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reflections

Mar 19, 2013 | 02:02 GMT

4 mins read

A Bailout for Cyprus

(Stratfor)
It can be difficult to separate the important from unimportant on any given day. Reflections mean to do exactly that — by thinking about what happened today, we can consider what might happen tomorrow.

The Cypriot government's announcement Monday that it had reached an agreement with the European Union and the International Monetary Fund for a bailout of the island's banking sector rekindled the debate about the terms and even the legitimacy of financial assistance for EU countries in distress. 

What is a Geopolitical Diary? George Friedman explains.

Once the deal is complete, Cyprus will be the fifth country to receive an EU and International Monetary Fund bailout since the beginning of the crisis. The first four were Greece, Ireland, Portugal and Spain. Every time a bailout is provided, two questions emerge. First, should the bloc rescue its member countries? Second, who has to bear the burden of these bailouts? 

For the most part, the European elites agree that the European Union has to provide bailouts to its members in times of distress and to prevent further contagion of the financial crisis. Only euroskeptic parties (often from the far-right or the far-left) openly question the need for bailouts. But financial rescues are often unpopular, particularly in northern Europe. Voters in these countries often question the need to use taxpayers' money to assist countries in the periphery, which are often perceived as less competitive and unwilling to apply structural reforms (a concept that is usually promoted by EU leaders). This rejection became particularly strong in the case of Cyprus, where one-third to one-half of the banking deposits belong to Russian citizens. The island is accused of being a hub for money laundering.

The answer to the question of who has to bear the burden of the bailouts is more complex. So far, the formula applied by the European Union includes a combination of financial assistance and economic reform. Receiving countries are required to cut spending, increase taxes and apply structural reforms in return for their bailouts. 

Most of the countries that received a bailout are facing negative economic growth and record-high unemployment levels. Spain and Greece are the clearest examples. Political consequences of the crisis are seen in the growth of anti-establishment parties in the periphery countries.

The Cypriot bailout adds a new dimension to the crisis. In its original form, the agreement between Cyprus, the European Union and the International Monetary Fund includes the creation of a special tax on bank deposits in order to reduce the European contribution to the bailout and increase the funds collected in Cyprus. This alternative — which is still being discussed at the Cypriot parliament — is new because it puts part of the weight of the bailout on the depositors. It means that Cypriots will likely have a part of their savings taken away. This prompted hundreds of Cypriots over the weekend to line up to withdraw as much cash as possible from ATMs.

Located in a strategic position in the Eastern Mediterranean, Cyprus is a critical component of NATO's Mediterranean operations, a critical intelligence gathering post for several countries and a financial hub for Russia. But Cyprus is no stranger to the European crisis. According to the EU Commission, the Cypriot economy contracted by 2.3 percent in 2012 and is projected to keep shrinking in 2013 and 2014. Unemployment more than tripled from 3.8 percent in 2008 to 14.2 percent in 2012. This bailout is likely to further worsen the quality of life for Cypriots and probably weaken the new government in Nicosia, which was elected less than a month ago.

The Cypriot bailout also raises questions about the willingness of Germany and other northern European countries to provide full bailouts in the future now that Berlin is signaling that the debtors will have to pay an even bigger price for bailouts.

Despite this new modality, one fact remains: the population of the European periphery continues to bear most of the burden of the bailouts. This dynamic not only aggravates the social aspect of the European crisis, but it rekindles the debate about the legitimacy of the European Union and the trustworthiness of the governments that support its policies.

Increasingly, populations in the European periphery reject the German leadership of the crisis and view the European Union as a force imposed over national populations. The European Union was founded on the promise of bringing prosperity to the Continent, and its legitimacy depends directly on honoring that promise.

In recent months, the debate over the future of the European Union focused on the issue of economic growth versus austerity. If the social aspect of the crisis continues to deteriorate, the debate can take a new turn: the defense of national sovereignty against foreign interference in national affairs.

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