Cyprus euro controls may last years as Sarris vows ‘weeks’

Offshore Kronur

The offshore krona trades lower than the official one because it reflects the difficulty exchanging them for dollars or euros, according to Hardarson. One euro was worth 159.54 kronur on official markets yesterday and 220 kronur offshore, according to Keldan.com, an Icelandic data provider.

The same is going to be true for the euro now that a member country is walled off from the rest, said Raoul Ruparel, chief economist at Open Europe, a London-based research group.

“Now there are two euros, one in Cyprus, one elsewhere,” said Ruparel. “The whole point about a single currency is that money is fungible, it can cross borders without any restrictions. The capital controls in one member basically ends that arrangement.”

To be effective, controls in Cyprus will have to be stricter than those in Iceland, Ruparel said. Iceland’s importers and exporters have been exempted from currency- conversion restrictions as long as they can show the exchange is for trade purposes. If a similar exemption were to be made in Cyprus, Russian companies on the island could use the loophole to take their money out swiftly, Ruparel estimated.

Russian Investment

Cyprus-based Russian companies, taking advantage of the island’s lower tax rates, are the largest source of foreign direct investment in Russia, according to central bank data.

Most efforts to restrict capital flows out of a banking system or a country have failed to protect the currency they were intended to prop up, according to separate papers by Sebastian Edwards, an economics professor at the University of California at Los Angeles, and Graciela Kaminsky, an economics professor at George Washington University.

Argentina restricted bank withdrawals in 2001, when it was faced with a banking crisis following the government’s debt default. Three months later the country had to abandon its currency peg to the dollar, which it had maintained for a decade. The government imposed losses on deposits through forced conversion of dollar savings to pesos at unfavorable rates.

Currency Peg

Being a member of the euro zone is similar to maintaining a peg to another currency at a fixed-exchange rate. When the local currency is overvalued as a result of inflation, countries with pegs eventually end the fixed regime and devalue, as Argentina did. Cyprus might do the same, faced with dire economic prospects, Open Europe’s Ruparel said.

“Stuck with an overvalued euro, Cyprus loses out on tourism, one of its two main economic activities,” he said. “The other one, banking, is dead with capital controls. So what advantage does Cyprus get from being in the euro now?”

Cyprus’s 18 billion-euro economy is the third smallest in the 17-nation euro area. Before the bailout, which was coupled with an austerity package, the European Commission predicted a contraction of 3.5% in 2013. Economists said afterward that the damage will be greater.

The decision to burn depositors with more than 100,000 euros and restrict money movements will hurt confidence in other weak economies and banking systems of the euro zone, according to a report yesterday by DBRS Inc., a Toronto-based rating firm.

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