Eurozone finance ministers agreed on Tuesday to lend Spain 30 billion euros this month to help its ailing banks.
This will be the first installment of a bailout of up to 100 billion euros agreed upon at a June 28-29 "breakthrough" EU summit.
With Spain under increasing pressure as skeptical markets pushed its borrowing costs dangerously high again, EU ministers were keen to keep the momentum going and also agreed to extend the 2013 deadline for Spain to cut its budget deficit to the European limit of 3% by one year. Spanish Prime Minister Mariano Rajoy earlier announced on Saturday that he would take further steps to cut the country's public deficit.
Cyprus Begins Bailout Talks
Cyprus began talks yesterday with potential creditors from the EU, IMF and the ECB to assess how much bailout money it may need to support its debt-ridden banks.
Officials from the three institutions met separately with the Cypriot Central Bank and Finance Ministry on Tuesday but the magnitude of the bailout is still unclear. Cyprus initially asked for almost €2 billion to recapitalise its second largest bank when it announced early last week that the country would need a financial lifeline. However, the size of the bailout looks set to increase with some speculating it could reach as much as €10 billion- more than half the size of Cyprus's €17.3 billion economy.
Cyprus has become the fifth euro-zone country to ask for a bailout of its financial sector joining the ranks of Portugal, Spain, Greece and Ireland. Its banks need urgent funds after suffering huge losses from write-downs on their Greek government bond holdings and their large loan portfolio in the debt-crushed country.
With Cyprus's economy having recorded negative rates of growth for the past three quarters, many Cypriots are worried about the conditions that will be attached to the bailout. However, authorities have made it clear that the country's low corporate tax rate, which has attracted thousands of foreign companies, will not be part of the negotiations. Nevertheless, the European Commission has said Cyprus must reform its pension system and bloated public sector that takes up a third of all government spending. This will most likely prove unpopular amongst Cypriots who already face record high jobless rates of almost 11%.
Amidst exceedingly low expectations, European leaders managed to put together a strategy aimed at halting the escalating financial crisis in the euro-zone when they met late last week at the EU Summit. They agreed to recapitalise banks directly instead of funneling the bank rescue funds to the national governments, which in turn would deploy the money. Direct recapitalisation is said to have some important advantages such as allowing bailout loans to remain off recipient countries' balance sheets to provide comfort to bond investors. In addition, the new plans will allow money to be transferred to countries in need in a much more efficient way.
European Council president Herman Van Rompuy said the summit had made great progress. "We are opening the possibilities for countries that are well-behaving to make use of financial stability instruments...in order to reassure markets and get some stability around some of the sovereign bonds of our member states."
Nevertheless, despite the fact that some heralded the summit as a "breakthrough", there are still many doubts about Europe's future as a monetary union. In response to the question "Can one currency shared by many independent states survive?" SIIA council member Assistant Professor Dr. Reuben Wong of the National University of Singapore said "Recent developments suggest that the public debts and banking problems are being addressed and can be expected to be resolved over the short to medium term. But the longer term issues of political union, regaining European competitiveness and sustainable growth, require making difficult decisions and structural adjustments, both within individual states and across the European Union. Some positive steps were made at the European Summit on 28-29 June on these questions, in particular the decisions to allow ailing banks to directly access the European Financial Stability Fund, and the setting up of a EUR120 billion growth fund."
He further added that "European states are at a major crossroad in the European integration process. Must more national sovereignty be surrendered? How far can the rest of Europe modify Berlin's preference for a stable exchange rate, low debt and high savings? Should transfer payments be made to poorer states within the EU and how should these transfers be decided? Is a fiscal or banking union feasible? These are intensely political questions that are currently being negotiated. A lasting solution will take years to work out. Expect more ups and downs in financial markets."
Report: Cyprus starts talks with EU, IMF officials on terms and size of bailout for its troubled banks (Washington Post, 3 July, 2012)
Report: IMF, EU aid teams start trawling Cyprus's books (Reuters, 3 July, 2012)
Report: A Presidential Bailout for Cyprus (Wall St Journal, 2 July, 2012)
Report: With expectations low, investors cheer EU Summit 'breakthrough' (Globe and Mail, 3 July, 2012)