Cyprus saved – but for how long?

Europe finally agreed a rescue package for Cyprus early this week but only after almost letting a tiny peripheral economy shatter the monetary union, says the Financial Times. Emergency support for Cyprus's bust banking system, which has also bankrupted the government, was due to run out not long after the deal was secured.

A default and a messy euro exit have been averted, and the package has dealt with "the most egregious errors" of the previous one, says Economist.com's Charlemagne blog. Cyprus has been trying to raise around €6bn itself and thus unlock €10bn of European cash.

Rather than impose a levy on depositors with less than €100,000 in an account the amount supposedly guaranteed by EU governments this deal restores that promise instead. It hammers big depositors in Cyprus's two biggest banks with a levy of up to 40%, and also bails in' senior and junior bondholders.

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The biggest bank, Bank of Cyprus, will be restructured and the second-biggest, Laiki Bank, will be wound down. The deal kept the banks closed for another three days with capital controls in place to prevent a bank run.

Cyprus faces a depression

Christine Lagarde, managing director of the International Monetary Fund, says this deal "puts Cyprus on a sustainable path to recovery", says Jeremy Warner on Telegraph.co.uk. Come off it. "No national banking system can survive such a restructuring."

Given how important Cyprus's banking system is to the economy, it implies an "immediate collapse" of 10%-20% in national income and an increase in unemployment to over 25%. This is akin to closing the City in Britain. "The impact on output, tax revenues, employment and public services would be devastating."

Cyprus "had a flawed economic model", says Larry Elliott in The Guardian. But now that it can no longer be an offshore haven for dodgy money, "it has no economic model at all". Tourism is the only alternative money-spinner, but it would benefit greatly from a cheaper currency, which is not an option.

As Cyprus plunges into depression, its debt-to-GDP ratio, an "already unsustainable" 140% of GDP after this deal, will shoot up, says Elliott. So expect "another rescue" and an eventual debt restructuring or euro exit for Cyprus. This mess isn't over.

What next for Europe?

"A rubicon has been crossed," as Ian King puts it in The Times. Many investors will now worry that the eurozone sees bank deposits even insured ones as "fair game as an alternative to using taxpayer funds to rescue banks". This raises the danger of bank runs elsewhere in the European periphery.

It may be that next time the crisis intensifies "the memory of the Cyprus ordeal will make depositors a little more likely to pre-emptively move their money", reckons the Free Exchange blog on Economist.com. But short-term contagion doesn't seem to be a problem: "there are no lines at Spanish ATMs". People seem to realise that Cyprus is a very small, special case.

But it still looks set to fan the broader flames, further undermining confidence in the future of the single currency. For one thing, a key principle of monetary union, free movement of capital, has been upended by the capital controls. "Some euros, it seems, are more equal than others," says Warner. "This is not a proper currency."

The past few days also reinforce the perception that the north is indifferent to the south's economic travails, which will further poison the politics of monetary union. And investors also have to wonder: if Europe "can make such a Horlicks out of tiny Cyprus", what will happen when "the crisis once again laps at the door" of Italy or Spain?