Gas talks stall as Russia pushes for EU guarantees on Ukrainian gas payments

Update 11.50 30/10/14:
Reuters is reporting that an EU spokesperson has said a deal is "very close" and talks will continue today, as we note below. As we also say below, a deal is still doable and likely, the question remains whether any form of EU payment guarantee will be needed and if this can get sufficient support within the broader EU member states.

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Despite another round of talks between Ukraine, Russia and the EU which ran late into the night yesterday the negotiations seem to have reached somewhat of a stalemate.

Earlier in the year the halting of gas supply between Russia and Ukraine (for Ukraine’s own use at least) was not seen as too big of an issue and it was hoped Ukraine would be able to leverage the combination of economic pain from sanctions and the Russian government’s reliance on commodities exports for funding to secure a relatively favourable deal. However, on the cusp of the harsh Ukrainian winter the power balance has steadily shifted and Russia has continued to hold firm and even broadened its demands.

What has been agreed so far?
Quite significant progress has actually been made compared to the starting point:

• Ukraine has agreed to pay for previous gas supply at a price of $268.5 per thousand cubic metres. This means $1.45bn will be paid by the end of October and $1.65bn ($3.1bn total) by the end of the year. Ukraine’s Naftogaz has set aside $3.2bn in an escrow account to pay for this.
• Going forward Ukraine will prepay on a monthly basis for its gas this winter at a price of $385 per thousand cubic metres. Russia has agreed to pay transit costs.

Russia has clearly shifted from its original price demand (at least with regards to back dated payments), but Ukraine has also compromised by agreeing to prepay and pay off existing debts.

What are the key sticking points?
There is really only one, but it’s a biggie. While Ukraine has proven that it can afford to pay off its existing debts there is much less certainty about its ability to prepay going forward.

We have noted before the significant downward spiral in the Ukrainian economy. While the fighting has calmed down to an extent, things are still far from normal, not least because the conflict has become frozen in the East with part of the country still de facto cut off.

Ukraine is now totally reliant on external funding from the EU and IMF. As we have seen in the Eurozone crisis the release of such funding is often more complicated than expected and creates a staggered cash flow linked to economic reforms. Such reforms should pick up following the election but remain tricky to implement in a country caught in the proverbial no man’s land in the sanctions war between Russia and the EU.

For these reasons Russia has continued to demand some form of explicit guarantee from the EU that Ukraine will be able to pay for the supplies over the winter – they are expected to cost around $1.6bn, though this could increase if the winter is particularly harsh.

Is a deal likely?
It’s looking difficult as this meeting was earmarked as the most likely one for a deal. Russia seems to be using this arena to flex its muscles given that it believes it has the upper hand. That said, the economic costs of sanctions and a falling oil price are creating problems for the Russian economy, though it’s not always clear whether economic logic is sufficient to alter Russian President Vladimir Putin’s position.

Getting explicit EU support for around $2bn to guarantee prepayment would be difficult. But, so far, the EU has been fairly supportive of Ukraine and may be willing to offer a more tacit agreement to provide further funding rather than outright underwriting of the payments. Furthermore, without a deal there will be a huge temptation for Ukraine to siphon off gas which it is transiting from Russia to Europe. This could cause Russia to halt all gas flow through Russia, something Europe is keen to avoid to say the least.

Talks are set to resume later today according to RIA Novosti. With all this in mind, and the fact that a deal remains in all sides' interests, we would think one could still be struck.

What are the lessons here?
Ultimately, this dispute is teasing out a key question for the EU in the wake of this crisis. It is becoming increasingly clear that Ukraine is economically devastated in the wake of the war and the sanctions. The offer of opening up markets in the EU is unlikely to be sufficient and the EU and IMF will have to face up to the fact that in the short and medium term they will probably have to offer significant amounts of cash to Ukraine to help stabilise its economy, currency and energy supply.

Putin is aware of how politically sensitive this is for the EU – it has just gone through a series of its own bailouts in the Eurozone crisis and now countries are being asked to stump up cash for a country which is not even a member (and is unlikely to be one for the foreseeable future, if ever). As with the sanctions, this narrative is likely to expose dividing lines within the EU and set the tone for the negotiations over the future of Ukraine.

Is Merkel lining up Lagarde as an alternative to Juncker?

There is an interesting report from Reuters this evening. According to unnamed sources, during a private meeting, German Chancellor Angela Merkel asked French President Francois Hollande whether he would be willing to back IMF Chief Christine Lagarde as the new Commission President.

As Alex Barker from the FT has pointed out, this may refer to a conversation taking place before the European elections, which would, of course, make the story far less interesting. 

Lagarde’s name has been bandied around before but has always been considered an outsider. 

If there's truth in the report it would obviously be very good for the UK and David Cameron, who is a big fan of Lagarde (along with many others). Number 10 will also be hoping that this is Merkel’s first action to try to move away from Jean-Claude Juncker. While she has never been entirely keen on him, she has come under severe domestic pressure. Having a clear, credible alternative ready, such as Lagarde, would certainly help. That said, Merkel's spokesman has already come out to reject the report and reaffirm support for Juncker.

In any case, there remain a number of hurdles to her becoming the new Commission President over the current front-runner Juncker:

• It’s not clear yet if she wants the job. Sources suggest she has not ruled it out but her position as Head of the IMF remains an illustrious one and would be hard to walk away from.

• As Reuters notes, Hollande did not give a clear answer on whether he would back Lagarde. It would be a big ask given that she is from the opposition UMP party and Hollande could well fear it would make him look weak. If he accepted her it would be giving up the chance to appoint his own French commissioner who would likely still have a high level job within the new Commission. On the other hand, rejecting the opportunity to have a French head of the Commission may not play well with the French public.

• Europe will be loath to lose the IMF’s top job and may not retain it. After the Dominique Strauss-Kahn incident there was a sizeable fight over whether Europe should retain the position, with emerging markets stressing that the whole management system of the IMF is outdated given their increased size and relevance for the global economy. If Europe lost control at the top of the IMF it might find it hard to stop a sizeable overhaul of the whole institution, which has been coming for some time. It would also be the second time in recent history that France has walked away from the IMF’s top job – not a tag any country wants to wear.

• The European Parliament (EP) could still block her and may well do given its fierce desire to see the Spitzenkandidaten process upheld. On the other hand, they have also pushed for diversity and as a renowned female European politician, and a strong candidate, it could be difficult for the EP to vote her down.

It may also be questioned whether she will get support within the European Council. Those who support Juncker could still put together a blocking-minority but this would be difficult if she had support of most of the large countries.

