Eurozone Debt Crisis: Cyprus bail-out
Negotiations with the Troika on a bail-out package—underway since mid-2012—resulted in an agreement on 16 March that unexpectedly included the approval of only EUR10 billion of financial aid from the Eurozone (instead of the requested EUR17 billion) plus a one-off levy on bank deposits, hitting small savers as well as those above the EUR100,000 insured maximum, including large foreign depositors who had taken advantage of Cyprus’ position as an offshore banking centre. The levy was required to raise EUR5.8 billion from this source as part of the total financing package. However, Cyprus' parliament overwhelmingly rejected the whole bailout package yesterday (with not a vote in favour). Political leaders are trying to find an alternative plan and the government is also seeking help from Russia. The situation is fluid and the outcome highly uncertain, but the room for sustainable adjustment has dwindled and risks have increased. Even if the worst case is avoided—collapse of the two largest banks, bank runs, sovereign default and possible EZ exit—the Cypriot economy will be affected adversely, including contraction in the banking sector (partly as a result of withdrawal of some overseas deposits) and an increase in public debt,
along with increased risk of an eventual debt write-down. Also, the economic adjustment programme will be painful, deepening the recession that brought GDP contraction of -2.4% in 2012, with at least another -3% likely in 2013. Moreover, the characteristics of the Cyprus bail-out, however small in terms of Eurozone GDP (less than 0.2%), have set an unfortunate precedent in relation to how to provide necessary financing needs, spurring concerns throughout the monetary union.
Eurozone: Towards a banking union
Provisional agreement was reached on laws allowing the ECB to create a single supervisory body (effective in mid-2014) for European banks with total assets above EUR30 billion (or 20% of GDP). This represents a significant step forward towards a banking union. The new institution is expected to aid stability across the zone banking system and protect the area from external shocks. In particular, it is hoped to break the vicious circle between sovereigns and banks (through a direct recapitalisation of banks by the ESM, rather than through the government) and to improve confidence in European banks. Next steps consist of finding an agreement on a common deposit insurance scheme (expected by June 2013) and on a common resolution scheme (through a Fund able to save banks from bankruptcies).
Germany: Mixed data
Latest indicators continue to provide a mixed overall picture. On the positive side, the Ifo Business Climate Index continued its improvement, for the fourth consecutive month, increasing by +3% mo/mo in February. Further, the Consumer Climate Index improved slightly in February, still driven by the robust labour market and a brightened economic outlook. Also positively, exports of goods were up by +3.1% y/y in January, mainly a result of higher demand from countries outside the EZ. On a disappointing note, industrial orders declined surprisingly in January, by -1.9% mo/mo, after improving by +1.1% in December 2012 and industrial production fell slightly, by -0.2%, following +1% in the previous month.
India: Interest rate cut
On 19 March, the central bank cut its key policy interest rate by 25bps, to 7.5%, the second cut this year (25bps in January) as officials try to manage a delicate balance between growth (weakening GDP expansion in 2012) and inflation (wholesale prices up 6.84% y/y in February). With inflation remaining above the target range of 4-6% and concerns relating to large current account deficits, the scope for further monetary policy loosening is limited, although signs of moderation in the wholesale price index may allow another small cut in interest rates in H2. Expect GDP growth of +6.5% in 2013 and +7% in 2014.