action of the EU itself, and this was the PSI (“haircut”) of the Greek public debt decision in October, 2011. The decision, applying conditions which raise questions about the adequacy of information and advice available to European heads of Government when they are taking crucial decisions in the European Council, resulted in a 4.5 billion euro loss by the Cyprus banks, who were in possession of Greek government debt, and henceforth made it impossible for the Cyprus Government to return to borrowing in international markets.

It is all very well to say, as some have claimed, that the Cyprus economic model was not viable, but the fact is that, though it had weaknesses, which critics in Cyprus, including myself, had pointed out, it faced no problem of viability, until a European action created enormous losses for the banks, which were not compensated as they have been in other countries.

Do you think Brussels will apply the same rigorous economic and ethical standards to other countries such as Luxembourg?

I would only express the hope that our friends in Luxembourg and our friends in Malta do not face the same need for a bailout from the Euro Group. For if they do, the fate of Cyprus may unfortunately be what they would also encounter.

Germany’s complex internal system of federal and coalition party governance, and internal electoral pressures have sometimes prevented its leaders from showing the understanding and tact towards less economically successful countries.

Euroscepticism and anti-German sentiment is growing across Europe, particularly in the south. However, German Finance Minister Wolfgang Schäuble recently brushed aside such a growing sentiment by describing it as jealousy “from those who have a little more difficulty.” Do you agree or do you think there is a real cause for concern?

I am afraid that there has been a tendency to re-nationalization and an orientation to national interest in much of the European Union. It is not the first time that Europe and European construction has experienced periods of great difficulty. One only has to think of the failure of the European Defense Community and the European Political Community in the 1950’s, which caused dismay even to Jean Monnet. There was also the period of “Eurosclerosis” in the 1970’s and early 80’s, which caused some to declare the end of the integration project. Yet very soon afterwards in 1986 we had an important step forward with the Single European Act.

I believe that the current tendency to look to national interests is due to two factors.

The first is that many of the countries of the European Union have been negatively affected economically by the process of globalization. Competition from the developing world and from other areas of the world, including the United states, as well as the demographic phenomenon of an aging population, has put pressure on social welfare systems in many countries in Europe, which together with issues related to EU and third-country migration, have caused a revival of extreme right wing parties, sometimes pushing center parties to a more introverted position.

The second issue of course is the euro-crisis which has set many European countries on a course of austerity, unemployment and pessimism. It is to be hoped that the imbalances created by the experiment of adopting a common currency without common economic governance can be corrected, indeed can be a spur to the next stage of European integration, with the European banking union and the European fiscal union being realized.

Germany, it is true, is an economic success story in Europe, having itself adopted, in the recent past, massive austerity measures, it is now in a strong economic position not only in Europe, but globally, with an annual economic surplus similar to that of China’s. Nevertheless it has a complex internal system of federal and coalition party governance, and internal electoral pressures have sometimes prevented its leaders from showing the understanding and tact towards less economically successful countries, which its leadership position calls far.

Germany has had leadership thrust on it, a role for which it was probably not prepared.

Do you feel there is an agenda for Germanic dominance in Europe?

To the contrary, I feel that part of the problem is that Germany has had a leadership, for which it is not prepared, thrust upon it, due to its economic strength and dominance and the fact that the other large countries of the Union, including Spain and Italy are introverted due to their own economic problems.

As a consequence, European actions and positions of the German coalition government seem to be often driven and dictated by the needs and vicissitudes of internal democratic electoral requirements, a formula for external policy which has been known to be ineffective and sometimes dangerous, since the beginning of the study of diplomatic practice.

This is even more dangerous since France and the United Kingdom, who have historically formed an equilibrium in relation to Germany, are largely absent.

France, perhaps for the first time since the period of de Gaulle -who for a while boycotted participation in the European Communities- seems to be absent since the election of President Francois Holland, presumably absorbed by its own social and economic issues.

The other weighty European participant, the United Kingdom, is in any event not a participant in the Euro Area and only tries to play a role in it when it perceives its own direct interests are being threatened. But it is also absorbed in its intermittent but intense internal debate as to whether it should remain in the European Union or leave.

And so Germany has had leadership thrust on it, a role for which it was probably not prepared, as for many years it was the financier of the European Union, while often following the political lead of France.

Germany must recognize that it is not true that the peoples of southern Europe are lazy or dishonest.

Germany defends that it should not pay –or risk its taxpayers’ money– for other European countries’ mistakes. Is this such an unfair position?