Therefore, Lagarde remains a case of wishful thinking at the moment. But, as we've said before, this is still anyone's race so never say never...

IMF takes a more critical line on Greece

The IMF  released its latest review of the Greek bailout on Wednesday. As might be expected it was a bit more critical than the version released by the European Commission and ECB a couple of days ago.

As also might be expected the press has focused on the fact that the report reveals an €11bn funding gap for Greece between 2014 and 2016 (higher than that suggested by the eurozone). The report also calls for the eurozone to consider further debt relief for Greece. Neither of these revelations is brand new, with both having been included in the leaked version of the Troika report a few weeks ago.

There are a couple of other interesting points in the 207 page report, including some concrete forecasts on the shares of Greek debt.

These amounts are pretty much as we predicted back in March 2012, where we forecast that by 2015 around 76% of Greek debt could be held by the IMF and eurozone (NB – it’s not clear how the ECB and national central banks holdings of debt [circa €40bn] are classified in the IMF figures. If they fall under private sector here, then the holdings by official creditors may well be higher in reality).

In any case, these amounts drive home that the real question facing Greece and the eurozone (after the German elections) is whether to write down these ‘official creditors’ or not – known as ‘official sector involvement’ (OSI). There will likely be a push to extend the loans further and cut their interest rates but, as the funding gap highlights, there are immediate liquidity and solvency questions facing Greece.

Other interesting points in the report include:

• The IMF warning of further social unrest: “The risk of political instability remains acute, especially in light of high unemployment and on-going social hardship. Further ambitious fiscal adjustment is needed for public sector debt to decline steadily, which exacerbates the possibility of social stress and political resistance.”

• Arrears clearance seems to be behind schedule with only €1.4bn of the targeted €4.5bn being paid off. However, Kathimerini reports that this has now been increased to €4bn according to Greek government data.

• Greece only just manages to quality for IMF assistance, with the IMF saying, “The program continues to satisfy the substantive criteria for exceptional access but with little to no margin.” The explanation involves a few stretches on the debt sustainability front, with the fund arguing, “The risk of international systemic spill overs in case of a permanent interruption of the program remains high and justifies exceptional access.” This raises an interesting question of whether, with the OMT and talk of a eurozone turnaround, the spill over effects are still significant enough to justify such IMF action?

• The comments by Paulo Nogueira Batista, the Latin American representative on the IMF board, who slammed the overly optimistic assumptions in the debt sustainability analysis and suggested the programme was flawed. He has since backtracked from his comments, while the Brazilian government has issued its support for the bailout programme. Nevertheless, the outburst is a timely reminder of the on-going disputes behind the scenes in the IMF, between the US/Europe and the emerging market countries.

Portugal's Finance Minister quits: A bolt out of the blue? Not really...

A surprise development in Portugal this afternoon, as Finance Minister Vítor Gaspar has announced his resignation. The office of Portuguese President Aníbal Cavaco Silva has said in a note that Gaspar will be replaced by Maria Luís Albuquerque - one of his deputies, with a long career in the Portuguese Treasury.  

Initially, the news sounded very much as a bolt out of the blue. That was until Jornal de Negócios published Gaspar's letter of resignation on its website. The letter reveals the following:

• Gaspar had already written to Portuguese Prime Minister Pedro Passos-Coelho in October 2012, stressing "the urgency of [his] replacement as Finance Minister."

• At the time, Gaspar had decided to quit over "a series of important events". In particular, he mentions the Constitutional Court ruling that struck down the government's plan to limit extra holiday and Christmas pay for public sector workers as unconstitutional in July 2012, and "the significant erosion of public support" for the austerity measures attached to the Portuguese bailout.

• However, Gaspar was asked to stick around a bit more - at least until the 7th review of the Portuguese bailout by the EU/IMF/ECB Troika was finalised and an extension of the bailout loan maturities was secured. Incidentally, the fact he has now been allowed to leave could be seen as a vote of confidence from the government in the strength of the Portuguese economy (although Gaspar may simply have been stepping up the pressure to be allowed to exit).

• Gaspar also points out that Portugal's consistent failure to meet its deficit and debt targets under the EU/IMF bailout agreement had "undermined [his] credibility as Finance Minister." On this point, it is probably worth reminding that, on Friday, it came out that Portugal's public deficit in the first quarter of 2013 had reached 10.6% of GDP - with the target for this year set at 5.5% of GDP.

• Interestingly, Gaspar concludes his letter by saying, "It's my firm conviction that my exit will contribute to reinforce your [Prime Minister Passos-Coelho's] leadership and the cohesion of the cabinet". This seems to suggest Gaspar may have lost faith in the reform approach taken in Portugal, and may not have been willing to push ahead with it (not least for the reasons mentioned above).

In any case, the news of Gaspar's resignation hardly comes at a great time for Portugal. As we noted in a recent briefing, the country faces some tough challenges this year:

• Domestic demand, government spending and investment are contracting sharply, leaving the country heavily reliant on uncertain export growth to drive the economy. 

• By cutting wages and costs at home (internal devaluation), Portugal has in recent years improved its level of competitiveness in the eurozone relative to Germany. However, this trend actually started to reverse sharply in 2012, meaning that the divergence between countries such as Portugal and Germany has begun growing again – exactly the sort of imbalance the eurozone is seeking to close. 

• In its austerity efforts, Portugal is now coming up against serious political and constitutional limits. For the second time, the country’s constitutional court has ruled against public sector wage cuts – a key plank in the country’s EU-mandated austerity plan – while the previous political consensus in the parliament for austerity has evaporated. 

How much impact this will have remains to be seen, although in a country where the economic future remains uncertain, suprises such as this are hardly ever welcome. In practice, though, the approach is likely to continue in much the same vein, firstly because the EU/IMF/ECB Troika has shown little willingness to be flexible with Portugal, and secondly because Maria Luís Albuquerque has often voiced her support for the approach taken so far.

That said, it is an interesting reminder of the strains the bailout programme is putting on the Portuguese government, as it begins the difficult task of finding a way to smoothly exit from its reliance on external funding.

Coalition row over public broadcaster gets nastier by the day in Greece

Ten days ago, we wrote a blog asking, "Will the closure of the public broadcaster set the scene for a coalition showdown in Greece?" Yes, it has. And it's looking nastier by the day.

Greek coalition leaders met for the third time this week yesterday, but failed once again to strike a deal on the future of the country's public broadcaster ERT. This despite Prime Minister Antonis Samaras offering to re-hire as many as 2,000 old employees to resume broadcasting. Democratic Left, one of Samaras's junior coalition partners, could pull out of government as early as today.

