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Made in Germany

Cyprus and the Euro Crisis

We discuss the issue with our studio guest, Marcel Fratzscher, President of the German Institute for Economic Research.

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DW: Economists say that the Cypriot economy could contract by 10% or more in the years ahead. What do you think about that?

Marcel Fratzscher: It's very hard to predict how exactly the Cypriot economy will evolve. I think, if you look at Greece, it contracted by close to 20 percent over the last couple of years. So these figures are probably not entirely unrealistic. But there is a huge amount of uncertainty and we have to see how the program now plays out. And whether we can -- from the European side and the Cypriot side -- regain confidence in Cyprus. And that will be the decisive factor for the growth prospect.

But some definites would have to be job losses, business bankruptcies, also a slump in tax revenues...

For sure. I think, for Cyprus, this will be a couple of very, very hard years. The Cypriot government will have to implement a number of structural reforms. It will also have to reduce its spending. So, for Cyprus as a whole, it will be a very, very tough couple of years.

Will it be a recession so deep that the country's going to find it very hard to pay back its loans?

This is one of the open questions. The EU and the IMF are now giving Cyprus 10 billion euros as a loan to restructure its economy and recapitalize its banks. There is a big amount of uncertainty whether this 10 billion will be enough. And the last week has shown that we have created a lot of turmoil, a lot of loss in confidence, so there is indeed a real risk that the 10 billion might not be enough to solve the problem.

And the conditions of the bailout, what's your opinion on that?

I think the conditions are fair, because they have been applied to all other European crisis countries. So if you look at Portugal, if you look at Ireland, if you also look at the bank support for Spain, they have all been on a level playing field when it comes to applying similar conditions. The conditions in terms of structural reforms are, I think, also appropriate. So overall, the program from the EU and the IMF is generous and constitutes a substantial part of what the needs for Cyprus are.

What are the chances of what we've seen in Cyprus though -- this taxing of depositors -- of that catching on, to become a model for other European economies that are struggling economically?

Yes, that's a big danger. We have to be very clear from the European side that Cyprus is different. Because the owners of the banks were not really big enough to be able to finance the debt cuts, the hair cut, alone so we needed to have the depositors. But for European politicians it will be crucial to clarify for the rest of Europe that Cyprus is unique. This will not apply to other European countries, in order to prevent contagion, or the domino effect, from spreading to other European countries.

Is this really going to mean the end of tax havens in Europe?

I think it should. I think there are two elements to that. I think tax competition per se is not a bad thing, but it can go too far. The second important element is that you also have to realize that having a low tax rate, attracting a lot of capital, increases risk tremendously. And this risk is carried not only by the country itself, but by Europe as a whole. And so we have to find a solution of reducing that risk and have a level playing field.

But no tax havens? What would that do to Europe's competitiveness?

Competitiveness, of course, has many dimensions. It has a dimension in the real economy, so that should be the focus -- to be competitive in industry and services. Of course we need to have a competitive financial sector, but we have to be very careful to balance the risks against the benefits of a deep financial system.

But the problem wasn't just, of course, a bad business model in Cyprus, it was also the financial crisis..

Sure. Cyprus was also hit very badly by the crisis in Greece. But I think that means very importantly that we have to find a European solution, to share the risk and reduce the risk overall for the eurozone.

So what exactly can Europe learn from Cyprus?

I think, first of all, we have to realize that a business model that has a country with too big a financial sector is dangerous and we should avoid that in the future. I think, second, we need to have a stronger European integration process. We need to move supervision of banks and financial systems from countries to the eurozone and the EU as a whole in order to have better and more effective supervision.

And, in the meantime, how's Cyprus going to go?

Cyprus will have a very tough couple of years, and I think it's very important that we manage that process as well as we can.

(Interview: Ben Fajzullin)