Cyprus awash in a tide of troubles

A lack of fiscal and economic reform is ringing the alarm bells

As Europe’s leaders strive to devise a solution to the sovereign debt crisis, they are understandably concentrating on the 17-nation eurozone as a whole, not the small corner represented by Cyprus. Yet the tide of troubles that has engulfed Greece, Ireland and Portugal is threatening to wash over the east Mediterranean island that for decades has been best known for incubating one of Europe’s oldest diplomatic disputes.

Athanasios Orphanides, Cyprus’s central bank governor, warned this week that the economy faced an emergency similar to that of 1974, when Turkish forces invaded the island after an abortive Greek-inspired coup aimed at uniting Cyprus with Greece. It was a somewhat over-the-top comparison. But he was closer to the mark when he suggested that, without a more determined effort to clean up the public finances and introduce structural reforms, Cyprus might need a financial rescue package similar to those negotiated for Greece, Ireland and Portugal over the past 14 months.

The governor’s comments illustrated how, in these dangerous times, a eurozone member state usually well out of the spotlight can easily succumb to a combination of extravagant budget deficits, contagion channelled through the banking system, government incompetence and sheer bad luck.

Cyprus does not face short-term funding difficulties, but its bond yields have risen sharply in recent months, pointing to investors’ concerns about the very high exposure to Greece of its commercial and financial sector. The communist-led government’s failure to keep public expenditure under control during the world financial crisis of the past three years has greatly exacerbated the problem.

Then, on July 11, came the explosion that destroyed Cyprus’s largest power station, killed 13 people, knocked out half the country’s power supply and disrupted the tourism industry on which the island’s economy heavily depends. The bill for this accident may rise to as much as €2.4bn, or 14 per cent of annual economic output.

Cyprus is sure to receive European Union aid to cope with the aftermath of the disaster. Its banks are flush with the deposits of non-residents, which could in theory be drawn upon in a funding crisis. The biggest problem is the government’s refusal or inability to undertake the fiscal and structural reforms essential for long-term survival in the eurozone. In this sense Cyprus is even more remiss than its struggling Mediterranean neighbours.

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