The likelihood of left-wing Syriza coming first in the snap Greek elections due on 25 January has again raised the prospect of “Grexit” – Greece’s exit from the Eurozone.
If Greece falls out of the eurozone it is likely to see a massive devaluation that would increase the size of what would become foreign-currency, euro-denominated debt.
When Argentina broke from its hard peg to the US dollar, its currency dropped by 75%. This means that Greece’s euro-denominated debt could treble in size.
Yet German media outlet Der Spiegel reported in the early new year that the German government considered an exit to be “manageable”.
Although the spokesman of Chancellor Angela Merkel later appeared to deny this assertion by saying the aim was to “stabilize the euro zone with all its members, including Greece,” it remains the case that the financial markets are far less concerned about the impact of a Grexit on the rest of the eurozone today than they were in 2012, when Greece had its last election and Syriza first shot ahead in the polls.
For Cyprus in particular, there are two key reasons why the economy is less vulnerable today.
The first is that the Cypriot banks no longer hold any Greek government bonds (GGBs).
In 2011, Bank of Cyprus held €2 billion in GGBs, the now defunct Laiki held €3b and Hellenic held €110m.
The 75% write-down of these bonds in the “private-sector initiative” (PSI) wiped out Laiki’s capital and culminated in the Cypriot banking crisis in March 2013.
Today that is no longer a concern.
The second reason is that Cypriot banks are no longer exposed to the Greek private sector, thanks to the controversial fire-sale of the Greek operations of Cypriot banks in March 2013.
Before that, the three main banks had lent €22.7 billion to the Greek private sector, which left them significantly exposed to a Grexit.
If they still had those portfolios, they would have to provision heavily for the non-payment of these loans, which would have had meant a heavy hit on their capital ratios.
If the banking sector is ringfenced from a Grexit, what about the real sector?
Here, the impact would be stronger, but would be partly offset by the fact that Greece’s six-year recession has already taken its toll on Cypriot exporters of goods and services.
Nowhere has this been more prevalent than in tourism. Between 2012 and November 2014, tourism arrivals from Greece to Cyprus dropped by more than 30.1%.
Total exports of services to Greece reached just €274m in 2013, or 3.6% of all exports, making it a much smaller market than Russia, at 20.5%, or the UK, at 18.9%.
There would be a larger hit for exporters of goods, since these account for 16.6% of the total.
But exports of goods have also been falling, dropping to €184m in January-September 2014, compared with €209m in the same period of 2013.
The main impact of a Grexit on Cyprus is therefore more likely to be indirect.
The first will be the effect on tourism. A Greece that is three times cheaper than it was last year will make it a far more attractive tourism destination than Cyprus, which is already more expensive than Greece.
The second hit will be on investor sentiment. Cyprus is hoping to re-enter the bond markets this year but trouble in Greece could put off investors and lead them to demand higher interest rates from Cyprus in return for lending it money.