This would leave the government with a wafer-thin majority of 153 seats out of 300 in the Greek parliament, although Samaras could try to win support from some of the 14 non-attached MPs on a case-by-case basis. Not ideal only one year after the coalition was formed, although it could avoid the prospect of snap elections.

Democratic Left MPs are currently in talks with the party's leader, Fotis Kouvelis, to make a decision. An announcement is expected shortly.

How did the problems escalate to this point?

Although the closure of ERT instantly flared up coalition tensions, it does seem surprising that the Prime Minister's party New Democracy (ND) has allowed it to get to this point - where a coalition split is a real possibility. On the surface, it seems it would be simpler for ND to give in and re-open ERT at least temporarily (that is after all what even the Greek Council of State suggested). However, this misses the confluence of problems which the Greek government is currently facing:

• The government is falling well behind on the sacking of civil servants and the necessary savings this delivers. It has agreed to dismiss 4,000 public sector workers by the end of this year and put a further 25,000 into the labour reserve (where they receive a reduced salary). Closing ERT instantly delivers up to 2,600 layoffs - though part of old ERT employees would presumably be hired once the revamped broadcaster is created. The EU/IMF/ECB Troika is ramping up the pressure for clear evidence that these promises will be fulfilled.

• The privatisations programme, due to raise €2.6bn this year, is clearly off track. This is mostly due to the failure to sell the natural gas monopoly DEPA. This funding gap must be filled from within the government's existing budget - and no concrete plans have been put forward so far.

• A further €1bn financing gap has opened up in the National Healthcare Provision Organisation (EOPYY), while the Troika remains unconvinced of plans for a new property tax which was forecast by Greece to boost revenue.

• Furthermore, the IMF could suspend the payout of the next tranche of Greek bailout funds due next month unless eurozone leaders plug a €3bn-€4bn shortfall in the country's rescue package. Compared to the internal funding gaps above, this is an external one which has arisen due to euro area national central banks refusing to roll over their holdings of Greek bonds as had been agreed under the last revision of the Greek bailout (as we reported in yesterday's press summary). Eurogroup Chairman Jeroen Dijsselbloem moved quickly to deny the reports, adding that "the [Greek] programme is fully financed for at least another year."

Therefore, the sum of these factors has escalated the ERT issue into one which could potentially undermine the coalition. The opening up of a new financing gap is hardly surprising, and is actually something we predicted at the start of this year.

As noted above, if the Democratic Left exited the coalition, the Greek government would still hold a majority in parliament, albeit a wafer thin one. Support from the Democratic Left on certain issues could be expected, but would of course no longer be guaranteed.

The Greek government is likely to face some very tough decisions in the near future. An erosion of its power now could make pushing these decisions through significantly more difficult.

Full letter from the Cypriot President to the Troika slamming Cypriot bailout

As we reported last week in our press summary and which the FT is today reporting on (and presenting as a bit of a scoop), Cypriot President Nicos Anastasiades has sent a scathing letter to the EU/IMF/ECB Troika slamming the terms of the Cypriot bail-out/bail-in package and calling for it to potentially be re-examined.

Below we post the letter in full, courtesy of the Cypriot website StockWatch, which published it over a week ago (added emphasis ours):

I am writing to update you on the economic and banking system developments in Cyprus following the Eurogroup decisions of last March and to request your support regarding a number of very pressing issues which need to be addressed the soonest.

1. The Cypriot economy is adapting to major shocks

The Cypriot economy is adapting to major shocks. Substantial private wealth has been lost and a significant number of Cypriot firms have lost their working capital at the two systemically important financial institutions which were subject to the bail - in. Restrictive measures, including capital controls, are seriously hampering the conduct of business and confidence in the banking system has been shaken. As a result the economy is driven into a deep recession, leading to a further rise in unemployment and making fiscal consolidation all the more difficult.

2. Application of bail-in was implemented without careful preparation

It is my humble submission that the bail-in was implemented without careful preparation. Its form was changed drastically within a week. Originally designed as a general bail-in across the banking system, it eventually became focused on the two distressed banks, the Laiki Bank and the Bank of Cyprus (BOC). There was no clear understanding of how a bail-in was to be implemented, legal issues are being raised and major delays in completing the process are being observed. Moreover, no distinction was made between long-term deposits earning high returns and money flowing through current accounts, such as firms' working capital. This amounted to a significant loss of working capital for businesses. An alternative, Ionger-term, downsizing of the banking system away from publicity and without bank-runs was a credible alternative that would not have produced such a deep recession and loss of confidence in the banking system.

3. Cyprus was forced to pay the cost to ring-fence Greece but no reciprocity has been granted

Another feature of the current solution was that deposits at the branches of Laiki and Bank of Cyprus in Greece were spared from a haircut to prevent contagion. These deposits amounted to €15 billion. The wish to avoid contagion to Greece was also evident in the Eurogroup's insistence that Cypriot banks sell their Greek branches. In addition and as a result of the sale, the Cypriot banks have lost their Greek deferred tax assets. As understandable as ring-fencing may be, this was absent at the time of deciding the Greek PSI in relation to the Greek Government Bonds which cost Cyprus 25% of its GDP (€4.5 billion). The heavy burden placed on Cyprus by the restructuring of Greek debt was not taken into consideration when it was Cyprus' turn to seek help.

4. Imposition of Laiki's ELA liability to Bank of Cyprus

The implementation of the sale of the Greek branches of the Cypriot banks, as urged by the Eurogroup, resulted in Laiki selling assets that were pledged against its ELA liability to Piraeus Bank, without Piraeus assuming the corresponding ELA liability. As such, Laiki was left with the related ELA liability but without the aforementioned assets. The ELA liability which was left "unsecured" as a result of the sale amounts to around €3.8 billion and was imposed on Bank of Cyprus as a result of the Eurogroup decision. It is worth reminding that a substantial part (in excess of €4 billion) of Laiki's ELA liability was required in the first place in order to cover deposit outflows experienced by Laiki's Greek branches.

Bank of Cyprus itself has a total ELA liability of around €2 billion. By taking an additional €9 billion from Laiki, which was accumulated over the course of the last year under very questionable circumstances, BOC has substantially increased the vulnerability of its own funding structure, with its cumulative ELA liability reaching a very high €11 billion. BOC was called to pledge its own assets to cover for the collateral shortfall for the €3.8 billion liability carried over by Laiki. Such a high amount of ELA liability hinders BOC's funding sources as the room for obtaining additional ELA is limited. The imposition of Laiki's ELA liability on Bank of Cyprus is the main contributor to the liquidity strain Bank of Cyprus faces.

