Cyprus, like all other Eurozone countries, has been struggling with debt and recession. However, due to the recent crisis in Greece it is looking more and more likely that Cyprus will be the next country requesting a bailout from the Eurozone, like Greece, Portugal and the Republic of Ireland have before them.

Cyprus has a total of 23 billion euros (US$29 billion) tied up in the Greek financial crisis. The second largest lender in Cyprus, Cyprus Popular Bank, lost 1.8 billion euro (US$2.2 billion) in Greek investments. The Cypriot government has since underwritten the 1.8 billion euro equity issue to help the bank raise capital from other investors, but if the bank is unable to raise the money from other investors by June 30, 2012, the government will have to put up the funds itself – an amount equal to a tenth of the Cypriot economy.

Talks about Greece leaving the euro currency are also making Cyprus more nervous. If Greece leaves the euro they will most likely switch back to the drachma. However, Greece will no longer have the advantage of other countries to appreciate the value of their currency even though they have a bad economy, meaning the drachma will be severely devalued in relation to the euro.

This devaluation will cause Greece to default on their loans to other countries including not only the bailout to the Eurozone, but also to Cyprus. President Demetris Christofias stated, “[Greece leaving the Eurozone and the euro currency] is something I hope will never happen.”

Cyprus and its banks have not been able to borrow on international markets since June of 2011 after two of the world’s top three credit raters gave Cyprus a junk status.

Since then Cyprus managed to borrow 2.5 billion euros (US$3.1 billion) from Russia which it has used to survive for the past year. Cyprus is trying to find another independent investor or country to loan them the 1.8 billion they need to save Cyprus Popular Bank and their economy. According to the Telegraph, Cyprus is in talks with China for another loan and possibly another undisclosed investor as well.

The European Commission has recommended that Cyprus make significant changes to its economy. Some of these changes include fixing its public finances, recapitalizing its banks, reforming labor and service markets, revitalizing the energy sector, updating education policy, and correcting pension and healthcare systems. Cyprus will release a new plan that will hopefully help them reach their deficit goal of 2.5% of GDP this year. Cyprus also hopes to keep its low 10% corporate tax to encourage financial investments.

If Cyprus is unable to receive another investment from an independent nation or investor or Greece leaves the euro, it will need to request a bailout from the Eurozone.

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Paul Krugman, one of the most famous economists in the world, recently claimed in an interview with the BBC that Greece’s best option is to leave the Euro. Krugman stated, “Greece was seriously, seriously irresponsible even during the good years.” He compared Greece’s spending to those of the US and other European nations and claimed that the irresponsible spending was “not to the same extent.”

Krugman explained that the problem for Greece is that it cannot print its own money which gives it an “enormous vulnerability.” Therefore Greece has two options: accept the demands that Germany is imposing on them in regards to lending or to leave the Euro. Krugman declared, “Greece must and will leave the Euro.”

However, Krugman also points out that it is difficult for any Greek politician to say that Greece should leave. In fact, Krugman believes “whoever says, ‘that’s it’ will have ended his career.” According to Krugman, Greece leaving the Euro could happen in a couple of weeks depending on the outcome of the Greek elections. The other option is that the European banks will eventually refuse to lend to Greece which will force it to create its own currency again.

Ultimately Krugman claims that this is the most desirable thing for the Greeks and for everyone else in the Eurozone. He believes that the main ramification will be the fact that the Euro membership is reversible. The greatest worry is that there will be a run on the Spanish and Italian banks. However, as long as the European Central Bank is willing to supply the Euros for this run there should not be a major problem.

In another interview with the Independent, Krugman also went more in depth as to who should be blamed for the Eurozone crisis. Krugman believes that the Maastricht Treaty of 1992 is what originally caused this crisis because it led the way for the use of a single currency in Europe.

Michalis Sarris, chairman of the Cyprus Popular Bank also commented on the possibility of Greece leaving the Euro on 17 May 2012. Sarris claimed that Greece leaving the Euro was not “inevitable” but was a “clear possibility.”

 Ultimately Cyprus hopes that Greece will recover without leaving the Euro because many of its finances are tied up in Greek investments. Sarris reported that the Cyprus Popular Bank suffered a loss of about 2 billion Euro do to the financial crisis in Greece. Sarris is hopeful and remains positive that Greece will be able to find a way out of this crisis without having to leave the Euro.

Paul Krugman is winner of the Sveriges Riksbank Prize in Economic Sciences (informally the Nobel Prize in Economics), Princeton professor, and a columnist/blogger for the New York Times. His books include End This Depression Now! and The Return of Depression Economics and the Crisis of 2008.

Image Courtesy of  Portokalis / Shutterstock.com

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