Cyprus, France and the euro-zone crisis

Economist
August 6, 2011

It started in Greece, and has spread steadily since. This week’s episode of the euro-zone crisis has focused on Spain and Italy, but other countries, at both ends of the size spectrum, keep coming into view. Cyprus, a midget within the monetary union, has been pushed to the brink of a bail-out. France is still in the rescuers’ camp, but it, too, is starting to attract attention.

Cyprus’s outsize banking sector, with assets of more than seven times GDP, is heavily exposed to Greece. In a “mild” stress scenario, featuring a haircut on Greek government bonds and losses on private-sector loans, Moody’s, a ratings agency, estimates that Cypriot banks will require a capital injection worth 16% of the island’s GDP. Domestic deposits were down in four of the first six months of the year, including a particularly steep drop in June. The shares of the largest listed banks have lost around half of their value so far this year.

The government’s ability to support the banks is in doubt following an explosion on July 11th that destroyed the Vasilikos power station, taking out half of the country’s electricity supply. The blast was triggered by seized Iranian munitions stored in containers at a nearby naval base. Amid regular power cuts, Cyprus will be lucky to eke out any economic growth this year. Progress on reform of Cyprus’s bloated public sector, already faltering, has broken down completely following the explosion, with President Demetris Christofias dismissing his cabinet on July 28th and the junior party in the ruling coalition leaving the government on August 3rd.

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