5. Urgent need for Troika to provide a long-term sustainable and viable solution to the liquidity issues Bank of Cyprus is facing as a result of the Eurogroup decisions

Instead of addressing the issue of severe liquidity strain on Cyprus' mega-systemic bank through a long-term sustainable and viable solution, the Troika partners seem to have chosen the path of maintaining strict capital restrictions. Artificial measures such as capital restrictions may seem to prevent a bank run in the short term but will only aggravate the depositors the longer they persist. Rather than creating confidence in the banking system they are eroding it by the day. Maintaining capital restrictions for a long period will inevitably have devastating effects on the local economy, will also affect the country's international business and will have an adverse impact on GDP. Under such scenarios spill over effects will no doubt register on other local banks through higher non-performing loans as a result of dampened economic activity. In addition, increased deposit withdrawals from other local banks, as fear of lack of liquidity of the only systemic bank will have a domino effect on the entire banking system.

I stress the systemic importance of BOC, not only in terms of the banking system but also for the entire economy. The success of the programme approved by the Eurogroup and the Troika depends upon the emergence of a strong and viable BOC. It is for this reason that I urge you to support a long-term solution to Bank of Cyprus' thin liquidity position. Such a solution will re-instate depositor confidence in the banking system and will allow the full functioning of the economy away from restrictive measures and capital controls. It will also facilitate the attraction of foreign direct investment in Cyprus.

My Finance Minister has alerted the Troika Mission Chiefs in writing on 19 May 2013, in relation to the need to implement a long-term viable solution to Bank of Cyprus' liquidity position. No response has been received yet.

A possible long-term solution could be the conversion of part of Laiki's ELA liability into long term bonds and the transfer of these bonds and corresponding assets into a separate vehicle. Another solution could be the reversal of the Eurogroup decision in relation to the merger of Good Laiki (carrying the €9 billion ELA liability) into Bank of Cyprus. In any case the BOC should exit resolution status without any further delays and should be granted eligible counter-party status by the ECB. Of course more options need to be examined. I should mention that an interim Board and an interim CEO is already in place at BOC and the final asset valuation is progressing according to schedule.

I urge you to review the possibilities in order to determine a viable prospect for Cyprus and its people. The new government of Cyprus, despite its expressed disagreements, has abided by the Eurozone decisions and remains determined to implement the programme fully and effectively. I am personally determined to lead Cyprus out of this dire situation and towards a path of sustainable growth and development. We are also fully committed to re-establishing Cyprus's stance as a credible EU partner. However, at this crucial juncture, we are calling upon you for active and tangible support.

Very strong stuff indeed. We can't imagine the Troika will take to it too kindly.

Will the closure of public broadcaster set the scene for a coalition showdown in Greece?

Imagine a Number 10 spokesperson announcing during the afternoon news bulletin that the BBC has become too expensive to run and will be shut down with immediate effect. You would be excused for thinking that the Government and the Corporation have joined efforts to take you for a ride.

Well, this is exactly what happened in Greece - and it wasn't a joke. Greek government spokesman Simos Kedikoglou went on TV yesterday afternoon to say that the country's public broadcaster ERT would go off the air a few hours later, because it had become a "refuge of poor transparency and waste."

As a result, ERT's almost 3,000 employees have been temporarily laid off. The Greek government says that a revamped and slimmed-down broadcaster (NERIT SA) will be up and running by the end of August. Protests were staged outside ERT's headquarters yesterday and are continuing today, while ERT journalists are still putting programmes on air via digital frequencies and the internet.

A couple of points are worth making at this stage:

• The decision to shut down ERT is clearly linked to Greece's commitment to firing 15,000 public sector workers by the end of next year under its EU-IMF bailout deal, although it's up to the Greek government to choose where to cut. Therefore, it's probably not entirely fair to blame the Troika for this (admittedly pretty extraordinary) decision;

• The fact that the Greek government prefers shutting down ERT altogether and then opening a brand-new company, instead of trimming the existing company down, could be seen as further evidence of how difficult it is to fire public sector workers in Greece - even in cases where inefficiency and waste are evident (at least according to what the Greek government spokesman said);

• On the domestic politics front, Greek Prime Minister Antonis Samaras has decided to go ahead with the closure of ERT despite open opposition from his coalition partners - PASOK and Democratic Left. The latter now want to submit a draft bill to scrap the decision, meaning that there is a risk of a coalition split - unless someone blinks.  

As the Troika has long suggested, it is clear that Greece's bloated public sector needs to be downsized significantly. That said, it is also clear that this situation has been poorly handled, particularly given the wider political and social tensions already at play in the country. The fallout of this story might be worrying - further splits in the governing coalition and wider public backlash against an austerity programme for which there is already very little buy-in.

We will keep monitoring the situation and give further updates on Twitter @OpenEurope.

Is the IMF turning bearish on Spain?

It’s been a busy week for the IMF, releasing their latest iterations of the World Economic Outlook, Global Financial Stability Report and the Fiscal Monitor. We’ve been poring over the reports and will continue to do so (see here for some initial thoughts on the WEO). One forecast in particular caught our eye – Spain's.

The IMF seems to have turned significantly more pessimistic on the prospect of a Spanish recovery. The charts below provide a comparison with the previous WEO forecasts (highlighting how these forecasts tend to be overly optimistic) - which very much confirms what we have noted before about the real risks in Spain.

The latest projections for the Spanish deficit (the dark blue line in the above chart) definitely represent a break from previous forecasts. In particular, the forecast for 2014 is 2.3% of GDP higher than in October. The IMF says this is:

“Reflecting the worse unemployment outlook and the lack of specified medium-term measures.”

Translation: the government does not have the necessary budget cuts and reforms in place to meet its desired deficit path – step it up Rajoy.

Such an increase manifests itself in the debt level projections as well. Worryingly, these no longer peak in 2015/16 and level off thereafter. Instead, Spanish debt to GDP is forecast to reach 111% in 2018 and looks set to keep growing rather than peaking and levelling off.

Effectively, this graph also highlights how the forecasts have progressed as the crisis in Spain has evolved from from financial, to a sovereign liquidity crisis and now into a sovereign solvency one. As the IMF notes, sustaining this will be tough:

“[Countries such as Spain] would need to maintain large primary surpluses over the medium term. In the absence of entitlement reforms, projected increases in age-related spending mean that additional measures will still be needed over time, however, to keep the primary surplus constant.”

Translation: Spain needs to run large primary surpluses for a long time, but in the face of increasing welfare and pension spending, this will need to come from a series of additional and painful cuts.