Not at all. However we know that in democracies much depends on how issues are presented to the voters.

It should help the European project if citizens in southern Europe recognize that Germany has heavily financed European integration for many years, and that it has achieved its current economically dominant position in Europe and its internationally competitive position through hard work and sacrifices as well as sometimes painful reforms, which it is now pressing other countries to adopt.

However, it would also be helpful if two things are recognized in Germany. One is that the introduction of the euro has been of enormous economic benefit to Germany, boosting its exports and strengthening its position of economic dominance, which is further enhanced by its freedom to sell its fine industrial products all over Europe in the internal European market.

The southern European countries in particular have not been in as strong a position to compete economically.

However, Germany must also recognize that while for historical reasons there are specific issues in some countries of southern Europe, including the efficient functioning of state institutions, it is not true that the peoples of southern Europe are lazy or dishonest. This is a stereotype that seems to have dominated German impressions during the crisis in Greece, and to which the issue of “black money” in relation to Cyprus has been added.

The European project has always, from its beginnings, encompassed national interests and motivations, but has always found ways to also pursue these national interests through increasing integration and the ability to form a consensus in the pursuit of a European interest. And the central issue is that the continuation of the European project is of crucial importance for all the countries of Europe.

It would seem that speeding exploitation of Cyprus’ hydrocarbon reserves may have taken a new priority now that the country’s financial sector has been essentially dismantled. What role do you think such reserves played in the bail-in negotiations?

Indeed, if the exploitation of the hydrocarbon reserves in Cyprus’ economic zone could have been sped-up up enough, a great deal of disruption and suffering for the people of Cyprus could have been avoided. However, there may have been some delay due to the developments of recent weeks, while most estimates seem to be that the beginning of exploitation that will yield significant income for Cyprus is placed at the end of the decade.

The prospect is clearly there, and this will contribute to genuine change in the Cyprus economic model, leading to a reduction in reliance on services, including banking services, and the possibility of diversified energy, and other high technology economic activities.

It seems that during the negotiations with the Euro Group and the Troika, the independence of the management of the hydro carbon reserves has fortunately been maintained, and Cyprus will be in a good position to develop its own natural resources, which will of course be of great significance for Europe as a whole, as the Cyprus reserves are estimated to have the potential of covering about 10% of additional European needs during the next decades.

Cyprus is also in a good position to participate with flexibility and to contribute to energy cooperation in the region, as it has good relations backed by relevant agreements with other regional countries, Egypt, Lebanon and Israel, who have hydrocarbon reserves.

These facts however do not seem to have been sufficiently taken into account during the events of recent weeks.

Based on the MoU drafts that we have seen in the press, and looking at the terms imposed on other euro zone members, does President Anastasiades have any clout left to negotiate the terms of his country’s own economic policies?

The negotiations have been completed and the government has announced several improvements in the MoU, including the maintenance of the independence of the management by Cyprus of its hydrocarbon resources, some extension of the period of implementation, the safeguarding of coverage of the public health sector, and the safeguarding of some jobs in the public sector.

The degree of paralysis, lack of liquidity, and unemployment in the immediate future could be such that it may force Cyprus out of the euro zone through suffocation.

What are the prospects for the emergence of the “new economic model” Europe calls for in Cyprus?

In the medium term, Cyprus has a good economic future based not only on its hydrocarbon resources, but also on the basis of a number of other advantages.

The first and most important, given the current state of the economy, is the resilience and enterprise of its people. This has been shown in the past, after the invasion of Cyprus by Turkey in 1974, which resulted in the occupation of 40% of its territory, and the displacement of one third of the population, resulting in the loss of 60% of the productive resources of Cyprus, raising unemployment levels to 20%. It was from this basis in 1974 that what has been termed by some the “Cyprus economic miracle” emerged. I should add that the occupation of the northern part of Cyprus continues, and that one would expect more understanding from other EU countries about the economic achievements of Cyprus under extremely difficult circumstance.

The second advantage of Cyprus is that it has a highly educated and highly skilled labor force, a fact which, combined with its modern infrastructure, including communications, and of course its pleasant climate have formed the basis for its ability to become a services center. Contrary to the impression that has been given, many of the foreign investors in Cyprus are not “fly by night” operations, but actually business men with homes in Cyprus, networks of business support in the legal, financial and accounting services sectors, and children at schools and universities in Cyprus. Some of these business men may not leave, despite the punishment which they have suffered.

