Cyprus Bailout 'Disaster' Risks New Euro Crisis

Nicos Anastasiades
Aris Messinis | AFP | Getty Images
Nicos Anastasiades

Even as Cyprus's President Nicos Anastasiades addressed the nation on Sunday night, saying savers would be compensated by shares in banks guaranteed by future natural gas revenues, he was said to be working to renegotiate terms of the highly criticized bailout deal.

Over the weekend, analysts warned the decision by the euro zone to force bank depositors in Cyprus to contribute towards a bailout—a first in the euro zone debt crisis—could hurt other peripheral nations, the euro and the global stock market rally.

That warning appeared to be coming true as the euro tumbled on Monday, falling below $1.29 in Asia trade to its lowest level this year. Asian equity markets were also deeply in the red as jitters over the Cyprus bailout dealt risk appetite a blow.

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

In his televised address, Anastasiades said he had to accept a tax on bank deposits in return for international aid, or else the island would have faced bankruptcy.

"The solution we concluded upon is not what we wanted, but is the least painful under the circumstances," Anastasiades said.

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In that speech, Anastasiades urged lawmakers to approve the tax in a vote Monday.

About 25 lawmakers from the communist-rooted AKEL party, the socialist EDEK and the Greens said they won't vote for the tax in the 56-seat Cypriot parliament amid deep resentment over a move some called disastrous. If Parliament rejects the tax, that would put the entire aid package in jeopardy. The vote was initially set for Sunday but was postponed until Monday—a national holiday in Cyprus.

The announcement of the vote postponement set off an immediate scramble among top European financial officials. One lawmaker told The Associated Press that European Central Bank was pressuring Cypriot authorities to hold the vote without delay.

Bailout is a 'Disaster'

Still, the structure of the bailout shocked many, including Sharon Bowles, chair of the European parliament's economic and monetary affairs committee, who called it a "disaster" for European Union rules and the single market.

(Read More: Cyprus Rescue Not a Fit for Other Countries)

Euro zone finance ministers forced Cyprus' savers to pay as much as 10 percent of their deposits towards a bailout of the country's troubled banking sector, a move which is expected to raise 5.8 billion euros. In return, the country will get 10 billion euros ($13 billion) in assistance.

The arrangement, structured as a bail-in, would give depositors shares in the banks in return for the levy.

According to the Financial Times, Cypriot authorities were trying to shift more of the burden to deposits larger than 100,000 euros, and adding an additional bank holiday on Tuesday to prevent a run on the nation's banks.

(Read More: Cypriot Authorities in Revised Deal Talks)

Sebastian Galy, senior currency strategist at Societe Generale warned the levy could unleash a sell-off in the euro and the stock and bond markets of peripheral nations on Monday.

In Asia, equity markets took a beating, with stocks in Japan and Australian falling 2 percent.

"This will probably go down as an ill thought-out rescue plan with consequences for peripheral Europe," Galy wrote in a research note. "It breaks a cardinal rule, namely public trust on which money relies…Some peripherals will suffer at the opening in Europe and [it will] hit EUR."

Doug Kass of Seabreeze Partners on Twitter predicted European stock markets could fall 3 to 4 percent on Monday, while the S&P 500 could fall 1.5 to 2 percent and Spanish and Italian 10-year yields could jump 15 basis points.

"The news is a wake-up call to investors that the European sovereign debt issue is far from being resolved," Kass said in a note.

But Marshall Gittler, head of global forex strategy at IronFX, an online trading platform, took the opposite view, arguing the bailout could be positive for the single currency.

(Read More: Cyprus Parliament Postpones Key Session)

"This settlement—assuming it passes—removes that tail risk from the market. It also puts Cyprus on a healthy footing, with a debt/GDP ratio estimated at 93 [percent]—not far off the EU average of 90. The economy here can start growing again. So it's a win-win for the EU and Cyprus and should be well received by the markets," he said.

Meanwhile, The New York Times reported on Saturday that savers had already been trying to withdraw money from banks via ATMs and that many machines had run out of cash. But it might be too late already. Cyprus has declared a bank holiday on Monday to prevent such a run on the banks and banned electronic transfers.

Cyprus Finance Minister Michael Sarris defended the government's decision in an interview with CNBC: "It's not a pleasant outcome, especially of course for the people involved. But we believe it is something that, compared with other possible outcomes, is the least onerous. And we also believe that the exchange of this levy with shares in the banking institutions affected gives an upside potential."

But the rescue has already been thrown into doubt with Cyprus' parliament postponing an emergency session on Sunday to discuss the levy and several parties opposing the deal.

"When the dust has settled on this deal, which I hope it never does, we will see that the single market has been sold down the river for a shoddy price," said the EU parliament's Bowles.

-Reuters contributed to this report.