So the IMF does not paint a pretty picture for Spain. Longer and deeper recession, larger deficits at a time when it needs to be moving to surplus and increasing debt, in turn raising questions about the country's solvency. Let’s not forget, that’s before bringing the bust banking sector into the discussion. Plenty for Rajoy to get on with then…

Update 16:20 18/04/13:
Christine Lagarde has reportedly suggested that Spain should be allowed to ease its austerity programme. Lagarde argues that, although Spain needs fiscal consolidation, it does not need to be front loaded. Such an argument is not going to sit well with the eurozone and will increase the tensions within the Troika (some of which were outlined in this FT article earlier today). As the graph below shows such an approach may not fit well with the IMF own growth forecasts. Even with a 7% deficit, growth next year in Spain will be 0.7% according to the IMF. How much more would need to be spent to get to a respectable 1.5% GDP growth? Double the deficit?

Maybe not something this extreme but with debt already heading towards an unsustainble path it's not clear that there is much scope for further spending, while markets may put pressure back onto Spain once again. This raises the prospect of a further bailout or transfers from other eurozone states, but as we pointed out at length yesterday, Lagarde is talking about something very different than removing austerity in that case.

IMF sees a mixed outlook for Europe - calls for more ECB action and a fiscal union

The IMF today released its latest World Economic Outlook forecasts. As usual the forecasts are not overly different from the previous ones - published in October last year - but there are a few interesting points.

The map above gives a pretty good feeling for just how bad Europe is doing relative to the rest of the world at the moment (click to enlarge).

The IMF warns about the risks of complacency and lack of  implementation of reform and austerity measures in the eurozone, something we touched on here:

Amid reduced market pressure and very high unemployment, the near-term risks of incomplete policy implementation at both the national and European levels are significant, while events in Cyprus could lead to more sustained financial market fragmentation. Incomplete implementation could result in a reversal of financial market sentiment. A more medium term risk is a scenario of prolonged stagnation in the euro area.

This seems to be clear reference to the banking union and the creation of a cross-border resolution mechanism to deal with banking crisis such as the one seen in Cyprus. This is a valid concern - there is huge uncertainty over the banking union.

The IMF also notes that while current account adjustment has been progressing in the eurozone it is not clear whether it is simply cyclical or the result of deeper reform:

Current account balances of adjusting economies have improved significantly, and this improvement is expected to continue this year. This increasingly reflects structural improvements, including falling unit labour costs, rising productivity, and trade gains outside the euro area. But cyclical factors also play a role, notably layoffs of less productive workers, and would reverse with eventual economic recovery.

Further to that point, there is also the interesting table below showing that Greece, Ireland and Spain have had some success in reducing unit labour costs (change is difference between the dot and the diamond). Greece mainly through cutting labour costs but the others also through increasing productivity. But there is some way to go yet, while countries such as France and Italy have made little to no adjustment. It's also worth keeping in mind that, while Portuguese ULCs have fallen from their peak, the trend and some of the fall has now been reveresed.

In addition, there are continued signs of a split in policy approach between Germany and the IMF. Comments such as these are unlikely to go down well in Germany:

Room is still available for further conventional easing, as inflation is projected to fall below the European Central Bank’s target in the medium term.

Greater fiscal integration is needed to help address gaps in Economic and Monetary Union design and mitigate the transmission of country-level shocks across the euro area. Building political support will take time, but the priority should be to ensure a common fiscal backstop for the banking union.

We'd have thought, after three years of being exposed to the politics of the troika, the IMF might be a bit more sensitive to the political intracacies of the eurozone crisis. However, it does highlight that the fundamental choice facing the eurozone has not gone anywhere..

Cyprus bailout: What are individual EU member states on the hook for?

Now remember, contributions via the European Stability Mechanism (ESM) are loan guarantees, not upfront cash. But here's the break-down of how much each EU country is on the hook for in the Cyprus bailout:



Update 05/04/2013 12.10: 
By popular request, we've been asked to put together a quick explainer/refresher of how this money will be provided. ESM loans do not require direct cash from countries but are based off loan guarantees which the eurozone countries give to the ESM. The ESM then issues debt on the market to raise the actual cash to provide the bailout loans. So, not extra cash contribution on the back of this bailout. That said, the ESM does require paid-in capital (€80bn), the payouts of which should have been factored into eurozone government budgets and certainly has been included in the bailed out countries. Also due to a eurostat ruling, each eurozone member's share of ESM bailouts will not count towards its national debt. As for the IMF, the funds usually come from the IMF's general reserve fund which countries will have already contributed their subscription (see here for more details). Again, in a sense, no new cash.

Details of Cypriot bailout agreement filtering through

The package is coming together. The IMF has officially announced that it will take part in the Cypriot bailout, providing €1bn of the total €10bn in loans - that gives a UK share of around €50m (see our thoughts here on UK IMF shares). That leaves €9bn to be provided by the eurozone, likely through the ESM. Below we breakdown the country shares (click to enlarge):

Other details of the Memorandum of Understanding (MoU) filtering through include:

• 2.5% interest rate on the loan, with a 10 year grace period on repayments, it will then be repayable over a 12 year period (repayments start in 2023 and finish in 2035).
• 4.5% in cuts/savings to be found before 2018 (on top of the 7% already scheduled by 2015) to drive Cyprus from a 2.4% primary deficit now to a 4% primary surplus in 2018 (two years later than previously envisaged).
• The figures given in the MoU leaked yesterday (which reports suggest are the same in the final agreement) imply an 8% contraction in GDP this year and 3% next year. This seems optimistic and could be closer to 10% and 5% respectively, if not worse, but ultimately depends on how long the capital controls are in place for.
• Eurozone officials will review the agreement tomorrow, with a final proposal to be presented on 9 April, which eurozone finance ministers are expected to approve at an informal Eurogroup meeting in Dublin on the 12 April.
• The Bundestag could vote on the deal around the 15 April. IMF board expected to approve the deal in early May.
• First tranche of bailout funds expected in early May, ahead of debt maturing at the start of June which Cyprus needs to pay off.

A few hurdles left to jump then in terms of approval from national parliaments – which is no mean feat given that the figures underpinning the bailout are likely to come under some well-deserved scrutiny.

Cyprus closes the shutters as it announces capital controls

Some more details coming out about the much talked about capital controls in Cyprus (details via @MatinaStevis and RANsquawk):

• Will include limit on cashing cheques (but will be able to deposit cheques).
• Time fixed deposits will not be able to be redeemed during the period of capital controls
• Credit card transactions capped at €5k per month
• Limit to cash transfers outside Cyprus of €3k per person per trip.
• Applies to all bank accounts
• Valid for 7 days from Thursday, will then be re-evaluated.

