Norman Villamin, Chief Investment Officer Europe at Coutts.
London – Parliament’s complete rejection of Cyprus’ bailout plan has sent policymakers back to the drawing board and is testing the resolve of the European Commission, International Monetary Fund and the European Central Bank “troika”. On the sidelines sit the Russians, who have the capability, but so far have not shown the willingness, to help.
The European Union (EU) is holding its ground, saying Cyprus needs to come up with its share of the funding for the bailout, which can’t rely on borrowed funds. Interestingly, the troika needs to be careful not to take too hard a line, as that may push Cyprus much closer to Russia. That seems to be the little leverage that Cyprus has.
Compared with the bailout of Greece, what is interesting is the juxtaposition of Russia and the troika here. Russia, with probably the greatest direct economic interest and social and historical connection to the island, is at this point a passive participant in plan to save Cyprus. The challenge will be to bring the Russians to the table and get them to share the burden.
Having displayed the stick (deposit levy) to get Russia to the table, the most obvious next step would be to dangle some carrots (such as offshore drilling rights) to facilitate a solution. This is not without precedent, as part of the Greek bailout programme included asset sales/privatisation.
The challenge is that this needs to be completed today, or authorities need to extend the bank holiday. With this in mind, it seems to me the Russians have a bit of an advantage in the negotiation. The only real pressure the troika could exert would be to cut off funding for the Cyprus central bank, which is reliant on the emergency liquidity assistance scheme (ELA). This would potentially raise the cost to Russia for not stepping in.
What are the near-term implications for asset markets? We have seen the euro push to recent lows, Spanish and Italian stocks sell off and yields on their government bonds rise (prices fall). Further downside from here requires a policy error, which though not impossible, I would be hesitant to suggest is the base-case scenario. Like flare-ups in the eurozone before, I believe a face-saving agreement will be found. It’s not likely to solve the broader crisis, but once again kick the can a bit further down the road.
In the more medium term, the headwinds to European growth continue to build. Any relief rally following a resolution will be limited by the need to address structural reforms, create pan-European institutions and redouble efforts to boost growth. In the absence of these, a weak euro will be the policy tool of choice. This leaves us favouring non-eurozone equities within Europe. (Coutts/mc)