(An earlier version of this story ran online.)
Ionna Constantinou, a 24-year-old lawyer in Nicosia, Cyprus, was up early on March 16, packing her bags for a weekend holiday in London. She turned on her laptop and logged on to Facebook (FB). “You see people screaming, posting links, and you say, ‘What’s happening?’ ” she recalls. The news—that the leaders of the tiny island nation in the eastern Mediterranean had agreed to raid deposits in the country’s banks as part of a bailout deal—instantly upended Constantinou’s plans. She and her boyfriend, a lawyer named Simos Angelides, immediately canceled their flights. They waited for the banks to reopen, to see whether their savings would still be there. And like all Cypriots, they wondered whether the financial system was about to collapse and take their country down with it. “It was like an atomic bomb that fell,” says Angelides, 35. “Now we’re just living in the radiation.”
In the early hours of March 25, after more than a week of wrangling between officials in Nicosia and Brussels, Cyprus reached a deal that may have prevented it from tumbling out of the euro. In exchange for a €10 billion ($12.8 billion) bailout from the European Union, the European Central Bank, and the International Monetary Fund, the nation’s newly elected president, Nicos Anastasiades, agreed to shutter the second-largest bank, Cyprus Popular Bank, largely wiping out deposits above the insured limit of €100,000. Depositors in the country’s biggest bank, Bank of Cyprus (BOC:GA), could lose as much as 40 percent of their uninsured savings.
The bailout hardly represents salvation. Although it plugs the government’s financial gap, it will devastate Cyprus’s services sector, which, including tourism and banking, accounts for 80 percent of Cyprus’s gross domestic product and 72 percent of its employment. “If you come in six months, everything will be closed, for sale, for rent,” says Angelides. “Cyprus will be a ghost country.”
Seemingly overnight, life has become unrecognizable. For much of the past two weeks, with most businesses closed, Cyprus’s 800,000 citizens were waiting to see how much economic pain they would have to endure. By temporarily sparing the savings of smaller depositors, the revised terms of the bailout allowed Europe’s leaders to avoid further political embarrassment. But it did little to lift the mood on the streets of Nicosia and Limassol, or ease the sense that the nightmare has just begun.
Cyprus is the third-smallest nation in the EU, a place known for its beaches and its banks, and has survived at least one similar shock before. Many in the country compared the current crisis with the one that followed the 1974 Turkish invasion of the northern third of the island, when roughly 200,000 Cypriots, mostly Greek-speaking, were displaced from their homes, and tourism—then the largest industry—came crashing to a halt. “The difference is that then the global economy was not in crisis,” says Maria Demetriou, the owner of a cooking oil manufacturer that employs 100 workers. “People were able to relocate.”
This time there’s no refuge. The government closed the banks to prevent a run on deposits. Long lines formed at ATMs, but stores and restaurants were empty. “I went and got the cash, and then I tried not to spend it,” says Stelios Panayides, an analyst at the Bank of Cyprus’s International Business Unit. “I went once to the grocery store and two times to the pharmacy for my children.” Nicosia’s commercial center, usually buzzing with foot traffic, was eerily vacant. “I went for a walk with my kids,” says Panayides. “The shops were empty. The groceries were empty. The streets were empty.”
With the banks unable to open, grocery stores, gas stations, and pharmacies, desperate for cash with which to pay their suppliers, began refusing credit cards. Checks—particularly from Cypriot banks—were considered void. Even the customs agency began demanding that the duty on incoming goods be paid in cash. “My whole factory was sitting there, twiddling their thumbs,” says Demetriou. “The only businesses that worked were the supermarkets, because people had to eat.”
Such scenes of desolation may only hint at the scale of hardships to come. Cyprus’s banking sector holds assets equivalent to nearly seven times the nation’s GDP. In a country already hit hard by recession, the sector’s implosion will blast a huge hole in the economy’s hull. Once Cyprus’s financial institutions reopen (the Bank of Cyprus said it would on March 28), foreign money may flood out as fast as the capital controls will allow. “The economic model as we knew it won’t survive,” says Costas Severis, a former member of the board of directors at the Bank of Cyprus who resigned on March 26. Some estimates put the projected loss in GDP as high as 20 percent. “Cyprus has no industry,” says Andreas Neocleous, head of one of the country’s largest corporate law firms. “Cyprus has no agriculture. We don’t know how to do anything else.”
The importance of Cyprus’s financial sector dates back to the late 1980s and early 1990s, when the country became the banking center for the Wild West economies of Russia and its neighbors. Roughly half of the €50 billion deposited in the country’s banks belongs to non-Europeans; the vast majority are Russian. European governments have long suspected Cyprus of being a tax haven and a center for money laundering. In recent years, however, the sector has changed its ways, according to the country’s politicians and bankers. In 2003, as part of negotiations for joining the EU the following year, Cyprus introduced a corporate tax of 10 percent (it rises to 12.5 percent this year). In 2009 it was placed on the Organisation for Economic Co-operation and Development’s “white list” of countries that have “substantially implemented” international standards on tax transparency.