We have already noted that these controls are pretty severe and have the potential to have a substantial impact on the economy. Below we list a few more thoughts:

• The fact that they are focused on limited external flows rather than internal transactions could be positive as it may help avoid a massive liquidity crunch in Cyprus.
• That said there could still be a very quick withdrawal of funds from banks, with people keen to hold cash instead. This could further destabilise the banks.
• Removal in 7 days seems optimistic, for two reasons. Firstly, the bank restructuring and recapitalisation may not be completed by then. But more importantly, the fears which would motivate massive outflows go further than just the banks. People will look to move money out of Cyprus because the financial sector has been massively shrunk and no longer looks an attractive investment. Furthermore, the economy looks consigned to a long period of economic contraction and its debt load may quickly become unsustainable. Lastly political unrest may grow. None of these motivating factors will be gone in a week.
• The lack of limit on cash withdrawals is a positive, although this could quickly change, especially with demand for cash likely to sky rocket.
• Many companies still use cheques in Cyprus, not least to pay employees, so limiting them could hamper the normal functioning of business. That said, since they can be deposited, this is mitigated a bit, although that only holds as long as people trust that they can access deposits - not clear they do at this stage.
• According to this via Zerohedge, any commercial transaction above €500 which sends money abroad will need to be proven to be in line with usual business practice. This will introduce a significant amount of time consuming paper work into the life of many everyday exports and importers. 

We’ll update the blog with more thoughts as more details become clear.

Cyprus update – halfway to a deal, but the biggest obstacle remains

It’s looking as if there will be a deal in Cyprus, although there are some big obstacles to be crossed to get there and it is likely to go down to the wire.

Last night the Cypriot parliament voted to approve a few bills which will make a significant bank restructuring possible and allow the government to install capital controls if it sees necessary, here are the key points of what was approved (and what was not):

• Plan to wind down Laiki bank – good assets and insured deposits below €100,000 will be shifted into a good bank which will be merged with the Bank of Cyprus. Bad assets along with uninsured depositors above €100,000 will be put into a bad bank – these depositors could lose as much as 40% of their money.
• Ability to enforce capital controls – these are wide ranging from limiting non cash transfers to turning standard current account deposits into time fixed ones, and pretty much anything else the government deems as necessary for ‘public order and safety’.
• The creation of a solidarity fund – this will not play a large role in the bailout deal, since it was already rejected by the EU/IMF/ECB Troika as an alternative to the deposit levy.
• No deal on the bank deposit levy – Eurozone finance ministers will meet on Sunday in Brussels with the Cypriot parliament only likely to vote on a deal after it has been cleared at this meeting.
• Bank of Cyprus has survived being ‘resolved’ for now.
• The Greek bank Piraeus will take control of the Greek parts of Laiki and Bank of Cyprus.

These measures are expected to raise just over €2bn (maybe more, we’re waiting on firmed details on the solidarity fund). That still leaves €3.5bn+ to be raised to meet the €5.8bn target set by the Troika – although reports yesterday suggested this may have been raised by €0.9bn due to worsening forecasts for Cyprus. Below we outline our key takeaways from the deal.

The largest obstacle to a deal remains: Clearly, this will once again come down to the deposit levy. With a smaller amount needing to be raised, it is likely to fall only on €100,000+ deposits. As we noted yesterday a levy of between 12% - 15% looks likely, although given the bank bailout plan it could hit some big Laiki depositors especially hard. Kathimerini reports that the levy could be pushed higher and focused on a smaller group of depositors. Ultimately, though, with few alternatives left now a levy on largest depositors seems the least destructive option (but still far from ideal).

This will go down to the wire: The ECB has set a Monday deadline for a bailout deal or it will cut of liquidity to Cypriot banks. The banks are due to open on Tuesday but this could be extended if no deal is found. As long as the banks stay shut (and with use of the capital controls, see below) they may be able to buy a few days to reach a deal, allowing the ECB to reverse its decision. Still, it will be a messy few days with the Cypriot parliament unlikely to vote on the deal until the it is approved by the Eurozone and assured of passing. If the deposit levy is only on large deposits, it should gain support from DIKO (the junior coalition partner), while reports suggest some opposition members could abstain or be absent from the vote to allow it to pass.

Still, this has been left very late and the decision to approve the above measures first seems to be putting the cart before the horse. This is not too surprising though (since clearly these were easier options to push through) and reminds us of other parts of the crisis – such as the decision to approve the ESM before the EFSF was revised to be fit for purpose.

The capital controls are severe: The government has significant leeway to limit the flows of capital. People have rightly been asking questions of whether this, de facto, moves Cyprus out of the single currency. Ultimately, money is no longer fungible between Cyprus and the rest of the Eurozone and, at this point in time, it’s hard to argue that a euro in Cyprus is worth the same as a euro elsewhere. The real problem though may not be imposing the controls but removing them, as WSJ Heard on the Street points out. It is hard to see how the Cypriot economy will be able to function properly with these strict controls on and at some point questions will surely begin to be asked if it would not be better off with a devalued currency outside the euro.

Why is Bank of Cyprus not being ‘resolved’? Reports suggest the Cypriot government has fought hard to stop the bank having the same fate as Laiki. This may be because it is the largest bank and a large employer in Cyprus, but it is could also be because it remains very close to the government and is the home for some of the largest Russian depositors. In any case, avoiding the tough decision to fully restructure the banking sector is likely to make things more difficult in the future.

Greek banks are getting a very good deal: The branches of Cypriot banks in Greece have around €22bn in assets and account for 8% of all deposits in Greece and 10% of loans. Clearly they are sizeable and hiving them off helps reduce the size of the Cypriot banking sector relative to GDP and reduces the cost of the bailout. It also protects the rest of Greece from contagion. That said, Piraeus is picking up a very good deal, not least because Cypriot exposure to the Greek crisis was a key driver of the current problems Cyprus faces. The purchase was done at a symbolic €1 but the cost of recap is €1.5bn. Funding will come from the Hellenic Financial Stability Fund (the Greek bank recap fund) and the Cypriot bailout programme – €950m from the former and €550m from the latter. So these banks, investors and depositors avoid any losses despite many being entangled in the Greek crisis. The fact that Piraeus bank shares were rocketing yesterday is a clear enough sign of who did better out of this deal.

