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Cyprus Economy Could Contract by 15%: Nomura

Monday, 18 Mar 2013 | 6:02 AM ET
Kakopetria in Solea Valley, Trodos, Cyprus
Wojtek Buss | Age Fotostock | Getty Images
Kakopetria in Solea Valley, Trodos, Cyprus

The decision to force bank depositors in Cyprus to contribute towards a euro zone bailout could mean the country's economy could shrink by 15 percent over the next two years, investment bank Nomura said.

At a grueling all-night meeting of euro zone finance ministers which ended on Saturday, Cyprus agreed to impose a "one-off levy" which would tax every depositor in a Cypriot bank under 100,000 euros at 6.75 percent. Those over that amount would face a 9.9 percent tax.

Markets opened sharply lower across Europe on Monday with Asian markets and Russia's MICEX index also tumbling over 2 percent. The banking sector was badly hit with financial institutions showing heavy losses across the continent.

(Read More: 'Unfair, Dangerous' Cyprus Deal Whacks Rich Russians)

Looking ahead to what this would mean for the country's economy over the next few years, investment bank Nomura gave a bleak picture.

"The Cypriot economy could contract by around 15 percent over the next two years if the measures are implemented," it said in a research note on Monday.

The proposals put forward on Saturday morning also included giving depositors shares in the banks in return for the levy. The benefits of that idea, however, were downplayed by Nomura.

Dutch Finance Minister Jeroen Dijsselbloem, who chaired the meeting in Brussels, said that under the program, the island's debt would fall to 100 percent of economic output by 2020, according to news agency Reuters. Nomura said, however, it was unclear as to how much the levy would impact the behavior of households and corporates, potentially altering Dijsselbloem's estimates.

(Read More: Cyprus Bailout Crisis Slams Brakes on Risk–On)

"The levy could be close to 15 percent of gross disposable income of Cypriot households, or 10 percent of GDP (gross domestic product). Even though their deposits will be replaced with equity and potentially natural gas-linked bonds, deposit holders' spending behavior would surely be affected."

In return for the emergency loan which would total 10 billion euros, Cyprus also agreed to increase its corporate tax rate by 2.5 percentage points to 12.5 percent. Nomura also argued that this would hit targets and would change corporate behavior, especially of those offshore companies that contribute about half of all corporate tax receipts.

Cyprus' growth was due shrink to 3.5 percent in 2013 and 1.3 percent in 2014, according to European Commission statistics. But this will have to be revised considerably, according to Nomura.

(Read More: Cyprus to Put Forward New Bailout Plan: Dow Jones)

"Our view (with the partial information we have so far) is that a figure closer to -15 percent for 2013-14 is more realistic, and will largely depend on the speed with which financial/economic stability can be re-established to avoid the recession continuing in 2015," it said.

The rapid downsizing of its financial services industry is even more important Nomura said, as it would have a longer-term impact on the country's growth potential.

"With a -15 percent recession in 2013-14 and 0 percent growth in 2015, the debt to GDP is set to peak around 128 percent of GDP during the program period from 145 percent in the baseline," it said.

"However, the 2020 impact is quite uncertain, especially since around 2018 the effects from natural gas investments should also have an impact. If the economy stabilizes by 2015-16, debt at 105-110 percent of GDP in 2020 is feasible even with a substantially lower potential growth."

By CNBC.com's Matt Clinch

Contact Europe: Economy

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