The 2012 Debt Crisis
  • Following the 2008 subprime crisis, Cyprus entered into a severe recession from 2009, its the economy shrank by 1.67%,[1] It mainly touched two pillars of the Cypriot economy: tourism and shipping sectors[2] which caused rising unemployment.[3] Economic growth between 2010 and 2012 was weak and didn't manage to reach its pre-crisis level.[4] Commercial property values declined by approximately 30%.[5] Non-performing loans rose to a reported 6.1% in 2011,[6] increasing pressure on the banking system. Despite its small population and relatively modest economy, for many Cyprus was a fiscal paradise and had a large offshore banking industry. Compared to a nominal GDP of €19.5bn ($24bn)[7] the banks had amassed €22 billion of Greek private-sector debt with bank deposits $120bn, including $60bn from Russia business corporations.[8] For instance, Russian oligarch Dmitry Rybolovlev owned a 10% shareholding of Bank of Cyprus.[9]
  • Cyprus banks first came under severe financial pressure as bad debt ratios rose. Former Laiki CEO Efthimios Bouloutas admitted that his bank was probably insolvent as early as 2008, even before Cyprus entered the Eurozone. The banks were then exposed to a haircut of upwards of 50% in 2011[10] during the Greek government-debt crisis,[11] leading to fears of a collapse of the Cypriot banks. The Cypriot state, unable to raise liquidity from the markets to support its financial sector, requested a bailout from the European Union.[12]
  • The Cypriot Government was reported requesting a bailout from the European Financial Stability Facility or the European Stability Mechanism on 25 June 2012, citing difficulties in supporting its banking sector from the exposure to the Greek debt.[13] Representatives of the Troika (the European Commission, the International Monetary Fund, and the European Central Bank) arrived on the island in July to investigate the country's financial problems, and submitted the terms of the bailout to the Cypriot government on 25 July.[14] 
  • On 16 March 2013, the Eurogroup, European Commission (EC), European Central Bank (ECB) and International Monetary Fund (IMF) agreed on a €10 billion deal with Cyprus,[15] making it the fifth country—after Greece, Ireland, Portugal and Spain—to receive money from the EU-IMF. As part of the deal, a one-off bank deposit levy of 6.7% for deposits up to €100,000 and 9.9% for higher deposits, was announced on all domestic bank accounts. Savers were due to be compensated with shares in their banks.[16] Measures were put in place to prevent withdrawal or transfer of moneys representing the prescribed levy.[17]
  • The plan was made under the following conditions: 
  1. Recapitalisation of the entire financial sector while accepting a closure of the Laiki bank,
  2. Implementation of the anti-money laundering framework in Cypriot financial institutions,
  3. Fiscal consolidation to help bring down the Cypriot governmental budget deficit,
  4. Structural reforms to restore competitiveness and macroeconomic imbalances,
  5. Privatization programme.

[1] "Cyprus: Economic Growth, Cyprus GDP growth rate".TheGlobalEconomy.com. Archived from the original on 25 February 2013.
[2] "Up Front – March 19, 2013 at 7:00am KPFA 94.1 FM Berkeley: Listener Sponsored Free Speech Radio".
[3]"Cyprus Unemployment rate –
[4]"RICS Cyprus Property Index Q4 2012". RICS Europe. Retrieved 14 April 2013.
[5]"Bank nonperforming loans to total gross loans (%)". World Bank. Retrieved14 April 2013.
[6] "Cyprus". International Monetary Fund. Retrieved 18 April 2012.
[7]Stephen Castle; David Jolly (12 June 2012). "Rates on Spanish Bond Soar".The New York Times. Retrieved 12 June 2012.
[8]Wearden, Graeme (13 March 2012). "Eurozone crisis live: Spain told to cut harder as Greek deal approved". The Guardian. London. Retrieved 13 March 2012.
[9]James Wilson (25 June 2012). "Cyprus requests eurozone bailout". Financial Times. Retrieved 25 June 2012.
[10]Tim Worstall (31 March 2013). "There's Something Very Strange About The Cyprus Bank Haircut. Very Strange Indeed". Forbes.
[11]"Greek bond investors take big 'haircut' in bailout deal Marketplace.org".
[12]"Greek debt 'haircut' takes off New Europe"
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Private Indebtedness
  • In Cyprus, the ratio of debt to GDP is very high for both households and non-financial corporations (NFCs). The private debt-to-GDP ratio in Cyprus is now over 340%, which is among the highest in the euro area. One of the reasons for the high level of debt is that the debt of shipowning special purpose entities (SPEs) registered in Cyprus is incorporated in the Cypriot national accounts (following the adoption of ESA2010). This effect on Cypriot corporate debt amounted to roughly 75% of GDP in 2014.