The deal has come full circle and has been very poorly managed: as we noted yesterday, we are basically back to a mix of the deal proposed by the IMF (bank restructuring) and the Eurozone (deposit levy) last Friday. The impact the events of this week will have on Cyprus should not be underestimated – there will be a huge outflow of capital (or will be whenever the controls are removed) and significant political upheaval. This has been poorly handled by both sides – the Eurozone failed to listen to the Cypriot government and was complacent about the impact of Cyprus on the wider Eurozone economy. The Cypriot government has fought to hang onto an impossible business model, focused on big finance funded by foreign deposits, and has looked to play a risky geopolitical game. Unfortunately, the ones that lose from all this are the 800,000 people who live in Cyprus.

The Cyprus Solidarity Fund and bank restructuring - what's the latest?

Is this Plan B or Plan C? We’ve lost track. Maybe Plan B+.

Anyway, it seems that the Cypriot parliament is currently discussing the proposal for a ‘solidarity fund’ which the cabinet has reportedly unanimously approved. This idea originated yesterday and was rejected by the troika overnight – we assume (hope) that this version of the fund contains some additional proposals to smooth over the previous disagreements.

What is the solidarity fund and what does it include (click to enlarge)?

The solidarity fund is essentially an investment fund or sovereign wealth fund which will pool a series of assets to help provide the €5.8bn in cash required by the Cypriot government to agree the bailout.

This is a broad list (we have assessed many of the measures already) and not all of them are likely to be included.

Now, clearly, some of these assets are liquid and can provide a cash flow, while others are not. It has been suggested that this fund will be used to purchase government debt in order to fully monetise the assets and boost government coffers. This seems strange to us since it would only succeed in worsening Cyprus’ debt level. It is also very likely to be rejected by the Troika for just that reason.

We also don’t necessarily see the benefit of extending the Russian loan. It helps from a cash flow sense, interest payments are cut by 2.5% and repayment is delayed by five years. But in the end Cyprus will end up paying €160m more. The Troika usually frowns on this type of approach.

CDU MP Hans Michelbach has also raised questions over the fund and specifically suggested it falls around €1bn short of providing the €5.8bn needed.

Laiki bank restructuring

The Cypriot Central Bank just announced that the second largest bank in Cyprus, Laiki Bank (or Cyprus Popular Bank), will be restructured and separated into a good and bad bank. This had been rumoured throughout the afternoon and sparked long queues at cash machines particularly Laiki ones, while the protests outside the Cypriot parliament have swelled with nervous Laiki bank workers and customers. The level of withdrawals has also been restricted to €260, while (somewhat ironically) the Central Bank has confirmed all depositors up to €100,000 will be guaranteed - no word on those above (see below).

This seems a reasonable move and could save between €1bn and €2bn on bank recap costs but problems abound. The cost of financing and winding down the bad bank will be large, who will finance it? Some reports suggest it could be the uninsured depositors – this may work but is likely to cause outcry amongst foreign investors and some Cypriot businesses.

The bill on bank restructuring is in front of the parliament now, along with a bill on the solidarity fund and a bill which includes some form of capital controls. It seems that the restructuring bill and the capital controls bill has support from the eurozone, but it is not clear that the solidarity fund does or the plans to fund the bank recap (as @SpiegelPeter notes).

The eurogroup will hold a call on this proposal at 6pm GMT, with a statement due after.

It is not clear if a vote will take place on it tonight in the Cypriot parliament, but we imagine they will at least need to wait for approval of the eurogroup.

What if the Cypriot parliament votes against the deposit levy?

This is the question which is now holding global financial markets on the edge - could it really happen and what would it mean, we assess the possible scenarios below.

Could the Cypriot parliament vote against the levy?

According to Reuters, Cypriot government spokesman Christos Stylianides told state radio that the vote “looks like it won’t pass”. Meanwhile, via Zerohedge:

• CYPRUS PRESIDENT: PARLIAMENT BELIEVES BAILOUT PLAN UNJUST, GOVERNMENT MAKING OTHER PLANS.
• CYPRUS PRESIDENT: PARLIAMENT WILL REJECT BAILOUT PLAN

As we were tweeting yesterday, the DIKO party (junior coalition member with 8 MPs) had said it would not vote for the deal without some improvements, although we suspect reducing the burden on small depositors could help convince them. The European Party (2 MPs) had previously said it would not support he levy, however, according to CYBC, it has now said it would support the levy if depositors are compensated with interest bearing government bonds (we assume linked to gas revenues, something which the government has already offered).

That said, according to the Cypriot press, the latest proposal sees deposits below €20,000 exempt, deposits between €20,000 and €100,000 taxed at 6.75% and deposits over €100,000 taxed at 9.9% - this is unlikely to satisfy demands to exempt smaller depositors. It also seems unlikely to raise the required €5.8bn, not least because it applies the same rate as the original to a smaller pool of deposits.

Separately, there are conflicting reports this morning on whether the vote will be delayed again. The government is unlikely to put this to a vote until it is almost near certain of getting it through.

What would the fallout be?

The fallout of voting down the package could be explosive and we can only speculate about what could happen next, but its eurozone membership would likely be brought into doubt. As we noted in our flash analysis, there are few other alternatives for Cyprus to raise the necessary cash, while the eurozone has made it clear it cannot foot the entire bill (such an option would make Cypriot debt unsustainable anyway).

The eurozone would likely give Cyprus a few days either to change its mind or come up with an alternative way of financing the €5.8bn. Another parliamentary vote could be held (the EU of course has form when it comes to demanding the 'correct' vote).

The ECB has already reportedly warned that rejecting a levy would have dire consequences. Specifically, the two largest Cypriot banks would go without recapitalisation and could see their liquidity from the ELA (sanctioned by the ECB via the Bank of Cyprus) cut off, leading to them becoming insolvent and collapsing – putting their €30bn of deposits at risk, since the government obviously cannot guarantee them. This would likely bring down most if not the entire Cypriot financial system.

With the financial sector close to or in the process of collapsing and no support forthcoming from the eurozone or ECB, since Cyprus rejected their terms, Cyprus could even be forced to leave the eurozone and begin printing its own new currency, one that would have little international trust and could lead to a spiral of hyperinflation, etc, etc (i.e. a very nasty scenario).

There is, of course, a chance that if faced with the prospect of Cyprus leaving the euro, the rest of the eurozone could blink and find an alternative way to bailout Cyprus but the politics of such a scenario would get very ugly indeed. The ECB may not follow through on its threat to withdraw liquidity for Cypriot banks but this would only be a temporary reprieve. The Cypriot government will run out of cash at the start of June when it needs to pay off a €1.4bn bond, while the banks' position could be worsened by the likely deposit outflows once banks open, even if the tax is not applied.

What are these “other plans”?

