21 December 2013 Cyprus haircut: is it worth it?

**How much do the Cypriot banks hold in Cyprus government bonds?**

A report in Der Spiegel on 20 December suggested that the IMF might demand a haircut on Cypriot government debt before it will approve the bailout for Cyprus that will recapitalise the banks and help finance maturing debt.
The crux of the matter is that the bailout could reach as much as EUR 18 bln or around 100% of GDP.
According to Sapienta Economics estimates, this could bring the debt/GDP ratio to 140% of GDP by 2016, thus raising questions about sustainability.
The notion of a haircut raises two questions. Would it damage Cypriot banks and even if not, would a haircut be worth it in any case?
Some reports have suggested that Cypriot banks hold the vast majority of Cyprus government bonds (CGBs). To find out if this is true, we have to dig around a little.
We know from the Public Debt Management Office that foreign investors bought “at least 75%” of the primary issues of European Medium Term Notes (EMTNs) in the past few years but a lower proportion of earlier issues.
A chart below that statement suggests that Cypriot banks hold 55% of the foreign issues, although to be honest it is not 100% clear if this chart refers only to foreign debt or to both foreign and domestic debt.
When the PDO wrote that report, outstanding issues in the foreign market were EUR 5.2 bln. Fifty-five per cent of that is EUR 2.9 bln.
This is within the ballpark of another figure produced by the IMF in 2011, which reported that the Cyprus commercial banks held EUR 8.4 bln in sovereign bonds, of which EUR 4.7 bln were Greek government bonds. This implies that EUR 3.7 bln held elsewhere, including Cyprus.
We know that at least one bank has holdings of sovereign bonds beyond Cyprus and Greece, so perhaps a figure of EUR 2.9 bln for CGBs as of 2011 is reasonable.

Cypriot banks may hold EUR 2.1 bln in CGBs
However, we must now bring the figures up to date. A number of redemptions were made in 2012, bringing the total outstanding figure for securities in the foreign market to EUR 3.8 bln as of September 2012. Fifty-five per cent of that figure is EUR 2.1 bln.
Judging from published statements, Bank of Cyprus (BOC) held EUR 574,927 in CGBs as of September 2012, while Hellenic Bank (HB), the third largest bank, held EUR 327,588.
Cyprus Popular Bank (CPB), which has a habit of giving out less information than the other two in its quarterly reporting, gives no data on its exposure to CGBs.
But if we know that BOC and HB already own EUR 0.9 bln in EMTNs, and we think that the total exposure of the commercial banks is EUR 2.1 bln, then CPB might hold as much as EUR 1.2 bln.
Remember that before the Greek haircut CPB held EUR 3.1 bln in GGBs, BOC held EUR 2 bln and Hellenic Bank only EUR 110 mln, so it seems to make sense that CPB would also have bigger exposure to Cyprus.
Since CPB is the one with the biggest capital problem then you can see why a haircut on CBGs will only increase CPB’s capital requirement by the same amount.
Another question to ask is whether a haircut will make Cypriot debt any more sustainable.
Total outstanding debt according to the government’s budget submitted to parliament is EUR 15.3 bln. The troika funding could take it, once you add interest payments, to EUR 28 bln by 2016, or 140% of GDP.
So a haircut on only EUR 3.8 bln is not going to make much of a dent in the total debt/GDP ratio.
There are only two ways to make Cyprus debt sustainable: either allow the European Support Mechanism (ESM) to funds banks directly—and sooner rather than later—or give Cyprus an extremely long repayment period with very low interest payments.
It was only by agreeing to the haircut for Greece (and the political leadership not understanding its consequences) that Cyprus got into so much trouble in the first place. It would seem a little unfair to hit Cyprus twice for the same reason.

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