By DAVID McHUGH and SARAH DiLORENZO, Associated Press
PARIS (AP) — What happens if Cyprus' banks collapse? If its government goes broke? If it leaves the euro?
The European Union, the International Monetary Fund, the European Central Bank and the country's leaders are trying to find a deal to secure a 10 billion euro ($13 billion) loan for Cyprus and stave off a failure of its banking system. The Cypriot parliament has already rejected one deal, which would have taxed all bank deposits in the country. The ECB has now put a ticking timer on this drama by declaring it would cut off emergency support to Cyprus' banks on Monday if no deal is found.
That's the worst case.
Even if a deal is found, the messy decision-making over the past week will have shaken confidence in Cyprus and the euro currency union itself. Here's what's at stake.
The consequences for Cyprus itself could be so rough that many analysts think some kind of deal will be struck. If not:
The only thing keeping Cyprus' banks afloat right now are short-term loans from the Cypriot central bank with the blessing of the ECB. The banks need this special funding because they can't borrow normally. They don't have good enough collateral to receive normal loans from the ECB, and others are reluctant to lend to them for fear of not getting their money back. The emergency lending program isn't publicly declared, but analysts say the Cypriot central bank has already handed out around 9 billion euros ($11.6 billion).
If the ECB pulls the plug, the Cypriot banks would probably not be able to open their doors, or would very quickly collapse because they wouldn't be able to satisfy the likely rush of customers pulling their money out. Then the banking system enters a sort of twilight zone — with the banks closed, there can be no real run on the banks, but salaries won't be paid, mortgage payments won't go through, electricity bills will linger.
After the banks, the next logical step is that the government goes bankrupt, either as it tries to shore up the banking system or because it is on the hook for insuring all deposits under 100,000 euros ($130,000).
The resulting disaster cannot be predicted clearly — and shouldn't be underestimated. The road could lead to an utter breakdown not just of the economy, but of the country's social fabric. Some economists say that as euros become scarce, Cyprus may have to issue some sort of IOUs for people to buy basic necessities. That could lead to hyperinflation, in which the prices of goods double and triple regularly. The country might have to prevent cash from leaving its borders. People may turn to barter. Commerce will slow or grind to a halt.
The country could leave the euro, and no one really knows what happens then. It's such a terrifying possibility for Cyprus and Europe that some analysts think the EU will step in at some point to prevent it from happening, even if most of the damage to Cyprus is already done.
"The euro area doesn't want a failed state in Cyprus," said Jacob Kirkegaard, senior fellow at the Peterson Institute for International Economics in Washington. "Once the disaster happens, I would actually imagine that the euro area would be relatively lenient with respect to engaging in a new program."
Even if Cyprus avoids the nightmare scenario, it is facing a long road back. The measures it ends up enacting to secure the loan could hurt growth — especially as it may have to raise taxes, doing away with one of the most attractive things for businesses setting up in Cyprus. And the mere threat of confiscating a part of bank deposits could ruin faith in Cyprus as a center of international banking — destroying its largest industry.
Some argue that investors who put their money in Cyprus have been paid for this kind of risk — through high interest rates and low tax rates. Even if they aren't scared away, any deal with international lenders will demand that the country severely shrink its banking sector anyway.
Cyprus' economy is a tiny fraction of the eurozone's — just 0.2 percent — but its banking sector is heavily connected to Greece and any collapse could have a disastrous effect on that already stricken nation. European officials would have to move quickly to insulate Greece. How well Greece is protected will largely determine how much impact a Cypriot banking system collapse will affect the eurozone.
That's if Cyprus manages to stay in the euro. If it leaves, the consequences are hard to predict. Some think it could raise fears other countries, such as Greece, might leave. That would cause those countries' borrowing costs on the bond markets to rise, making it harder for them to finance deficits and potentially requiring them to seek bailouts. If fears worsened, investors and savers could pull their money out of these countries, threatening their banking sectors.