It’s not clear exactly what Cypriot President Nicos Anastasiades meant when he suggested the government is making 'other plans'. We have long noted that deeper connections to Russia remain a viable option for Cyprus. With Russia angry at the eurozone for trying to burn some of its depositors, some more financial support could be forthcoming (but maybe only for Cyprus outside the eurozone) – with significant geopolitical implications as we noted here.

Other options which have been bandied around include: a financial transaction tax and the recent proposal from Lee C. Buchheit and Mitu Gulati (the men partly behind the Greek restructuring) to convert deposits into deposit certificates with fixed long term maturities. However, the former has been widely rejected by Cyprus and may not yield sufficient funding. The latter is an interesting proposal but may only offer liquidity support rather than solvency, while the banks would still remain under-capitalised. Such a proposal would still require significant backing from the eurozone and Russia – both of which are likely to come with onerous terms – and present similar obstacles to a deal.

So, all in all a 'No' vote, however tempting to Cypriot MPs, only leaves more drastic alternatives, hence it remains a possible but not probable outcome.

Eurogroup distances itself from decision to tax small depositors in Cyprus

At some point yesterday, it became clear that Cypriot President Nicos Anastastasiades would not have sufficient support to push the deal on the deposit tax through parliament – at least not in its current form.

That led to an extension of the bank holiday to at least Thursday, the parliamentary vote being moved to 4pm GMT today (from yesterday) and the Eurogroup holding a teleconference yesterday evening.

The result of the conference was this statement, the key part being:

The Eurogroup continues to be of the view that small depositors should be treated differently from large depositors and reaffirms the importance of fully guaranteeing deposits below EUR 100.000. The Cypriot authorities will introduce more progressivity in the one-off levy compared to what was agreed on 16 March, provided that it continues yielding the targeted reduction of the financing envelope and, hence, not impact the overall amount of financial assistance up to EUR 10bn.

The statement seems to be more of a hand washing exercise than a definitive end to the issues plaguing the Cypriot bailout – i.e. do whatever you need to in order to raise the €5.8bn but don’t blame us for your political troubles.

Ultimately, it is not clear that deposits below €100,000 will not be taxed. The two options on the table remain:

-          Depositors with up to €100,000, taxed at 3%; those with €100,000 to €500,000 taxed at 10%; and those with over €500,000 taxed at 15%. (This could also include an exemption of deposits below €20,000).

-          Tax deposits over €100,000 at 15.2% and exempt deposits below €100,000.

How much difference will this move make?

Well, removing the burden on smaller depositors would be a positive one, as we have suggested. That said, with the cat out of the bag as it were, this is unlikely to dial down frustrations or concerns significantly. This option is now on the table and the political divisions it has exposed are unlikely to be easily papered over.

Despite the fact that it seems the Cypriot government played a large role in the decision to structure the tax to hit smaller depositors in the first place, the anti-German feeling seems to be rising. Meanwhile, we still believe that the position of the government – which was elected on the basis of ruling out losses for any (large or small, foreign or domestic) depositors – remains precarious.

The Great Cypriot Game - How important is gas to Cyprus' economic and geopolitical future?

Update 12:00 18/03/13:

Russian Finance Minister Anton Siluanov has had some interesting things to say on the deposit levy (via Reuters):

"We had an agreement with colleagues from the euro zone that we'll coordinate our actions."

"It turns out that the euro zone actions on the introduction of the deposit levy took place without discussions with Russia, so we will consider the issue of restructurisation of the (Cyprus) loan taking into account our participation in the joint actions with the European Union to help Cyprus."

It seems Russia is none too happy with the eurozone approach, unsurprisingly. If it does refuse to ease the terms of the €2.5bn bailout loan it previously gave Cyprus, it could hit Cypriot funding requirements, although probably not by a substantial amount. Still it could result in eurozone bailout funds being used to pay off a Russian loan in the near future - something which may not sit well with German taxpayers. Again, the interesting fall out will be to see how this impacts Russia's approach to Cyprus and the EU more broadly.

***************** Original post ********************************

In the middle ages, Cyprus was a key battle ground between great powers seeking dominance in the region. Well, the country - which, remember, only accounts for 0.2% of eurozone GDP - could become a hotspot once more (though we shouldn't be over-excited about this).

According Greek Reporter, Gazprom made an offer over the weekend to the Cypriot government to fund the bank restructuring planned under the Cypriot bailout (which is set to cost up to €10bn) in exchange for exclusive exploration rights for Cypriot territorial waters. How reliable this story is remains to be seen, but it does hint at the geopolitical tension which we have been warning about.

Gazprom is known to be very close to the Russian government and despite Russian President Vladimir Putin overtly slamming the deposit tax - calling it "unfair, unprofessional and dangerous" -  it is unlikely that they would let this opportunity pass untouched. Fortunately, the Cypriot government is said to have rejected the deal off the bat, but if displeasure towards the eurozone and the EU grows, the Russian option may become increasingly appealing.

So how important is the gas element for Cyprus' economic and geopolitical future? Well, there is no denying that Cyprus could potentially be sitting on top of gas reserves worth many times its GDP. However, as a revenue stream it is far from a sure thing. Here is how we put it in our flash analysis released on Friday:

Recent exploration has suggested Cyprus may have between €18.5bn and €29.5bn (103% - 163% of GDP) in untapped gas reserves lying in its territorial waters (according to Deutsche Bank). There have been rumours that this future revenue stream could be incorporated or used to backstop the bailout somehow. Although an appealing idea, there is still a huge amount of uncertainty around the real value of these reserves and how soon they can begin producing revenue

So far, one field has been explored (known as Block 12) and estimates of its potential value go as high as €100bn. See below for a useful diagram (via Baker Tilley):

However, there are a few key points to remember when considering the impact of this on the Cypriot bailout:

• Exports from the gas fields are not expected to begin until 2019 at the earliest. Cyprus runs out of cash in June this year, a short and medium term solution is needed now. Tapping the further reserves (beyond Block 12) will take even longer.
• There needs to be significant investment, potentially up to $4bn to begin extracting the gas – the Cypriot government certainly cannot afford this. Although there is sizeable interest in the exploration rights, the FT’s Nick Butler notes that Noble Energy (which explored Block 12) is not bidding for further rights, which raises some concerns.
• Furthermore, Turkey is still contesting Cyprus’ ownership of these reserves. Although Cyprus currently has the backing of the international community, this dispute could further hold up progress in tapping these reserves. Many of the energy companies looking into Cyprus also have interests in Turkey and may not want to put those at risk.

To us then, the offer by the Cypriot government to provide Cypriot depositors with bonds linked to gas revenues sounds like a nice idea, but will not compensate these depositors for some years, at best.

But, remember with a view to Moscow, this is definitely one to watch.