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How tiny Cyprus affects India and world
Financial markets around the world were rattled by developments in Cyprus, a small country in the European Union. Indian shares fell tracking losses across markets in Asia and Europe on Tuesday. This was despite a 0.25% cut in the benchmark repo rate by Reserve Bank of India on that day. The repo rate cut reduces the cost of borrowing for banks and borrowers. Stock markets were expecting a boost to the overall market sentiment with the rate cut as it reduces the cost of borrowing for companies and boosts profits. However, the crisis in Cyprus is hurting.
Here are things to know about the problem:
What is the problem: Imagine you are told that you need to pay 10% tax on deposits that you have in your savings bank account. The European Central Bank proposed that savings depositors in Cyprus should pay around 10% of the bank balance to bail out the banking sector. This is a sort of a wealth tax imposed on those who have a saving account in the Cyprus bank. Cyprus agreed to over $ 12 bn bail-out to help its troubled banks and to service government debt or pay an interest to lenders. The size of the bailout is half of Cyprus GDP of $ 23.5bn. However, later the Cypriot Parliament rejected such a deal. This brings an element of uncertainty to markets.
What is the consequence: The result of such an action has triggered a fear among depositors. Those saving money in Cyprus have decided to pull out their money and hoard cash. They are selling euros and buying US Dollar or any other non-euro currency. This puts pressure on the euro. It has also put pressure on other weak economies like Greece, Spain and Portugal. “The worry is that depositors in other financially weak, or bailed out, nations might fear similar bailout provisions in the future from the EU,” according to CARE, an Indian rating agency.
How is India affected: India’s equity markets rely heavily on money injected by foreign institutional investors. A weak sentiment in global equity markets directly hurts foreign flows into India. Daily FII flows into Indian equities slowed to around $ 20m to $ 30m over the past three days from well over $ 100m last week, according to the Securities and Exchange Board of India data. If the US dollar strengthens against the euro, it could put a further pressure on the rupee, according to CARE, the rating agency. This could make FIIs wait and watch the situation and slow down foreign flows to India.
Background : Cyprus's borrowing costs have risen steadily because of its exposure to Greek debt. Two of Cyprus's biggest banks are among the largest holders of Greek bonds in Europe and have a substantial presence in Greece through bank branches and subsidiaries. Greece went through turmoil as it has not been able to service the large debt. As a result, Cyprus experienced numerous downgrades of its credit rating in 2012 and has been cut off from international money markets. The Cypriot economy contracted in 2012 following the write-down of Greek bonds. A liquidity squeeze is choking the financial sector and the real economy as many global investors are uncertain the Cypriot economy can weather the EU crisis, according to the CIA Factbook, the resource website of US intelligence agency.
The European Central Bank wants Cyprus to raise 5.8bn euros from a tax on depositors in Cyprus. However, the Cypriot Parliament rejected any such plan. This could lead to the collapse of two large banks in that country, according to reports. The tax is 25% of the country’s gross domestic product or GDP. According to the CIA factbook, the country’s government earns $ 9.6bn in revenue and spends $ 10.6bn.