After a disastrous bailout of the Cypriot banking system, one of the world’s top rating agencies downgraded the sovereign rating of Cyprus. One of the concerns cited by Moody’s is the possibility of Cyprus leaving the eurozone.
Moreover, the ratings agency believes that the restructuring of the two biggest Cypriot banks will lead to “economic dislocation” and that the imposition of capital controls will further increase the risks of exiting the eurozone.
Moody’s analysts are not the first to point out such a possibility. Several politicians and economists have advised the Cypriot government to return to the Cypriot Pound in order to make the island’s economy competitive. One of the most vocal supporters of the return to the Cypriot Pound is the conservative British MEP Daniel Hannan who told SkyNews that the best solution for Cyprus is to default on its debts, decouple from the eurozone and devalue the local currency. Even the local religious leaders, like the Archbishop of Nicosia, have raised their voice in support of exiting the eurzone.
The international rating agencies consider that a return to a national currency would be a disaster, but it is worth noting that a partial return to a national currency has already taken place. Because of the capital controls imposed by the ECB, a euro from the Cypriot banking system does not have the same qualities as a euro from an account in a German bank.
A “Cypriot euro” cannot be freely exchanged or transferred to a bank account in another country, so it is safe to say that the European Union has two types of currencies, a “normal euro” and “Cypriot euro”. Most likely, the capital controls will not be lifted soon, even though the European officials promise that the free flow of capital will be allowed next week. If the capital controls are lifted, the massive capital flight from the Cypriot banks will instantly bankrupt the island’s banking system, so the ECB will be very reluctant to lift the restrictions on capital flow.
Today, Cyprus has a surrogate national currency but doesn’t have any benefits associated with it, because Cyprus can’t print the “Cypriot euro”. If this is the case, then why not go all the way and take Daniel Hannan’s advice? Defaulting on the sovereign debts, decoupling from the eurozone and devaluing the local currency is not a panacea but is likely to be a better solution than the toxic bailout prescribed by the Eurogroup.
Categories: EU Erosion