Finally, despite the problems with Turkey, Cyprus has excellent relations with all the other countries of the region, to the extent that it has long aspired to acting as a bridge between Europe and the Middle East.

The problem is in the immediate future, with the main danger being that the measures taken in relation to the two banks have had a crippling effect on many businesses. A double digit recession is forecasted for the rest of the year. The degree of paralysis, lack of liquidity, and unemployment in the immediate future could be such that it may force Cyprus out of the euro zone through suffocation, a fact that would be a calamity for Cyprus, but also damaging for the Euro Zone.

The solution for this dangerous eventuality is for the euro zone to take over the half of the debt which has been created for Cyprus which it is not responsible for, and which amounts to about 10 billion euros, a sum which though not insignificant is totally manageable for the Euro Zone. This part of the debt is composed of the direct loss of 4.5 billion euro from the PSI in the Greek public debt and the 5.5 billion euro which is composed of ELA funds channeled to banks -which are now in Greek hands through Cyprus.

Membership to the European Union and the euro zone has been a historical and strategic choice for Cyprus, not a tactical move.

Several adamant defenders of the need for Cyprus to exit the EMU have emerged in recent days, including Nobel Laureate Paul Krugman. What are your thoughts about Cyprus ultimately abandoning the common currency?

As I have already mentioned, Cyprus may be forced out of the euro area and this would be a calamity for Cyprus and dangerous for the Euro Area. I do not however believe that exit from the euro is something that Cyprus should pursue.

Paul Krugman’s comments in his blog received a great deal of publicity, including in Cyprus, particularly due to his Nobel Laureate status. In his short reference, he implies that the future of Cyprus, after an exit from the euro, would lie in tourism and agriculture. Tourism is, and will probably remain, a key activity of Cyprus, though its capacity to create high grade jobs is severely limited and in recent years demand for labor in the tourist sector has been largely satisfied by immigrants, a fact which unfortunately may become problematical during a period of high unemployment.

High value agriculture could have a potential in Cyprus. But again with a very limited prospect for employment growth, and even potential as an economic sector, given that at the moment agriculture contributes just over 2% of the GDP of Cyprus, and accounts for 6% of total employment, and is severely limited by the perennial water shortage of Cyprus.

But the main issue is that about 70% of school leavers in Cyprus go on to tertiary education, and tourism and agriculture do not provide suitable job opportunities for most of them.

Furthermore Cyprus is an importing country, even for inputs necessary for tourism and agriculture and the devaluation and great increase in the cost of imports, which would accompany leaving the euro, would probably make life as we now know it impossible.

Finally, I would indicate that membership to the European Union and the euro zone has been a historical and strategic choice for Cyprus, not a tactical move. Under current circumstances the political implications of Cyprus leaving the euro would be complex and, on the whole, negative for Cyprus, the EU and the region.

The European Union’s leadership at the moment is more attuned to the needs of the German electorate than the needs of European cohesion and further integration.

You spent many years representing your country in Europe. How have your views on the future of the EU changed?

I would stress that I moved from diplomacy to the academic world ten years ago, and that I now express only personal views.

The condition of the EU today is worrying. There are serious problems connected with the cohesion, leadership and functioning of the European Union, which could pose a threat to the future of the European project.

The two main issues are the economic crisis and the inclusion within the European Union of countries at different stages of economic development, within a single structure including a common currency, without a common system of economic governance. Clearly the difficulties and adjustments involved in this system have led to friction and the revival of the kind of memories that one might have considered had gone from the European mind.

As I previously mentioned, the individual impact of the crisis on the various members of the Union has resulted in a degree of introversion which has thrust the leadership of the Union on Germany, the largest and most powerful country and the main financial contributor to the Union, whose leadership at the moment is more attuned to the needs of the German electorate than the needs of European cohesion and further integration.

It is also the case that the new Lisbon institutions have, under these conditions, not functioned as effectively as was hoped, so that we see views about the economy of a member country expressed by prominent individuals such as the chairman of the Euro Group and the Finance Minister of Germany in a more dominating way than by the institutions of the Union.

The success of the European project has never been assured. There have always been doubts, uncertainties and failures. And while the dangers today are real, there is also the possibility of hope. The problems in the euro zone could also be seen as a normal mechanism of integration in the neo-functionalist perspective, where integration in one sector (in this case the common currency) has effects which lead to integration in other sectors, (in this case banking and fiscal union).

Whether this will prove to be the case we will see in the near future.

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