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22 March 2013updated 22 Oct 2020 3:55pm

“It must realise its current business model is dead”

Merkel on Cyprus.

By New Statesman

Merkel summed up the situation earlier this morning in Cyprus, via Reuters.

She’s right – when Cyprus gave in to political pressure and decided to ditch the levy on small savers, it also said goodbye to its economic structure. If it had taxed under $100,000 depositors, it may have been able to maintain its weird, top-heavy banking sector fuelled by Russian oligarchs. It’s too late now though. Cyprus’s solutions are falling away fast – today’s news was that Russia is really, really unlikely to come to Cyprus’s aid.

Cyprus’s banking system is odd though. At times it has done well – back before the financial crisis, Cyprus was described by the International Monetary Fund as going through a “long period of high growth, low unemployment, and sound public finances” – but it this wasn’t sustainable. Here’s the Telegraph’s Rachel Cooper on what happened next:

By 2011, the IMF reported that the assets of Cypriot banks were equivalent to 835pc of annual national income. Some of that was down to investment by foreign-owned banks, but most was Cypriot.

This imbalance might have been sustainable had the country’s two largest banks not made loans to the Greek government worth 160pc of Cypriot GDP.

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When the value of the debts owed by the Greek state was cut by 75pc, the Cypriot banks were hit hard. Cyprus became stuck in a familiar negative cycle: already weak government finances were further ravaged by slow economic growth and the turmoil in the eurozone.

It will be painful, but in the long run the dismantling of Cyprus’s financial foundations may be no bad thing.

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