C3--Cyprus Capital Controls--What to Look for

Cyprus officials continue to suggest that the banks will re-open tomorrow. Before the banks can re-open some specific capital controls will be announced. It is a very thorny issue and there may yet be further delays

The purpose of the capital controls will determine their shape. Although Cypriot officials have a wide berth to impose capital controls, a relatively narrow restrictions are likely. The purpose is to allow as smooth of a restructuring of the two largest banks in Cyprus. This means there will likely be continued limits on how much can be taken from bank accounts. In order to separate the insured depositors, who in Cyprus 2.0 will be left whole, and the uninsured depositors, the ability to move money between accounts will also likely be limited. 

The important take away, though is that these are not the kind of capital controls that are meant to address the external deficit or impact cross border settlement as in the Target2 system. Only if capital controls venture into this area, will talk Cypriot euro make sense (which of course has not stopped some from speculating that this is already taking place). 

The EU Treaty on the Functioning of the European Union allows for capital controls in limited, but specified circumstances. Officials from the Troika appear to recognize and support the need for limited capital controls in Cyprus. 

The Cypriot finance minister is suggesting that the capital controls instituted could be tailor made for each bank, depending on the particulars. He has suggested that the capital controls could have a short shelf life or a week or so. However, while market participants rightfully skeptical. Whether it is the capital controls introduced in the 1997-98 Asian financial crisis, or more recently in Iceland (where capital controls are still in place) and have lasted much longer than initially anticipated.

However, these capital controls were meant to address balance of payments issues. The capital controls that will soon by announced by Cypriot officials are not meant to address that but rather to try to maximize the opportunity to stabilize the banking sector in this hazardous transition.

The specifics are expected to be announced later today. They will likely include limits on daily cash withdrawals, restrictions on account transfers within the same bank and, the likely forced extension of time deposits at maturity. 

As unsavory as the capital controls are, in this particular context, they do seem necessary and not a prelude of the beginning of a Cypriot euro, or even, more broadly, a Southern euro. EMU, as we have argued, and many others have observed, was born incomplete and it is growing institutional capacity through the innovation that the crisis requires. 

The Cypriot crisis is no more a turning point than the Greek, Irish, Portuguese and Spanish assistance. The ECB, EU and IMF analysis, positions, and/or capacities have evolved. Each country has some unique characteristics and share some common characteristics. The individually negotiating programs are tailored to country specific issues, and shaped by the Troika's institutional capacity, and the political interests of the major creditor countries, like Germany.

We continue to be struck by the fact that although the Cypriot parliament's approval for the program is not needed, a vote by the German parliament is required. The bypassing of the Cypriot parliament does not seem necessary. Moreover, it needlessly antagonizes others, who fear a German hegemon.