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Commentary

Cyprus Deposits Have To Pay Bailout Tax; It Is India’s 7th Largest FDI Source

Cyprus is now in the news, as it gets bailed out by the IMF, the ECB and the European Commission. Unfortunately, as a condition for the bailout, all bank deposits in Cyprus above 100,000 euros will pay 9.9% “one time” tax to pay for the bailout.

Additionally, even deposits under 100,000 euros will pay a tax – at the rate of 6.75%.

These moves are supposed to give the government 5.8 billion euros. Neary half of this comes from wealthy russian investors who had deposited money into Cyprus-based banks, and who will pay this tax as well. However, most Cypriot residents will be impacted, including pensioners.

They are, quite unsurprisingly, trying to take out money from their banks to avoid having to pay this tax. However, banks have already sealed off this much money away from all accounts, so you can withdraw all but the amount of this tax from your account.

Ironically, the reason for the bailout is the bad condition of Cypriot banks, made by bad loans that were given to Greek individuals; but the deposits of these banks in Greece will not have to pay this tax – that means Greek borrowers caused the crisis by defaults, but Greek depositors in these banks won’t have to pay the penalty.

While European leaders say that this is a “unique” case and in other future bailouts, depositors will not be harmed (as they were not in earlier bailouts, including those of Greece), I personally think they will need to. But this is unprecedented, in that it’s only depositors – large senior debt holders of banks don’t pay anything!

Plus, it is grossly unfair that Greek depositors don’t pay – but they had to do that to avoid a Europe wide bank run – and to be honest, I think eventually that is inevitable.

The other steps that the recently elected non-socialist government will need to do is to privatize their telecom, electricity and ports companies. Additionally, they will need to cut the size of the banking sector (8x their economy due to the large operations abroad) and also increase corporate tax to 12.5% (from 10%).

The impact on India: India has a juicy double taxation avoidance agreement with Cyprus, and a number of FIIs and PE investor have registered operations there to extract the best value. Network18 has large subsidiaries (Roptonal, a TV18 holding trust etc.) listed as being based in Cyprus. Reliance Globalcomm has even set up a regional hub there from which they get their next-gen submarine link into asia. If they have money lying around or money in a fixed deposit in a Cypriot bank, even that is hosed (to the extent of the tax).

Also, there is a lesson here. If depositors will take the hit, India might see a situation like this in the future as well. So I would recommend that you keep at least a month’s expense, in cash, in your house. Or, buy physical gold or stocks or gold or real estate. It will serve you well.

Further, it turns out that Cyprus is a fairly large competitor for Foreign Direct Investment (FDI) into India, ranked 7th with about $6.8 billion in the last 12 years (or 4% of the total). From FIPB:

image

This is not likely to be fun. Will Indian markets correct on Monday from this? Will the rest of Europe panic?

Monday is a holiday for Cyprus, but it will likely get very crazy very fast. Keep your seat belt fastened.

  • Mukul Agarwal says:

    Dear Mr Deepak, ur posts r interesting & informative usual & this one is no exception. Couple of things that I did not understand & request further guidance on-
    1. Why is there a possibility of India facing similar situation like Cyprus in near future?
    2. In case of such a situation arising, will stocks & real estate be good bet to invest in or cash & gold ideal?
    Appreciate ur revert. Thanks. 🙂

    • Mukul,
      Not the near future, my bad – but all bets are off if there is worldwide contagion.
      Come to think of it, Real estate will fall a lot before it stays a store of wealth, so yes, losing 10% of your deposit might actually be better. GOld is more likely to rise in such a situation.

  • mangoman says:

    Deepak,
    You jumped the gun very fast.
    We may not have such a situation before we clean up our real estate mess. Before doing that we may raise rates by atleast 2%(as you have been suggesting), much to the dismay of corporates.

  • mangoman says:

    But however, any cyprus based investor (black money conversion) can panic in the near term? can we put a figure as how much money is routed to india through cyprus?

  • akshat says:

    Deepak,
    I guess things will get ugly here with stuff like car/home/personal loans etc. Your deposits with which you might have paid off the loan would reduce but the outstanding amount will remain the same. Even with stocks, the company’s cash would bear the brunt along with reduced inclination amongst the public to purchase products. Gold looks like the best bet, unless bank lockers are seized or you start getting midnight knocks on your door. Gold confiscation has happened before in the US, no telling what TPTB would do.

  • Ravi Shankar says:

    I am getting jumpy about my account with citibank, what if it goes under, recently they increased the minimum daily average to 1 lakh rupees (includes FDs and other investments made). I know I am good for only 1 lakh rupees under the deposit insurance scheme. I have moved out of all risky assets and waiting for a financial meltdown that does not seem to be coming, waiting for almost 4 years now. Bank credit when it vanishes, there is deflation of asset markets can’t see it any other way!

  • Krish says:

    Deepak. You came up with few articles earlier on how our Indian banks are lagging behind deposit mobilization in comparision with credit growth. I think even RBI has recognized that there is hardly any retail participation in bank deposits. Much of the banks mobilization of deposits is from debt market on mass scale and not retail FDs.
    With this disappointing scenario, there was a talk earlier that RBI should extend the indexation benefit to the FDs to encourage the mobilization and participation in bank FDs.
    Does India need this distress route. Imposing such measures would erode the confidence of the depositors forever and it would take long time to repair the damage. I am not sure such a move would be smart in Indian scenario.

  • Dheeraj says:

    Enormously myopic move by these Europeans.
    Will only exacerbate the crisis.
    However, looks like they’re actually going after all that Russian money parked in the “disproportionately large” Cypriot banking system. It will have unintended consequences though.
    While India may not be in such a situation, I think our institutional structures and sheer scale and size of the banking system would prevent such a move to be imposed overnight (as it has been in the case of Cyprus). If they do, however, the inevitable run on banks would undermine the whole effort in any case.

  • Sanjeev says:

    Iceland too fell into the same trap, but it seems to have come out of it by doing some tough but right things. Unfortunately I don’t think Cyprus has the same quality of people that Iceland does.
    In the meanwhile take a look at Blodget’s post on Business Insider here:
    http://www.businessinsider.com/cyprus-bailout-risks-europe-bank-runs-2013-3

  • Adheer Pai says:

    Does the Government of Cyprus want a bank run ?
    Well, if I have 100,000 euros in the bank, which the government says is fully insured, and now the government says next they will deduct 10% from to keep the money full insured – what is the first thing I am going to do ?
    Withdraw as much money as possible as quickly as possible from the bank, store it as cash, or perhaps gold ?
    So we now have a bank run triggered by the government itself, and then thieves and looters stealing and looting people.