Why has micro Cyprus, which accounts for just 0.2 of the eurozone’s GDP, been bullied by the troika? Is the French Government right in stating that Cyprus has a “casino economy”? In what way is the “Cypriot business model” dead, as claimed by Angela Merkel?

The Cypriot experience provides important lessons for the development trajectories followed by small economies

Ian Traynor, The Guardian’s correspondent in Brussels, proposed that “the central aim of the shock therapy was to bring down an oversized banking sector that was failing” (March 25). He speculated that Malta and Luxembourg could be next in line for a bailout.

An online poll carried by the same newspaper showed that 34 per cent of respondents expect Slovenia to follow Cyprus. Malta (16 per cent) placed third after Spain (19 per cent).

Understandably, the local reaction to such ‘speculative journalism’ was vehement. The message is clear: Malta’s banking sector may, on a GDP per capita basis, be as big as that Cyprus but that is where the similarity ends. Malta’s core banking sector amounts to just over twice its GDP, is relatively liquid, risk averse, has limited exposure to foreign government bonds and the vast majority of deposits and loans it administers are domestic.

A big chunk (six times our GDP) of Malta’s banking sector provides few, if any, banking services to local residents. The Maltese Government is committed to ensure the continued success of this sector and the MFSA has been doing a good job at regulating the industry. Moreover, according to Basle II, holdings of government debt in a State’s own currency are deemed as zero-risk. The threats for our banking sector originate primarily overseas.

It’s almost three years since the first Greek bailout and Europe is still plagued by its currency crisis. The euro survives but it is no longer a single denomination. The eurozone leaders have been unable to send a coherent and consistent message of how they propose to deal with sovereigns in trouble. It is still not clear whether depositors’ sharing in the ‘bail-in’ is meant to be the new norm or simply because Cyprus was treated as a ‘special case’.

Against strict EU rules regulating the free movement of capital, Cyprus has been allowed to introduce temporary capital controls due to ‘exceptional circumstances’. These controls include a daily withdrawal limit of €300 and a ban on taking more than €1,000 in cash out of the country. The EU’s present mood is one of cutting down corporate tax abuse while seeking increased tax harmonisation and fiscal discipline. How fast the eurozone will move towards a banking union has still to be seen. In the meantime, Germany keeps insisting that the European Stability Mechanism lends money only to governments and not to directly finance bank recapitalisation.

These measures may be necessary to defend the single currency but accentuate economic divergence rather than the much-trumpeted convergence.

The EU’s mood is shared by other rich countries. Hoping to raise an additional €200 billion in tax revenue over the next 10 years, in 2011 President Barack Obama declared “war on tax havens”. This issue is high on the agenda of the G8, which will be meeting in the UK in September.

These powerful governments are after taxing the estimated €25 trillion held in these tax havens.

David Cameron has been complaining loudly about there being “too many tax havens” and Vince Cable, the UK Business Secretary, referred to tax havens as “sunny places for shady people” (Tax Journal. November 12, 2012).

The unfolding Offshore Leaks, listing thousands of politicians and businessmen having secret bank accounts in tax havens, will only serve to convince the G8 to tighten financial regulations. Of course, there are tax havens and tax havens but the way that the troika treated Cyprus betrays this growing sentiment against fiscal paradises. The fact that ‘Russian fat cats’ account for some 40 per cent of bank deposits also made Cyprus a ‘special case’. In less than six months, Merkel will be facing a general election and the last thing she wants is to be accused of using German taxpayers’ money to bail out Russian oligarchs. Many economists considered Cyprus (together with other small economies such as Ireland, Iceland and Slovenia) as an economic success story. Unfortunately, they relied on statistics and failed to delve into the institutions and structures behind the numbers.

With the benefit of hindsight, the Cypriot economy grew much faster than it developed. Its experience provides important lessons for the development trajectories followed by small economies.

American economist Dominick Salvatore hypothesised that small states were often allowed to free ride internationally by exploiting their relative insignificance. Malta too made good use of what Godfrey Baldacchino terms the “jurisdiction-resource” to grow its economy, including financial services.

In the emerging global and regional scenarios, the ‘importance of being unimportant’ is likely to be increasingly challenged as rich countries combat what they consider as ‘free riding’.

The main competence of small economies is their ability to move fast. Cyprus is already thinking of promoting itself as a ‘gambling resort’ to prevent its economy from shrinking an estimated 20 per cent over the next two years.

It would be good for small EU States if Merkel explains what she meant by the “Cypriot business model”. Not all states can follow the German one.

fms18@onvol.net

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