Morgan Stanley analysts say the unprecedented depositor haircut agreed to as part of this weekend's bailout deal of the Cypriot banking system will be good for the sovereign, echoing similar comments by Goldman.
Daniele Antonucci, a Europe economist for Morgan Stanley, says that " assuming a successful implementation of the bank levy, the Cyprus debt trajectory can shift downward to a more sustainable path (see chart), in line with the 100% debt/GDP target for the 2020."
However, there are four big problems facing successful implementation of the controversial plan, according to Morgan Stanley (and one of them is Russia).
The first is that the Cypriot government may not approve the package. The deposit haircut is wildly unpopular in Cyprus for obvious reasons. However, there are already reports this morning that the government is considering revising the deal to allow those with the lowest account balances to avoid the tax, making it more progressive, so this could help it pass through parliament a little more easily.
Second, while the IMF has gotten involved with a financial contribution, it hasn't mentioned a role as a supervisor of the program and enforcer of conditionality yet.
" It is worth highlighting that a rescue programme without IMF supervision may disappoint investors and cause market volatility," says Antonucci.
Third, the Cypriot government will likely face legal challenges over the decision to impose depositor haircuts.
" According to the FT, the domestic depositors will be compensated with banks stocks, unlike foreigners, writes Antonucci. "Although there are not enough details to draw an educated conclusion, we cannot rule out possible legal challenges due to the different treatment of depositors based on their domicile."
Finally, there is Russia, which seems like the most substantial issue:
Russian Response: With regards to the Russian role, the planned trip by Cypriot ministers to Moscow early next week may indicate that Russia is not yet on board. The levy is probably a negative surprise in Russia, and Russia's support may prove difficult to secure without further concessions.
Russia is likely to weigh three important factors: 1) the significant loss for Russian depositors on the levy, with deposits from non-EU residents, many of whom are Russian, amounting to 31% of the total (€21bn) at end-Jan 2013; 2) the reduction in the role of Cyprus as a provider of finance for Russia, as the banking sector shrinks; and 3) the cost of a longer repayment schedule and lower interest rate on the €2.5bn Russian loan to Cyprus provided in 2011.
In our view, Russia may only agree to adjust its €2.5bn loan and support IMF participation when a) it has clarity on the impact of the measures on Russian interests and b) it has secured some mitigation of the levy's impact on Russian depositors, and some constraints on the shrinking of the banking sector to protect Russian interests.
It seems like it could be difficult for Russia to secure concessions that could protect its interests in Cypriot banks, as the government in Cyprus seems keen on making the haircuts more progressive.
Naturally, this means that all of the wealthy Russian oligarchs hiding money in Cyprus will have to pay more, not less.
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