Cyprus to Join PIIGS?
It is not every day that Cyprus makes it into the news, but recently there have been fears that it will join the PIIGS in the European debt crisis. Like many of the PIIGS (Portugal, Ireland, Italy, Greece, and Spain), the Cypriot economy and finances were doing rather well before the global recession began in 2008. As the below charts show, the economy grew fairly strongly between 1999 and 2008, and Cyprus was able to cut its government deficit so that it in fact had 3.4 percent government surplus in 2007. This growth and budget cutting allowed the Cypriot government debt to fall below the magical 60 percent of GDP, allowing it to join the euro in 2008.
However, it now appears the Cypriot economy had a potentially fatal Achilles heel: Cyprus has a huge banking sector (according to The Economist, it is about seven times GDP), and these banks are heavily exposed in its Hellenic brother, Greece. As a result, a Greek haircut would severely hurt Cypriot banks, requiring the Cypriot government to probably have to step in and recapitalize the banks. This potential tragedy is becoming common among small European island countries. After all, Iceland and Ireland also had similar economic success stories that turned out to have been built on shaking banking ground and then suffered economic decline.
The spark (in this case literally) for a Cypriot economic calamity was an explosion on July 11th that destroyed the Vasilikos power station, which accounts for half of the country’s power supply. As a result, The Economist speculates that Cyprus will probably not be able to grow its way out of its fiscal problems this year. A bailout may have to follow. Sadly, after Cyprus, only one European island country remains which has an oversized banking sector and has not yet been in the sights of international markets—tiny Malta.