Cyprus’s plan to impose capital controls threatens to test the ties that bind Europe’s monetary union and could see euros on the Mediterranean island valued differently to those in the rest of the bloc.
The capital controls, being imposed to avert a run on banks after an EU bailout, will limit foreign transactions and capital outflows but not movements of money within the country itself.
The controls could be in place for a few weeks although the experience of other countries, such as Iceland, suggest it may take much longer.
After 12 days shut, banks in Cyprus reopened for business yesterday, replenished with cash flown in from the Frankfurt-based European Central Bank and reinforced with guards posted at their doors.
After a rollercoaster few weeks, lenders were taking no chances. In Nicosia, the divided capital, customers who waited under the hot midday sun were handed hastily photocopied printouts listing the arsenal of capital controls the newly bailed-out state has been forced to exact to stop a mass exodus of money from the country.
The story that emerged was of the extraordinary calm that Greek Cypriots were prepared to exhibit on a day when many inside and outside of Cyprus had feared a potentially devastating run on the island’s banks.
Far from panicking, the people now on the frontline of the eurozone debt crisis took a pragmatic approach to the disaster and formed an orderly queue.
Depositors in Cyprus are allowed to withdraw up to 300 euros a day under the draconian restrictions introduced by the finance ministry to “safeguard the stability of the system”.
Despite the efforts to control the outflow of funds, Cyprus’s central bank said that foreign depositors had already withdrawn 18% of their cash from the nation’s banks in February alone.
The impact the restrictions have on the Cypriot economy depends on their exact nature and whether they are applied to payments as well as capital transfers.
Restrictions on payments would be a far bigger incursion into the functioning of Europe’s internal market than controls on capital transfers, as euros held in banks in Cyprus could not be used to pay for goods and services elsewhere in the bloc.
By definition, that would make them less liquid than French or German euros and de facto, worth less.
If capital controls are relatively short-lived, that situation would be reversible. The longer it goes on, the more it would question Cyprus’s place in the eurozone.
But with the alternative likely to be massive capital outflow, Nicosia has little choice.
Cyprus’s plan to impose capital controls will mark a first for the 17-country eurozone.
The experience of Argentina’s ‘corralito’ a decade ago, when authorities restricted withdrawals to prevent bank runs, offers a recent precedent but the Cyprus case breaks new ground.
Restricting capital transfers - movements of money or securities - to other countries but not payments could open up myriad ‘work around’ options for people trying to get their money out of Cyprus.
One could be to buy goods in another eurozone country, shifting funds out of the island to pay for them.
To counter such scenarios, the Cypriot government could introduce limits on such payments or require them to be approved by a licencing authority - red tape that will impede business and slow turnover.