Greece may not bounce back as quickly as Cyprus from capital controls
By Y.Y. | LONDON
ALTHOUGH Greece's banks are closed this week due to the country's brinkmanship with its creditors, there is at least some good news to be found in the European Union's other Greek-speaking member state. After a five-year recession, Cyprus's economy has finally started to recover. Earlier this month, the IMF stated that Cyprus has made "strong" progress towards achieving the objectives set out by its bail-out, worth €10 billion ($11.1 billion), in March 2013. Cyprus's experience is notable, as the script it followed is similar to Greece's in a few important ways.
On March 19th 2013 the Cypriot Parliament rejected a European bail-out programme because of the unpopular condition that all depositors, not just big ones, face conversion of their deposits into bank equity as part of a plan to recapitalise the banks. The next day Cyprus closed its banks. The European Central Bank (ECB) threatened to cut off emergency lending to Cyprus's banks within the week. But after six days, the Cypriot government agreed to a renegotiated bail-out, which put more of the burden on big depositors. The ECB withdrew the threat to turn the liquidity taps off. This meant that banks could re-open after two weeks, but with restrictions on withdrawing cash and transferring money abroad left in place. Fresh deposits coming from abroad were exempted from the controls. Restrictions were relaxed after a year, with the final caps lifted this April.
It is difficult to assess the effects of capital controls—especially in Cyprus. They are often used by countries that are already in an economic mess, making it difficult to separate the effects of the controls from other underlying problems. As a paper written by economists Kristin Forbes, Marcel Fratzscher and Roland Straub points out, the use of capital controls historically has more often been as part of long-term measures designed to protect trade advantages, rather than as a short-term response to financial crisis. When controls have been used in crisis, they have typically been imposed in emerging economies. To a certain extent Cyprus, Iceland, and now Greece, only have each other to learn from.
What is clear is that controls make life tougher for all sectors, not just banks. Firms reliant on import and export flows are particularly affected. But the alternatives are usually worse. If Cypriot banks had fire sales of assets in order to meet the massive demand for outflows, the medium-run liquidity problem (in which the banks were simply short of cash in hand) would have quickly transformed into a long-run insolvency problem (in which their assets have fallen below the value of their liabilities).
Better, then, to shut the banks and wait out the crisis. That is more or less what happened in Cyprus. Although a record €6.3 billion was withdrawn from banks, on net, in April 2013, deposits soon started to return. Foreign investors came back. Bank of Cyprus raised €1 billion from them in July 2014, and Hellenic Bank sold over half of its shares to Belarussian and American firms the same year. The real economy also suffered much less damage than expected (though it did continue to contract through the end of 2014). Tourism suffered a little during the crisis but has more than caught up since, with tourist arrivals in the first five months of this year increasing almost 10% year-on-year. Although the financial sector has taken a big hit, the growth of the island's business-services industry has begun to make up for the loss.
But such a strategy relies on confidence returning. Cypriots only suffered six days of uncertainty between rejecting and agreeing to a bail-out. Greeks, on the other hand face a very different dynamic. Their crisis has dragged on for more than half a decade now. Its latest chapter has unfolded over most of 2015. And Greeks may have to wait at least a week until the results of their referendum this Sunday, accepting or rejecting the country's current bail-out offer, are announced. Even if the answer is "yes", it may many weeks before a bail-out agreement is formally hammered out. There are few good parallels to suggest what Greece is in for.
