CYPRUS GETS FINAL APPROVAL TO ADOPT EURO JANUARY 1, 2008

UNCLAS NICOSIA 000582

SIPDIS

SENSITIVE

SIPDIS

E.O. 12958: N/A
TAGS: EFIN ECON PGOV EUN CY
SUBJECT: CYPRUS GETS FINAL APPROVAL TO ADOPT EURO JANUARY 1, 2008

REF: A) NICOSIA 498 B) NICOSIA 439 C) NICOSIA 247

D) NICOSIA 144 E) 06 NICOSIA 2033

(U) This cable is sensitive but unclassified. Please treat
accordingly.


1. (SBU) Summary. As expected, EU finance ministers formally
invited Cyprus (and Malta) to adopt the Euro on January 1, 2008,
during the July 10 ECOFIN meeting in Brussels. The EU finance
ministers also set the final rate at which the Cypriot pound will be
exchanged into Euro at one Euro equals CYP 0.585274 (or roughly one
Cypriot pound equals 1.71 Euros). This is the same rate at which
the Cypriot pound joined the Exchange Rate Mechanism II in May 2005,
and at which the GoC unilaterally pegged the Cypriot pound to the
European Currency Unit (ECU) in 1992. Cyprus and Malta will become
the fourteenth and fifteenth EU member states to adopt the Euro but
will add only around 1.2 million people to the current Eurozone
population of 318 million and will increase the Eurozone's GDP by
only 0.2 percent. Adoption of the Euro will apply only to the
government controlled area of Cyprus. The area administered by
Turkish Cypriots will continue to use the Turkish Lira as its legal
currency. For more information on the GoC's changeover plans and
possible effects of Euro adoption, please see reftels. End
summary.


2. (U) Cyprus cleared the final hurdle toward Euro adoption July 10
when, as widely expected, EU finance ministers formally invited the
Government of Cyprus to adopt the Euro on January 1, 2008. The
finance ministers also set the final rate at which the Cypriot pound
will be exchanged into Euro at the same rate at which the Cypriot
pound entered the ERM II on May 2, 2005. This rate of one Euro
equaling CYP 0.585274 (or one Cypriot pound equaling 1.7086014
Euros) means a slight depreciation of the Cypriot pound vis-a-vis
the Euro of roughly 0.2 percent from the rate at which it was
trading on July 8. After entering the ERM II on May 2, 2005, the
pound quickly appreciated, peaking at CYP 0.5729 per Euro in
September 2005 (or 2.1 percent above the central parity rate),after
which it slowly depreciated against the Euro, ending up just above
the central parity rate this summer.


3. (SBU) Finance Minister Michalis Sarris welcomed ECOFIN's
invitation calling "the forthcoming adoption of the Euro a milestone
in the history of the Republic of Cyprus." The goal of Euro
adoption has already contributed to the growth of the Cypriot
economy by forcing the GoC to introduce fiscal discipline and sound
economic policies. Real GDP has grown roughly 3.8 percent per year
since 2004. Long-term interest rates have fallen 330 basis points
in the past five years, while mortgage rates have fallen 160 basis
points. Inflation has dropped from 4 percent in 2003 to roughly two
percent today.


4. (SBU) Adoption of the Euro is also expected to continue to spur
Cypriot growth by locking Cyprus in to the Eurozone's historic low
inflation and interest rates, reducing currency transaction costs
and exchange rate risk, increasing competition through greater price
transparency, and providing easier access to a large, liquid,
capital market. While Cyprus will be giving up its ability to
pursue independent monetary and exchange rate policies, Central Bank
officials believe this is not much of a sacrifice. The GoC never
used the latter; the EU is Cyprus's main trading partner; and
Cypriot business cycles are largely synchronized with those of the
larger EU states. Nevertheless, a recent poll showed only 38
percent of Cypriots believed that adoption of the Euro would have
any positive effects for Cyprus, while most Cypriots (83 Percent)
believed it would lead to unjustified price increases.


5. (SBU) The GoC plans to introduce a number of programs to address
the fear of unjustified price hikes. For instance, the GoC is
establishing special "Euro Observatories" to monitor price levels in
stores, has established significant fines for those found taking
advantage of the currency changeover to "cheat" customers (up to
170,000 Euros),and plans to "name and shame" offenders. It is also
introducing a voluntary system under which businesses that comply
with a set of "fair pricing" guidelines will be able to display
special logos. Several businesses, including Cyprus's largest
retailer, have also unilaterally announced plans to reduce prices on
January 1 by around one percent.


6. (SBU) Nevertheless, some observers warn that retailers

traditionally raise prices on January 1 to reflect Cyprus's two
percent inflation rate and fear that Cypriots may attribute
justified price increases to the Euro changeover. Furthermore,
EU-mandated increases in the VAT rate for certain foods and
medicines that are required to go into effect January 1 are by
themselves expected to increase the price level a further one
percent. To help Cypriots avoid mistakenly conflating the effects
of these increases with adoption of the Euro, the GoC has asked the
EU for permission to delay the tax increase until July 1.
Nevertheless, critics warn that any price increases in the first
half of 2008 are likely to be attributed to adoption of the Euro and
could undermine Cypriot support for the island's new currency. The
success or failure of the introduction of the Euro could have
political consequences given that presidential elections are
scheduled for February 2008.


7. (SBU) The GoC also announced plans to further intensify its
much-maligned Euro information campaign and to require dual pricing
as of September 1. Some businesses have already begun showing
prices in both Cypriot pounds and Euro, and the Organization of
Industrialists and Entrepreneurs is encouraging all its members to
begin dual pricing immediately. The GoC plans to allow dual
circulation of the two currencies from January 1, 2008 to January
31, 2008 only, during which all business will be required to give
change in Euro. Banks, however, will exchange Cypriot pounds for
Euros until June 30, 2008, while the Central Bank will exchange
Cypriot coins until December 31, 2009, and Cypriot bank notes until
December 31, 2017.


8. (SBU) While on January 1 the Euro will become the official
currency in the government controlled area of Cyprus, the area
administered by Turkish Cypriots will continue to use the Turkish
Lira as its legal currency. Nevertheless, the GoC's adoption of the
Euro should remove the contentious issue of which currency a future
united Cyprus should use. A united Cyprus in the EU will be
required under EU rules to use the Euro, an outcome that seems
acceptable to both sides.

SCHLICHER