Although Cyprus does suffer from an inefficient public sector, its problems are different from those of its southern European neighbors. By EU standards, its government has been fiscally responsible. In 2011 the country’s debt was 71 percent of GDP, compared with 121 percent for Italy, 81 percent for Germany, and 87 percent for the euro zone as a whole.
Cyprus would probably be in good shape if not for the 2011 bailout of the Greek government engineered by euro area ministers, which required a haircut for holders of Greek bonds. Having spent much of the previous decade rapidly expanding into their larger neighbor, Cyprus’s banks were fatally exposed. A mixture of greed, political pressure, and misguided patriotism had spurred them to gather huge amounts of Greek bonds, all of which suddenly lost more than half their value. The devastation left a nearly €4 billion hole in the finances of the two biggest Cypriot banks. The slump that followed delivered another blow, leaving them with billions in nonperforming loans. “There is not the slightest doubt that the Cypriot financial crisis is the result of the Greek economic crisis,” says George Vassiliou, a former president of Cyprus.
The nation’s problems may have been beyond the capacity of any government to fix. But not having control over its monetary policy certainly didn’t help. A country with its own national currency can ease pressure on its finances by devaluing its currency or allowing inflation to rise. Cyprus could only ask its depositors to take the hit. “Inflation seems to people like snow or rain, a natural phenomenon that nobody’s responsible for,” says Marshall Gittler, head of global foreign exchange strategy at IronFX, an online trading company based in Limassol. “When deposits are cut, voters can see the guys who are doing it on TV. They know their names.” Bound by tight European monetary policy set in Frankfurt and Brussels, the country was also hurt by the downstream effects of election-year politics in Germany, Europe’s biggest economy. German politicians, including Chancellor Angela Merkel, can’t afford to be seen taking anything but a hard line in negotiations with a nation widely seen as a haven for Russian oligarchs. “The malicious intent is clear,” says former President Vassiliou. “They wanted to punish the Russians. In practice, they punished Cyprus.”
Along with Ireland, Cyprus has one of the highest education rates in the EU, and English proficiency is widespread; 48 percent of its 25- to 34-year-olds have a university degree or its equivalent. Many are lawyers and accountants who can take their skills abroad. For older Cypriots and those dependent on the financial sector, the future looks more dire. “It feels like a war situation,” says Anna Papaioannou, 51, an employee in Cyprus Popular Bank’s IT department. “It’s like you have cancer and instead of treating the patient, you kill him. And then you say the problem is solved.”
Papaioannou and her husband have five children, two of whom are still in university. They are making payments on five student loans as well as the mortgage on their house. Papaioannou already accepted a 10 percent salary cut in October, and an additional 8 percent cut was expected in March. Last year her husband lost his job as an electrical engineer. He spent nine months unemployed before finding work as a computer science instructor in the town of Polis Chrysochous, which meant having to rent an apartment on the other side of the island.
This winter, to make ends meet, Papaioannou turned off the heat in her house. “At our age, in this economic situation, how can we find another job?” she says. Adding to the anxiety is the fate of a collective savings plan, hundreds of millions of euros in deposits belonging to Cyprus Popular Bank’s employees. If Parliament doesn’t act to save the savings, the fund will be completely wiped out by the bank’s collapse. “Maybe we’ll end up without work and without savings,” says Papaioannou. “We’ll have to ask for help outside churches or community centers.”
The uncertainty has fueled conspiracy theories. In 2004 the islanders rejected in a referendum a union with the northern Turkish-occupied part of the island on terms they considered disadvantageous. Many fret that Turkey and others will now take advantage of Cyprus’s weakness to force them to accept the union. Another worry regards recently discovered natural gas reserves off Cyprus’s southern coast and the possibility that their profits could be seized to pay off an ever-increasing deficit. Constantinou, the young lawyer, has more basic fears. “I’m also scared of getting robbed,” she says. “People will be pulling their money from the banks, and they will know everybody has cash in the house.”
Some Cypriots are warning of a looming meltdown, should people like Papaioannou find themselves unable to pay their mortgages. “What happens if there’s a massive recession and more loans can’t be repaid?” says Stavros Malas, the runner-up in February’s presidential election. Already, many expect real estate values to drop as repossessed properties flood the market.
The crisis has left Cypriots with a deep sense of bewilderment, bitterness, and betrayal. “What was the main reason we joined the euro?” says Demetra Kattou, 47, a French teacher in Limassol whose husband may soon lose his job at Cyprus Popular Bank. “It was a matter of security, to have friends to help us survive.” In Kattou’s school, the students have been distracted, infected by their parents’ stress. “I teach French, and I’ve been telling them that the French are our friends. The children are asking me, ‘Why are we learning their language if they’re not going to help us?’ ” she says. “We’re talking about 12- and 13-year-olds who no longer have a future.”
She compares the situation to Greek tragedy. “In ancient Sparta, they would throw crippled children from the mountain,” she says. “We feel like we’re being thrown away because we are helpless, we are weak. In other countries, don’t they help those that need it?”