This time, it is Cyprus’ turn to face a bitter financial crisis as bank depositors get hit and capital controls are imposed.
Demonstrators in
Athens. The roots of the eurozone crisis lie in its unwillingness to
uphold fiscal discipline. Photograph: Louisa Gouliamaki/AFP/Getty Images
THE
financial crisis in Cyprus has again shown that over-dependence on the
financial sector and an unregulated and liberalised financial system can
cause havoc to an economy.
The particular manner in which a
financial crisis manifests itself may be different from country to
country, depending on the ways the country became financially
over-reliant or over-liberalised, and also on how ever-changing external
conditions affect the country.
For the past two weeks, Cyprus
hit the headlines because of the rapid twists and turns of its crisis,
the terms of the bailout it negotiated with its European and IMF
creditors, the hit that bank depositors are forced to take, and finally
the “capital controls” that the government has imposed to prevent bank
runs and capital flight out of the country.
Depositors with more than 100,000 (RM396,000) could lose more than half their savings.
Bank
customers can only withdraw 300 (RM1,189) daily; cashing of cheques is
prohibited; transfers of funds to accounts held abroad or in other
credit institutions are prohibited; transfers due to trade transactions
above 5,000 (RM19,832) a day require central bank permission; the use
of credit cards overseas is restricted to 5,000 (RM19,832) per account a
month; and travellers can only take out 1,000 (RM3,960) or equivalent
in foreign currency per trip.
These capital controls, announced
on March 28, were highlighted in the media as the first to be imposed by
a country belonging to the European Union.
It was like the
slaying of a “sacred cow”, because the freedom to move funds out of and
into the European countries had been treated almost like a human right.
But
it is this total freedom for the flow of funds that has contributed or
even been ultimately responsible for so many financial crises in so many
countries in the past few decades.
This liberalised system of
capital flows enables residents to place their funds abroad or to
purchase foreign assets like bonds and shares.
It also enables
foreigners to bring in funds either for short-term speculation and
investment or longer-term investment and savings.
After the
Second World War, capital controls were the rule: flows of funds to and
from abroad were mainly restricted to activities linked to the real
economy of trade, direct investments and travel.
From the
mid-1970s, the liberalisation of capital flows took place in the rich
economies and gradually spread to many developing countries.
The
finance ministers of Brazil and of other developing countries have been
protesting against the easy-money policies in rich countries that have
had adverse effects on emerging economies.
When the internal or
external situation changes and investor perception changes with it, the
inflow of funds turns into its opposite.
The sudden outflow of funds, and depreciation of the currency, can then cause an even more devastating effect on the economy.
In
the 1997-99 crisis, East Asian countries that had over-liberalised
their financial system found that local banks and companies had borrowed
heavily in US dollars.
When their currencies depreciated, many of the borrowers could not service their loans.
The countries’ foreign reserves dropped to danger levels, forcing them to go to the IMF for bailout loans.
Malaysia
fortunately had some control over the amount local companies could
borrow from abroad, which prevented it from falling into an external
debt crisis.
The imposition of capital controls over outflows in
September 1998 enabled Malaysia to avoid a financial crisis requiring an
IMF bailout.
The immediate response from the IMF and the Western
establishment was that the capital controls would destroy the Malaysian
economy.
Today, the economic orthodoxy has changed, and most
analysts including at the IMF give credit to Malaysia for the capital
controls.
The Malaysian controls included a temporary ban on
foreigners transferring their ringgit denominated funds (for example in
the stock market) abroad, a limit to the funds local travellers could
take out of the country, and limits to overseas investments by local
companies and individuals.
Today, the IMF itself has changed its
position, saying that capital controls in certain situations are not
only legitimate but may also be necessary.
It has partially recognised that unregulated capital flows can cause financial instability and economic damage.
In
the case of Cyprus, analysts now conclude that its growth model was
flawed because it was too reliant on a bloated financial sector, having
become a haven for foreign savers, especially from Russia.
But a major factor in its recent crisis was that the country’s biggest banks invested in Greek government bonds.
In October 2011, a bailout package was arranged for Greece by the European Union and the IMF.
Part of the bailout terms was that holders of Greek government bonds would take a “haircut” or loss of about 50%.
This
Greek debt restructuring meant a loss of 4bil (RM15.9bil) for banks in
Cyprus, a huge amount in a country whose GNP is only 18bil
(RM71.4bil).
Now, it is Cyprus’ turn to be reconfigured and
re-created as part of a 10bil (RM39.7bil) bailout scheme. The two
biggest banks, Bank of Cyprus and Laiki Bank are to be drastically
restructured, with the latter to be closed.
The biggest
innovation designed by the European Union and IMF creditors is that the
bank depositors will have to take losses. Deposits less than 100,000
(RM396,000) are to be spared, after an original plan to also “tax” them
by 6.75% was cancelled after a huge outcry and the fear of contagion,
with bank runs in many European countries.
The final plan is for
deposits over 100,000 (RM396,000) in the two banks to take losses not
by the originally planned 9.9% but by much more.
The new European
policy of getting bank depositors to take a big hit in bailouts of
banks will have big ramifications for public confidence in banks.
The new perception is that money put as savings in banks is no longer safe.
The question remains: will the policymakers learn the real lessons from these crises?
GLOBALTRENDS BY MARTIN KHOR
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