  • Cypriot household debt is on aggregate backed by asset holdings, but the assets of indebted households are relatively illiquid. The debt-toasset ratio of Cypriot households as last measured by the Eurosystem Household Finance and Consumption Survey (2013) is below the euro-area average. However, the net liquid assets of indebted households are relatively small as a fraction of annual gross income, and the debt-to-income ratio is around 150%, second only to that observed in the Netherlands.
  • Household incomes have deteriorated since 2013, contributing largely, but not solely, to the high ratio of non-performing loans in the household sector. Household incomes deteriorated during the crisis due to lower wage growth and higher unemployment, which reached 16% in 2013, and remained at around 15.5% in 2015.
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Sustainability of Public Finances
  • Fiscal developments have largely out-performed the primary balance targets that were set at the onset of the programme. Net of the one-off effect from banking recapitalisation, the 2015 primary surplus grew to 2.7% of GDP. This was 5pps of GDP better than initial programme projections. The primary balance improved marginally from 2014, on the back of stabilising revenue and primary expenditure, and despite factors beyond government control (such as new location rules regarding VAT). With a headline government balance deficit of ½ % of GDP in 2015, these developments are expected to lead to a deficit of well below 3% of GDP
  • The debt-to-GDP ratio, which was contained by revisions to the denominator, is expected to set out on a downward trajectory, supported by good fiscal performance and economic recovery: According to the updated projections, the debt-to-GDP ratio peaked at about 109% in 2015 and is projected to fall to below 90% of GDP in 2020. This is significantly lower than the 105% projected at the on-set of the economic adjustment programme for 2020.
  • Robust programme performance, the economic recovery and continued access to the ECB's expanded asset purchase programme have contributed to decreasing yields on Cyprus’s foreign-law bonds and Treasury bills. In February 2016, the yields for ten-year-to-maturity bonds and three-month Treasury bills stood at 4.1% and 0.5%, respectively. 
  • Cyprus’ government bond credit rating has been increasing since mid-2013, but remains below investment grade ( 33). The main reasons for the rating upgrades are that macroeconomic and fiscal developments have been better than expected at the start of the economic adjustment programme, and that capital controls have been removed.​
  • A major reform of the whole public pension system (the government employees’ pension scheme and the general social insurance scheme) was undertaken by the Cypriot authorities in late 2012.  It has significantly improved the system's long-term viability by stabilising the public pension spending as a share of GDP until 2060 (estimated at 10.2% of GDP in 2060, 0.2pps lower than in 2013 and 6.2pps lower than the estimation prior to the 2012 reform) and increasing its financing through increase in contributions by employees, employers and the State (estimated at 9.8% of GDP in 2060, 2.8pps higher than in 2013).
Debt Sustainability Assessment
  • The public debt-to-GDP ratio rose sharply after 2008, but after peaking in 2015 is expected to decline owing to the significant efforts made under the economic adjustment programme. In line with the overall pro-cyclical expenditure stance, the debt-to-GDP ratio rose by about 7% of GDP to about 64% of GDP during 2000-2003, after which it fell to about 45% of GDP in the run-up to the euro area accession in 2008. 
  • All in all, looking at the various scenarios projected and the main results, Cyprus still faces risks of fiscal stress in the short-term and moderate sustainability risks in the medium term, while long-run risks are low ( 2 ). Moderate risks in the medium run emerge from the analysis of the sustainability gap indicator S1. According to this analysis, reaching a structural primary balance of 2.4% of GDP by 2022 from the currently forecast structural primary balance of 2.1% of GDP in 2017 would be required to reach the reference value of 60% debt-to-GDP ratio by 2030. The S2 indicator suggests low risks to public finances in the long run, showing that only a very small structural primary surplus of 0.1% of GDP would be required to ensure sustainability of public finance in the long run. However, in the short run (i.e. within one year), Cyprus appears to face risks of fiscal stress, as suggested by the fact that the S0 indicator is above the critical threshold, despite being reduced, with risks mainly stemming from the macro-financial side of the economy. Indeed, the large share of non-performing loans in the banking sector could represent a source of short-term contingent liability risk, although risks stemming from banking sector spillover are contained through the implementation of the EU Bank Recovery and Resolution Directive (BRRD), which limits the financial sector exposure of the Cyprus sovereign 

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