By MENELAOS HADJICOSTIS and TIA GOLDENBERG, Associated Press
NICOSIA, Cyprus (AP) — Cyprus will have to seek bailout funds from the European Union in order to recapitalize a banking sector pummeled by exposure to Greek debt, and it must prepare itself by taking tough steps to shore up its finances, the chairman of the country's second-largest lender said Friday.
The comments by Cyprus Popular Bank's Michalis Sarris further bolster a growing sense that the island will be the next in line to ask for help from the European Financial Stability Facility. Other top Cypriot officials also have recently left open the door to a bailout.
Sarris is a former finance minister who helped steer Cyprus' adoption of the euro in 2008, and the bank he leads now is the Cypriot lender most exposed to the risk from Greek debt. Cyprus Popular Bank posted a record €2.54 billion ($3.2 billion) loss last year after taking a 76 percent write-down on its Greek government bond holdings.
In an interview with The Associated Press, Sarris said there's no longer a stigma attached to asking for EU bailout cash. But he also said that if Cyprus turns to the EU bailout fund, it should do so with a convincing plan to cut spending so that it can avoid being forced to impose much tougher austerity measures later.
"We will have to seek some sort of support, and the more orderly fashion that it's done in, the better it is for everybody," Sarris said. "What I do expect over the next few weeks, we will put a program together, we will discuss it with our European partners, and I think, in exchange, we will get the support that is needed to really put some credibility behind the pledge of the government to help the banks through this difficult time."
He said the government needs to balance its books by trimming a huge public sector that takes up around a third of the country's €18 billion ($22.67 billion) budget and increase competitiveness by retooling automatic pay raises that are calculated according to inflation. He said the same applies to banks' operating costs.
Taking firm action now — including even jacking up the relatively low sales tax of 17 percent — would help safeguard the country's low 10 percent corporate tax that underpins its large service sector, Sarris said.
Sarris said Cyprus could avoid the fate of Greece, where the government has slashed public sector salaries and pensions and imposed repeated tax hikes over the past two years in return for billions of euros in rescue loans from other eurozone countries and the International Monetary Fund. The measures have left Greece in a fifth year of recession, while also sparking a political crisis as voters have soured on austerity-backing parties.
The key is convincing the public that some painful measures must be taken now to avoid far more painful ones later, he said. "Compared to what others had to do, we are very far from (cutting all the way to) the bone, we will be cutting fat and this is something others wish they had the opportunity to do," Sarris said.
The Cypriot government is now cobbling together a fresh package of spending cuts, but President Dimitris Christofias said last week that it would not come at the expense of workers' salaries and benefits.
Sarris said the government's measures haven't gone far enough. "It is no secret that our civil service is overpaid and overstaffed and we need to control that on both counts," he said.
The government last month underwrote a €1.8 billion ($2.3 billion) equity issue to help the Cyprus Popular Bank raise capital from private investors by a June 30 deadline.
However, state coffers are running dry because Cyprus is unable to borrow from international markets after two credit ratings agencies downgraded it to junk status. The country is relying on a €2.5 billion ($3.15 billion) low-interest Russian loan to see it through the year, and Christofias has said the government is looking to secure a similar loan without elaborating.
Compounding the island's bank woes are record unemployment of around 10 percent and a dismal economic outlook for this year. The Cyprus Central Bank on Thursday projected the economy to shrink by 1.1 percent of gross domestic product — a sharp downward revision of an earlier estimate — before rebounding to a slight 0.4 percent in 2013.