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Sector focus on Europe ex-UK: Cyprus bailout revives Eurozone concerns

The eurozone bailout of Cyprus and its Draconian terms for cash deposits has spread concern through investment markets. Three fund managers give their views on what the crisis means for the wider markets.

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Tom Becket, chief investment officer, Psigma Investment Management

The Cyprus debacle has shown that not all bricks in the European wall are equal. It has also shown that the European wall’s foundations that were fortified by Mario the builder last summer are not as solid as many had thought.

Indeed with foreman Angela Merkel over-seeing operations, much of the planning work and assumptions are becoming increasingly uncertain as she worries about the implications for her contract extension later on this year. Apparently the Germans are not overly keen on bailing out their Russian friends, as well as their Club Med cousins. I wonder why?

European politics remain an impediment to growth in Europe, as evidenced by continuing poor economic data, and a genuine danger for the global economy.

The Cyprus bailout has thrown up a number of new concerns, particularly over the viability of the current existence when not all member-states are equal. It has also raised fresh worries about bank deposits that were originally considered sacrosanct.

What precedence does the cash grab have for other recipients of the Euro handouts? What will happen to bank deposits in Spain, Italy and elsewhere if things start to look doubtful there again?

Rather than ease concerns, this bailout might heighten them, which is why we have seen volatility in markets over the last week.

There are some who are ‘suggesting’ that Cyprus could be to the European crisis what Bear Stearns was to the sub-prime crisis. Whilst it is far too early to offer such a miserable prognosis it is worth remembering that small drops in the pond can cause big and unexpected ripples.

Markets have moved a long way in a short space of time and needed to ‘cool off’. The Cyprus chaos and its ramifications might well provide that.

However, it is worth noting that markets, whilst volatile, have taken this latest news in their stride for now. Perhaps that should be no surprise, as Jim O’Neill of Goldman Sachs pointed out that China produces another Cyprus every week, in terms of GDP.

Cyprus is merely a small brick in the global wall. Let’s hope this game of Jenga can carry on smoothly.

Russ Koesterich, chief investment strategist, BlackRock

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Stocks ended their multi-week winning streak as investors became uneasy over the banking crisis in Cyprus, a situation that had threatened to spill over into other parts of Europe.

Ultimately, a deal was announced early on the morning of March 25 that should help secure Cyprus’ banking system and prevent a messy exit from the eurozone.

The past six months were relatively quiet in terms of the European debt crisis that had dominated investor attention through much of 2011 and 2012 but we saw a flare-up last month in the island nation of Cyprus. While Cyprus represents only a tiny portion of Europe’s overall economy (just 0.2 per cent of gross domestic product), it is an important country to watch since its problems are indicative of a broader concern: the still-fragile nature of the European banking system. Cyprus’ problems emerged not due to profligate public spending, but, rather, because its banking system is too large relative to the size of its overall economy.

The bailout that was announced should help stabilize the country in the immediate term, and because the package is designed to shrink the size of Cyprus’ banks, it should provide some longer-term relief as well.

As with the stopgap measures put into place throughout Europe over the past couple of years, however, the deal will certainly not solve all of the issues.

Cyprus itself still faces a significant recession and Europe’s banking system as a whole remains undercapitalized and vulnerable to shocks.

Although the European Union has technically agreed to tighter banking integration, the implementation has been slow.

This remains a politically contentious issue and, with German elections pending in September, we are unlikely to see any real progress on this front until late 2013 or early 2014. In the meantime, we expect the European banking system to remain a source of systematic risk in the coming months.

Luca Paolini, chief strategist, Pictet Asset Management

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The botched bailout of Cyprus, the political deadlock in Italy and the country’s subsequent credit rating downgrade by Fitch to BBB+ serve to remind investors that the euro zone debt crisis remains unresolved.

Cyprus shows how a small problem can easily morph into a crisis if not properly managed.

The country’s banking troubles may well be a special case – bank deposits are almost four times the country’s GDP and are mostly held by foreigners. Yet the “bail-in” of depositors (above the €100,000 limit) and senior bondholders, as well as the introduction of capital controls, sets a dangerous precedent and will in all likelihood encourage deposit outflows from other heavily-indebted EU countries at the very first whiff of trouble.

Moreover, the agreed bail-in measures are set to raise the cost of capital for the weakest banks in the euro zone as depositors and investors will be encouraged to discriminate between good and bad banks.

By re-introducing the negative feedback loop between bank and state solvency, the bail-in of depositors also runs counter to recent efforts to build a European banking union, one of the most significant institutional innovations so far in the crisis.

In the words of the German finance minister Wolfgang Schaeuble, deposit insurance is “only as good as a state’s solvency”. Indeed, it is rare for countries facing a banking crisis to impose losses on depositors.

According to the IMF, this has happened in only 14 of the 65 major banking crises it has studied, including Russia in 1998.


Our view is that the bail-in of depositors in Cyprus cannot be simply dismissed as a containable, local problem; it could potentially be a watershed event, undermining ECB president Mario Draghi’s pledge last year to do “whatever it takes” to save the euro. The handling and terms of the Cyprus bailout threaten to undermine long-term confidence and trust in European institutions at precisely the wrong time. At a minimum, it represents a policy mistake, one that EU officials may come to regret should the eurozone crisis take another turn for the worse, a scenario we view as highly probable.

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