Cyprus deal will hit the euro

The strings attached to Cyprus's bail-out has undermined confidence in the single currency.

The deal to bail out Cyprus has "weakened the eurozone as a whole", says The Economist. Cyprus looks condemned to a long depression. The collapse of its oversized banking sector, which had reached 700% of the island's GDP, means the economy could shrink by as much as a fifth. As a result, debt as a proportion of GDP will continue to soar.

So Cyprus will need another rescue. And for now its woes are likely to exacerbate a key threat to the euro's survival: "rising resentment of creditor countries in a stagnant periphery".

Meanwhile, the capital controls now in use in Cyprus to stop money leaving the country mean that a euro in Cyprus is not worth the same as one elsewhere. "A precedent for restricting the movement of euros is one that investors and depositors will not soon forget."

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Bank depositors in other nations will also fear being asked to cough up in future rescues indeed, Dutch finance minister Jeroen Dijsselbloem initially suggested that this would be the case, before being forced to back down and insist that Cyprus was special'.

You can see why, says Liam Halligan in The Sunday Telegraph. Other troubled countries "could easily suffer from massive capital flight, their banks awash with red ink and their exhausted sovereigns, having propped up said banks for years, fiscally incapable of doing much more".

If other countries get into trouble and look set for a bail-out, the Cyprus precedent could tempt depositors to move their money pre-emptively, undermining the banking system, fuelling a market panic, and making defaults more likely.

So where might trouble strike next? Slovenia looks a prime candidate, says Capital Economics. It's another country where an overextended banking sector (worth 144% of GDP) is threatening to bust the government. Non-performing loans have climbed to 15% of total assets 20% in the three biggest banks following a construction binge and an ongoing double-dip recession.

Economic growth could shrink by more than 2% this year. The banks need recapitalising to the tune of about €1bn, or 3% of GDP, but the government may have trouble finding the money. It will have to raise a whopping 10% of GDP this year, due to tax shortfalls, maturing debt and bank recapitalisations. And markets are becoming increasingly nervous: ten-year bond yields have jumped by 2% to 6.5% in a fortnight.