The International Monetary Fund today agreed on terms with Cyprus for the country's bailout. The result, and the response of Cypriot officials to the arrangement, tell us quite a bit.
Under the deal, the IMF will give Cyprus 1 billion euros ($1.3 billion) and the European Union will provide an additional 9 billion euros. As we know, the price of the bailout was lowered by collapsing the two biggest banks in Cyprus and taking money from their large depositors.
In addition to losing their offshore-finance business, the Cypriots will have to undergo austerity -- 5 percent of gross domestic product worth of cuts by 2015, and 4.5 percent of GDP in cuts annually by 2018, according to the Wall Street Journal.
More money will come from increased taxes. Arguably, though, we now know the difference between the corporate-tax rate in an offshore tax haven, and the lowest rate that the EU will accept as just a low-tax regime, if it gets a say. The IMF deal requires Cyprus to increase its corporate-tax rate from the current 10 percent to 12.5 percent -- the same as the base rate as in Ireland.
A final hammer is taken to Cyprus's offshore model by doubling the tax rate on interest income, to 30 percent from 15 percent, according to the WSJ report.
Just as interesting, though, are the activities of Cyprus's commerce minister, George Lakkotrypis. On live TV, he read from the text of the loan agreement to state that revenue from, and management of, Cypriot hydrocarbon reserves would be "under the full authority of the Cypriot government" -- clearly a big concern for a population wondering where the wealth will come from when the big Russian money is gone.
Lakkotrypis is losing no time. He is on his way to Lebanon, which is unhappy about the way Cyprus and Israel have been carving up the eastern Mediterranean to explore for gas. He will move on to Israel on April 8. He said he would have "concrete proposals" for the Israelis. The Cypriots want to move exploration forward as quickly as possible and then to pre-sell natural-gas contracts for future output in order to finance construction of an liquefied-natural-gas terminal to export the stuff. Obviously, if the IMF has its claws into Cypriot gas revenue, the money might be used to reduce deficits instead. Hence the "hands-off" assurance in the loan agreement.
The Cypriots are right that their best hope for a comfortable future lies in natural gas, and the choice of LNG makes sense: A pipeline to Greece would be wildly expensive and a pipeline to Turkey puts the Cypriots at the mercy of their sworn enemy, which still has troops on the northern half of the Island. Building the terminal, though, shouldn't stop Cyprus from exploring a deal with the Turks, who have begun a rapprochement with Israel and are definitely open to a deal on a pipeline. The Turks also look like swamping any Cypriot efforts in a race to drill for gas and oil, deploying more new rigs than any other country in Europe, including Norway.
Ultimately, Cyprus will need to reunite its Greek and Turkish halves in order to make its gas windfall safe from legal and physical challenge. This is a big opportunity that could unlock more gas, more investment, and more of the political stability that increases tourism. Played right, Cypriots could one day look back at the collapse of their flawed big banks as a blessing in disguise. Admittedly, the odds against everyone involved doing the right thing are long.
(Marc Champion is a member of Bloomberg View's editorial board. Follow him on Twitter.)
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