Cyprus talks with lenders as debt sustainability in focus

NICOSIA Fri Nov 9, 2012 1:40pm EST

1 of 2. Representatives of the European Central Bank, International Monetary Fund and the European Commission arrive at Cyprus' finance ministry, where the third round of bailout talks are being held, in Nicosia November 9, 2012.

Credit: Reuters/Andreas Manolis

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NICOSIA (Reuters) - Cyprus launched a last-ditch bid with potential lenders on Friday to get financial aid needed before coffers in the tiny euro zone economy start running dry.

Battered by its exposure to debt-crippled Greece, Cyprus sought a full bailout from the EU and the IMF in June to buffer its banks and plug widening deficits after attempts to secure a credit line from Russia failed.

The government has said it could have difficulties paying salaries in December. It is currently heavily reliant on short-term financing from domestic banks.

Economists from the European Central Bank, the International Monetary Fund and the European Commission, known as the "troika", arrived for talks at the finance ministry on Friday morning. They did not speak to journalists.

"A great deal of work has been done, there has been progress in the negotiations with the troika until now," said Stefanos Stefanou, the Cypriot government spokesman and a member of Cyprus's negotiation team, referring to previous consultations with the group. "Obviously though a lot of work remains to be done."

The size of the potential bailout -- speculated to be anything between 11 and 16 billion euros and the bulk of it for banks -- will be huge in proportion to the 17.9 billion euro economy, the third smallest in the euro zone.

Debate on how Cyprus will manage to pay it back will feature prominently in discussions. Cyprus says it wants the euro zone's ESM bailout fund to recapitalize the banks directly, but heavyweights in the bloc disagree with the ESM undertaking legacy debt.

"Economically the biggest challenge of these talks will be how to get a deal which make the debt sustainable," said economist Fiona Mullen at Sapienta Economics.

The IMF, which announced its participation in the mission on Wednesday, hinted as much: It said it wanted a 'financing solution consistent with debt sustainability'.

Cyprus is already staring at a public debt which catapulted from 71 percent of GDP in 2011 to about 90 percent this year after coming to the aid of its second largest bank, Popular.

Lenders want privatizations, wage cuts in a public sector which is one of the most highly paid in Europe, a culling of wage indexation and the creation of a "bad bank" to park soured assets.

Cyprus says it will not privatize "profitable" state enterprises and its leftist President Demetris Christofias says he is prepared to take to the streets to defend wage indexation.

Friday's talks were open ended, but it was unlikely that a deal was imminent, a senior Cypriot official said on condition of anonymity.

(Reporting By Michele Kambas. Editing by Jeremy Gaunt, Ron Askew.)

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