The Cyprus story

The economy of Cyprus is only 0.1 percent of the GDP of the European Union, yet the financial crisis of 2012 and onwards has taken up proportionately much more time and effort for domestic and international decision-makers. We noted in the Introduction that the 10 billion euro received in support represented one-third of Cyprus's GDP. As will be presented in more detail below, Cyprus also represents the greatest failure of European bank resolutions among all the cases studied in this book.

Cyprus was in trouble already when it entered the euro zone on 1 January 2008. Its growth rate was declining and the country went into recession in the beginning of 2009, with GDP falling by 3 percent. Despite booming tourism (2 million tourists, yielding 11 percent of GDP in 2006), the current account worsened to a deficit of 12 percent of GDP in 2007 and 16 percent of GDP in 2008, occasioned in the main by a lack of competitiveness. It was (too) easily financed by a strong inflow of deposits, up to one-third stemming from outside the euro area, largely Russian.

The budget had been in deficit for a decade until 2007 when it showed a temporary surplus, only to fall back into a persistent deficit of around 6 percent of GDP for the following years, occasioned by a spending boom blamed on the incoming Communist president, Dimitris Christofias. Fortunately, Cyprus had started the crisis with a debt-to-GDP level below 50 percent, but it rose to 88 percent at the beginning of 2013, just below the euro zone average. It is, however, forecast to continue its rapid increase, peaking at almost 130 percent of GDP by 2015, second only to Greece and in line with Portugal, Ireland and Italy (see Figure 27). However, with a debt-to-GDP ratio of 115 percent at the beginning of 2014, it appears that the actual trajectory may prove somewhat more positive than the forecast. On the other hand, it had risen by 25 percentage points in one single year.

Bank of Cyprus, Popular Bank (Laiki) and Hellenic Bank

As in so many other countries that we have studied, the problems created by the banking sector were firstly its outgrown size, 750 percent of GDP in 2010 in Cyprus (see Figure 10), and secondly the property boom.