NYTIMES: Cyprus silently exiting the Eurozone ?

Currency Controls in Cyprus Increase Worry About Euro System
By ANDREW HIGGINS
Published: July 9, 2013

NICOSIA, Cyprus — On a visit to Athens this year, Marios Loucaides, a Cypriot businessman, saw an apartment he liked in the heart of the Greek capital and decided to buy it. He told the owner he would seal the deal with a bank transfer — the price was 170,000 euros, about $220,000 — once he got back to Cyprus.Marios Loucaides, a Cypriot entrepreneur, had a deal collapse after he was prevented from moving euros to Greece.

Alexandros Diogenous, whose company imports cars from Germany, lamented the disparity in interest rates between Cyprus and the rest of the euro zone.After returning home, however, Mr. Loucaides discovered that the euros he had on deposit here in Nicosia, the capital, could not be moved to Greece, even though the two countries share the same currency and, in theory at least, the same commitment to the free movement of capital.The apartment deal collapsed. And so, too, did Mr. Loucaides’s belief that Europe has a common currency. Tangled in restrictions imposed in March as part of a bailout for the country’s ailing banks, a euro in Cyprus is no longer the same as one in France, Germany or Greece.

“A Cyprus euro is a second-class euro,” said Mr. Loucaides, the managing director of the Cyprus Trading Corporation.

Capital controls, once a tool used frequently by governments in times of crisis, have become extremely rare in Europe, though they are not unknown. Iceland, which is not a member of the European Union and uses its own currency, imposed them in 2008 after its three main banks imploded.

With a gross domestic product of about $23 billion and shrinking, Cyprus is little more than a rounding error in the $9.5 trillion euro zone economy. But Cyprus is also the first nation using the euro to restrict the flow of capital, raising a crucial question: Has the breakup of the euro zone — something European leaders have been struggling to prevent for three years with frantic summit meetings in Brussels and a series of bailout packages worth hundreds of billions of euros — in fact already started?

President Nicos Anastasiades of Cyprus certainly thinks so. “Actually, we are already out of the euro zone,” he said, citing restrictions on the movement of euros from Cyprus as evidence that his country’s money now has a different status and value from that in France, Germany and the 14 other European Union nations that use the currency.

“It is a peculiar situation,” Mr. Anastasiades said in an interview.

The rules of the European Union, enshrined in the 1992 Maastricht Treaty, ban restrictions on the movement of capital, but the measures by Cyprus have been endorsed by the European Central Bank and the union’s executive arm, the European Commission, as essential to prevent money from fleeing the country. While the European Central Bank declined to comment on the Cyprus situation, officials in Brussels say they remain firmly committed to maintaining the euro as a single currency.

Nevertheless, many financial experts say Cyprus has, in effect, made a “silent, hidden exit” from the euro, said Guntram B. Wolff, the director of Bruegel, a Brussels research group. Despite a softening of restrictions, he added, “the euro in Cyprus is still not the same as a euro in Frankfurt.”

The rigid capital controls introduced in March have been steadily relaxed, but they still snarl businesses and ordinary Cypriots in a web of red tape.

Within certain, and constantly changing, limits, individuals and companies can now make transfers abroad and between banks in Cyprus, operations that were initially prohibited. However, they need to present invoices and other documents to justify moving their money. Transfers over 500,000 euros, about $640,000, by a company — and 300,000 euros, about $380,000, by an individual — require the central bank’s approval.

It is still forbidden to cash checks or to open a new account unless a previous one existed at the same bank. Individuals can withdraw no more than 300 euros a day, while the limit for companies is currently set at 500 euros. Signs at airports warn passengers that it is illegal to carry more than 3,000 euros out of the country.

All these rules and the paperwork they create add to the cost of many transactions, effectively reducing the value of the euro in Cyprus compared with a freely movable euro in the rest of the euro zone.

“Our euro looks like a euro and feels like a euro, but it is not really a euro,” said Alexandros Diogenous, the chief executive of Unicars, a company in Nicosia that imports cars made by the VW Group in Germany.

One measure of this, Mr. Diogenous said, is the wide gap in interest rates between Cyprus and the rest of the euro zone. “I’m paying 7.75 percent on long-term loans, but my partners in Germany are paying 3 to 4 percent,” he said.

But this issue is increasingly academic: most banks in Cyprus have stopped issuing loans altogether.

Mr. Diogenous said that getting authorization to transfer money abroad to pay for his vehicles initially took 10 days or longer and was a significant obstacle to business. It now takes just 24 hours, a headache but just about a bearable one.

The taint now attached to a euro in Cyprus “challenges the very essence of a common currency area,” said Harris Georgiades, the new finance minister. He said he planned to lift all restrictions by the end of the year, but first needed to get unspecified help from the European Central Bank to ensure Cyprus’s banking system could withstand the jolt.

A big problem with capital controls is that, once imposed, they tend to linger longer than anyone anticipates because fear builds up over what might happen once they are gone. The controls introduced in Iceland are still in place five years later. The Cypriot authorities initially said their controls would last just a week and then extended them to a month. They have now been in force for four months.

But while already partly out of the euro zone, Cyprus still does not enjoy the main advantage of having a wholly separate currency: the freedom to devalue. In the European Union, this is a prerogative held only by Britain, Sweden and other countries that kept their national currencies.

Michael Kammas, director general of the Association of Cyprus Banks, an industry lobbying group, said his organization favored swiftly lifting all restrictions, which have created a deep wariness abroad of dealing with Cypriot banks and are hampering trade. A letter of credit issued by a bank in Cyprus, for example, is now rarely accepted abroad or even within Cyprus, forcing traders to pay for goods in cash.

But no one is eager to see the controls lifted too soon. Mr. Kammas cautioned against doing so until confidence returned to a banking system shattered by the March closing of Cyprus’s insolvent second-biggest bank, Laiki, the confiscation of money held by its big depositors and the freezing of all but a small portion of deposits over $130,000 at the Bank of Cyprus, the country’s biggest financial institution.

But removing restrictions in a country where nobody, not even bankers, trusts banks would probably lead to a flood of money out of the country and the collapse of the entire banking system, said Theodore Panayotou, an economist and the director of the Cyprus International Institute of Management.

When the European Commission and the International Monetary Fund demanded that Cypriot bank depositors and investors holding bonds from these banks suffer losses as part of the bailout deal, they set a precedent that has since become a central element of Europe’s banking crisis strategy. At a meeting in Brussels last month, European Union finance ministers endorsed the “bail-in” as a necessary part of bailouts for banks in the future.

Mr. Panayotou says he believes that by detaching Cyprus from the rest of the euro zone, albeit in an informal way, European policy makers have taken the experiment one step further and are now testing what happens when the common currency is no longer really common. But officials in Brussels insist they have no such hidden agenda.

Dimitris Bounias contributed reporting from Nicosia, and Jack Ewing from Frankfurt.