There is an ongoing drama that warrants more attention than the media has afforded it. European policymakers are amidst negotiations regarding the scope and execution of an impending bailout for Cyprus -- the eurozone's fifth bailout. While the fact that yet another European nation needs a bailout is important in its own right, this bailout -- while small -- represents certain obstacles that policymakers will have to surmount. The fashion in which they accomplish this has implications for bailout policies going forward, and has the capacity to shake the tenuous confidence ECB President Mario Draghi has afforded the region via threats of unlimited bond purchases.
The European Commission forecasts that Cyprus' public debt will reach 97% of its gross domestic product (GDP) in 2013 and 103% by 2014. However, the nation's banks experienced losses in excess of four billion euros as a result of the Greek debt restructuring. It is estimated that Cypriot banks will require up to 10 billion euros ($13.19 billion) worth of bailout aid to stabilize their finances. The problem is that this figure represents more than half the size of Cyprus' economy, and would be the second largest bank bailout as a proportion of GDP. Should Cyprus attempt to satisfy its banks' capital requirements on its own, its debt-to-GDP ratio could balloon to 140% when accounting for the 10 billion euros of bank aid and the 1.5 billion euros needed to cover government deficits over the bank bailout's four-year duration. Realizing this level is unsustainable, Cyprus requested an official bailout in June 2012, and European policymakers have been deliberating ever since.
A report highlighting more definitive figures regarding Cypriot bank funding requirements is scheduled to be released in mid-January. As such, European policymakers will probably hammer out the final details of the bailout package in late January or early February. The Cypriot government has indicated it has enough cash to stay solvent until March. Given the relatively tranquil funding environment currently enjoyed by Europe's indebted periphery, it is unlikely that European policymakers will want to compromise the respite with concerns of a Cypriot insolvency. Considering this, it seems plausible to expect definitive bailout guidelines before Cyprus runs out of cash in March.
However, complicating the bailout deliberations was an emphatic statement released by Cyprus' current President, Dimitris Christofias, indicating he would not consent to any privatization of state-owned entities as part of a bailout package. Citing a commitment to his party, Christofias said that any bailout containing such stipulations would have to wait until the next government can sign it after the country's Presidential election on February 17. It is not uncommon for bailout packages to include measures to raise capital via the sale of state-owned assets.
Considering that European policymakers promised Greece's record setting debt restructuring as a one-of-a-kind instance, a similar restructuring does not seem possible for Cyprus -, unless of course policymakers are willing to recant on this past promise. The risk of forcing private creditors to accept losses on Cypriot debt is that it could undermine the current confidence in peripheral European debt, and could usher in another round of funding pressure for countries like Spain and Italy.
Considering the detriments of private sector involvement, it seems likely that state-owned asset liquidations will almost certainly be part of a Cypriot bailout. However, due to Christofias' refusal to agree to privatizations, we can reasonably assume that a bailout accord will have to wait until after Presidential elections in mid-February. The fact that Cyprus runs out of cash in March means that any agreement will probably come in right under the wire. This brinkmanship could compromise the more risk tolerant environment that has emerged recently and allowed yields on Spanish and Italian debt to reach multi-year lows.
Cyprus is the eurozone's third smallest economy, meaning that the full size of the nation's funding requirements is relatively insignificant when compared to the capital needs of larger economies. As such, the bailout proceedings in this instance have not garnered the same degree of media attention as past measures. However, if a decision is not forthcoming as Cyprus teeters near default heading into March, a sudden bout of risk aversion in credit markets could break the reverie afforded in recent months to peripheral European nations like Spain and Italy. It is for this reason that market participants would do well to monitor any developments pursuant to Cyprus' impending bailout.
While solvency concerns would intuitively benefit precious metals, remember the transient correlation between metals and risk assets that was especially pronounced in 2012. Therefore, it is likely that contention and delays surrounding Cyprus' bailout could trigger a risk-off mentality, meaning it is feasible that metals could sell off along with stocks and other risk assets in that environment. Should this occur, depressed precious metal prices will provide an attractive entry point for investors who realize that national solvency concerns and a further strain on the inter-nation relations in Europe are positive for precious metals in the long-run.
There is also the chance that European policymakers can establish the bailout framework and Cypriot politicians can agree to it in a timely fashion, which should benefit risk tolerance and lend strength to the broader risk complex. However, considering the fairly small scale of this bailout, the positive effects of an amicable resolution will probably be limited. It is the implications of delays and the threat of Cyprus defaulting that could affect more dramatic developments in the investment world.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.