Why Cyprus should ditch the euro

Cyprus should leave the eurozone. The punitive “bailing in” of Cypriot depositors will throw the economy into a profound recession from which it could take many years to recover. Leaving the euro would also be painful but it would at least be productive pain. A devalued currency would provide Cyprus with the competitiveness needed for future growth.

Cyprus’s plight resembles that of previously bailed-out eurozone economies but is worse because of the new “bailing in” elements. The citizens of Greece, Ireland and Portugal have retained savings in euros that are worth what they were before crisis occurred. But in the Cypriot case savings above €100,000 are set to be taxed heavily—at a rate rumoured to be 40 per cent. The direct and indirect impacts on the Cypriot economy will be devastating.

Cypriot households and businesses are going to suffer an immense loss of wealth without any corresponding fall in their liabilities. Spending will plunge. Bankruptcies are inevitable. Unemployment, at 14 per cent, has already quadrupled since 2008, and it will soar far higher. Debt burdens—national, corporate and household—will become less tolerable. The result seems likely to be at least one and perhaps two years of double digit falls in annual GDP.

But that is only the immediate cataclysm Cyprus faces. More worryingly, it is hard to see where fresh growth will spring from. The offshore banking industry has now been brought down and is unlikely to revive. Even a substantial natural gas find may not be big enough to turn around the island’s fortunes.

Cyprus faces crisis but it will not get the usually benefits of crisis: change that prepares the way for a fresh phase of growth. Devaluation and debt default are the usual remedies in countries torn by economic crisis. They are ugly but they do prove revitalising. In Cyprus it is hard to see how recovery can take place without them.

The euro exit route would also be far from pleasant. A newly created Cypriot currency would undoubtedly plunge. All the nation’s previous euro savings could easily lose half their value, or even more. Inflation would rise. Default on many debts would be inevitable. GDP would at first fall very heavily.

But devaluation would also make economic recovery possible. The island would become cheap and competitive. As in Iceland, whose fate Cyprus might well emulate, a tourism boom would be certain. Unemployment would not prove as persistent as it has been in Greece and Spain, where the rates are now a hideous 26 per cent.

Ultimately Cyprus would be a test case for something new: an exit from the eurozone currency bloc. And it could prove to be a pioneer. Greece and other eurozone periphery economies, condemned at present to continuing recession and very high unemployment, may see that having left the zone Cyprus finds a way forward. Nor need departures from the euro be an utter disaster for the currency itself. The euro founders’ big mistake was to cast the net too wide. A smaller zone might ultimately be a healthier one.