Playing chicken with the Eurozone

So the Cypriot parliament voted firmly against the Eurozone/IMF rescue package with the incumbent party abstaining and the Opposition voting against it. In the end the package received no votes at all. There are now reports that the Cypriot banks will remain closed until the 26th of March while the ECB has said it is ready to provide additional liquidity, but only with the existing collateral rules.

In the meantime the Cypriot government is doing its best to find an alternative and that obviously includes Russia. Cyprus has asked for a 5 year maturity extension and an interest rate reduction on its existing 2011 €2,5bn loan, but reports are that discussions are in a broader context. Exactly what that means is unknown at this stage, but there are rumours of negotiations ranging for naval bases to gas deals as the Moscow Times reports:

Cypriot Finance Minister Michalis Sarris plans to offer a wide range of benefits to Russia in exchange for its help to rescue the island’s financial sector during a meeting with his counterpart Anton Siluanov Wednesday, a report said.

Cyprus would charge a tax of 20 percent to 30 percent on Russia’s deposits in local banks and offer Russia stakes in its energy projects in exchange, according to the plan that Sarris intends to negotiate, The Wall Street Journal reported, citing an unidentified official in the Cypriot government.

As part of the deal Russia will also get control of the board of directors at Cypriot banks, the official said.

On Tuesday President Vladimir Putin held telephone negotiations with his Cypriot colleague Nicos Anastasiades, having voiced concerns about “any possible measures, which could damage the interests of Russian entities and individuals,” Kremlin spokesman Dmitry Peskov told Interfax.

The two leaders agreed to continue bilateral consultations, as well as those with the European Commission, on the possible bailout for Cyprus, Peskov said.

Quite obviously the negotiations are on-going and as I type nothing has been delivered. The rest of Europe now waits for Cyprus to decide exactly what it is going to do and whether Russia can force the Cyprus’s hand.

Given the unknowns you certainly can’t rule out a complete collapse of the Cypriot banking system as, at least at this stage, Europe appears unwilling to budge on the negotiations. In response to Cyprus’s decision both the European Commission and the German government simply stated that are now waiting for a new credible plan to appear from Cyprus. As I stated yesterday I think the likelihood of any further concessions is very small simply because of the lack of political capital left in creditor countries and the coming German election. The issue is, however, if no one is willing to fill the gap on what the IMF considers sustainable, then they won’t participate and the deal is dead.

It’s currently a game of three way chicken, which way it goes is anyone’s guess, but either way there is little doubt that Cyprus is going to be in serious economic trouble for many years to come. Whether or not the Cypriot banks ever open their doors again is now an open question, but you can be sure in the case that they don’t the ECB will be ready to active its emergency facilities to limit contagion.

While all eyes are on Cyprus it’s easy to forget about the other struggling nations of the zone. But rest assured its still not going well for them either with the continuation of the downgrades in growth forecasts.

This from Portugal;

Portugal’s centre-right government expects the economy to plunge deeper into recession this year, announcing deeply pessimistic forecasts that will fuel growing anti-austerity sentiment in the country.

The cut in estimates on Friday comes after concluding a tough round of talks with international lenders. The government said the deeper-than-expected downturn in Europe meant the Portuguese economy would shrink by 2.3 per cent this year, more than twice as much as the previous government forecast, as export growth slowed to 0.8 per cent.

Unemployment in Portugal is forecast to soar to 19 per cent by December and not fall below 17 per cent for four years, amid painful austerity measures and a deepening recession in Europe.