Analysis: "Cyprus euros" could take on own value with capital controls

Wed Mar 27, 2013 11:43am EDT
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By Paul Carrel

FRANKFURT (Reuters) - Cyprus's plan to impose capital controls threatens to test the ties that bind Europe's monetary union and could see euros on the Mediterranean island valued differently to those in the rest of the bloc.

The capital controls, being imposed to avert a run on banks after an EU bailout, will limit foreign transactions and capital outflows but not movements of money within the country itself, the head of the Cyprus chamber of commerce said on Wednesday after meeting government officials.

The finance minister has said the controls could be in place for a few weeks although the experience of other countries, such as Iceland, suggest it may take much longer. Banks, shut since nearly two weeks, are due to reopen on Thursday.

The impact the restrictions have on the Cypriot economy depends on their exact nature and whether they are applied to payments as well as capital transfers. A report from Greek newspaper Kathimerini suggested there would be restrictions to both, and that these would initially last for seven days.

Restrictions on payments would be a far bigger incursion into the functioning of Europe's internal market than controls on capital transfers, as euros held in banks in Cyprus could not be used to pay for goods and services elsewhere in the bloc.

By definition, that would make them less liquid than French or German euros and de facto, worth less.

"If you were to impose restrictions equally on capital transfers and payments, then economically a Cyprus euro would be a different currency vis-a-vis a non-Cyprus euro," said Kai Schaffelhuber, partner at Allen & Overy law firm in Frankfurt.

"You would have to buy non-Cyprus euros to pay for goods and services in other countries," he said. "With the rules of supply and demand, the Cyprus euro could then take on a different exchange rate."   Continued...

People leave a Bank of Cyprus branch in Athens March 27, 2013. REUTERS/John Kolesidis