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No tax, no bailout? A worst case scenario for Cyprus

A Cypriot policeman stands next to graffiti in Greek reading 'Thieves' at the entrance of closed branch of the Laiki (Popular) Bank in central Nicosia on March 20, 2013.

Cyprus is in turmoil following the decision last night by its parliament to reject a bailout plan from the eurozone. The plan entailed a one-off tax of up to 10 percent on Cypriot bank accounts. But should the rest of the world worry about what’s happening on a tiny island nation in the middle of the  Mediterranean?

Yes, perhaps. 

Here’s the worst case scenario: Cyprus continues to reject the bailout deal. Its banks go bust. The country is forced out of the eurozone. Hedge funds speculate on which euro country will be next to head for the exit. There are bank runs across the continent, and mayhem in global markets.

Some observers say that this possibility makes it all the more remarkable that the Europeans -- and the Germans in particular -- refuse to pump that little extra bit of cash into the small island economy.

“It’s just ridiculous that they wouldn’t. That they threaten bank runs across Europe,” says analyst Louise Cooper. “They threaten contagion, for 7 billion. It’s ridiculous but the reason they’ve done it is because it’s German election year.”

The German government fears that if they cut a special deal for Cyprus, much bigger euro countries like Spain and Italy will be lining up for extra assistance. And that would be exceedingly unpopular with German voters. 

So far financial markets are taking the Cypriot fiasco in stride. They seem to believe that Europe cannot afford to let  Cyprus sink, or that the Russians will ride to the rescue -- but that eerie calm in markets may not last. 

About the author

Stephen Beard is the European bureau chief and provides daily coverage of Europe’s business and economic developments for the entire Marketplace portfolio.
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