CYPRUS: FINANCIAL CRISIS IN EASTERN EUROPE

C O N F I D E N T I A L SECTION 01 OF 02 NICOSIA 000180 SIPDIS TREASURY FOR DAS ERIC MEYER STATE FOR EUR DAS GARBER E.O. 12958: DECL: 03/13/2019 TAGS: ECOIN ECON EFIN EUN PREL CY SUBJECT: CYPRUS: FINANCIAL CRISIS IN EASTERN EUROPE REF: A. STATE 23758 ¶B. MARCH 3 EUR TELECONFERENCE ¶C. 08 NICOSIA 932 ¶D. NICOSIA 172 Classified By: AMB F URBANCIC FOR REASONS 1.5 B AND D ¶1. (C) Summary: The Governor of Cyprus' Central Bank is fairly confident that Eurozone nations in eastern and central Europe will be provided with sufficient assistance from the EU and ECB to avoid systemic risk. Non-Eurozone member states he believes will not be allowed to fail, but he is less confident about how that will be accomplished and he has no insight into how the GOC intends to respond to their needs. Other nations in the region will have to depend on the IMF and pose the biggest threat to the markets. These views were largely echoed by a senior offical in the President's office, who questioned the EU's overall capacity for taking coordinated action. End Summary. "We Already Have Quantitative Easing" -------------- ¶2. (C) Per ref A, econoff met with Central Bank of Cyprus Governor, Athanasios Orphanides, on March 9 to discuss what the EU and its institutions can do to mitigate the growing financial crisis in Central and Eastern Europe. Orphanides stressed that members of the Eurozone "will be rescued" if their difficulties continue to grow. This will be done primarily as part of the overall stimulative measures being taken by the ECB. He noted that the ECB is already undertaking quantitative easing, although not calling it by that name, because it is making unlimited funds available for euro banks in return for "the extensive collateral these banks possess." Orphanides argued that the most important statement made by ECB President Trichet after the Bank's March 5 meeting was that "non-standard measures would continue as long as needed and beyond the end of the year." This, combined with Trichet's promise that he would not exclude any additional non-standard measure, is indicative, claims Orphanides, that ECB collateral purchases, which had already been extended from three to six month maturities, will be extended as long as necessary and provide "unlimited funds at fixed rates to any bank that needs liquidity" even though some "haircuts" (reduction in principal amount) may be involved. ¶3. (C) Orphanides believes that the biggest problem in the eastern/central Eurozone is the dominance of non-local banks which have been reducing their lending in response to a need for them to focus on their home market problems. Remaining local banks have balance sheets too small to sufficiently restimulate their economies. The Governor believes that, one way or another, the EU and the ECB will find ways to funnel sufficient Euros into Eurozone economies to ensure that insufficient liquidity is not a barrier to monetary stimulus. "That's a European Commission Problem" -------------- ¶4. (C) In regard to non-Eurozone EU members, Orphanides proclaimed, "politically, we can't allow any EU member to fail." That said, he is opposed to fast-tracking these nations for membership in the Eurozone noting that "the ECB can't overstep its political powers; we are not allowed to take financial risk, it's not part of the Bank's mandate to take losses-what to do about non-Eurozone members is really a decision for the EC." However, he argued that even the poorest of these countries is rich in some assets and the goal should be to "monetize these resources." Specifically, he said that an exchange of assets, such as claims on government land (as collateral) in return for loans would be a means to provide liquidity to some of these states. ¶5. (C) Orphanides believes the biggest risk of system collapse would be in non-EU states in the region, specifically mentioning Ukraine and Turkey, because the EU has no political mandate (and likely no political will) to provide sufficient help. He argued that the best thing the US can do to help is to provide additional funds to the IMF for this purpose and then press the Europeans to follow suit. When asked if his government will press for this approach, Orphanides replied "you'll have to ask them, they don't seek my advice on these matters." (see ref C regarding the strained relations between the Governor and the Finance Minister). Orphanides was critical of the GOC's stimulus package because he is highly skeptical of the government's ability to speed up spending; "they have yet to demonstrate they can or know how to do it. And there is no Plan B for them." ¶6. (C) The Ambassador delivered ref A points to Leonidas Pantelides, the diplomatic coordinator in the President's Office, who acknolwedged the need to help all EU members although he did not express any opinion on what should be done. He lamented that "the only thing the EU has accomplished is economic and monetary union, there is no coordination on anything else, and now even this is under threat." Panteldies noted that the Hungarian Ambassador had previously called on him to explain their situation and the risks of rising economic nationalism within the EU as evidenced by bank bailout funds being restricted to use within national borders; "European banks made money in Hungary for years, and now they are being told not to use any of that money in Hungary" Pantelides said. While agreeing with our points, Pantelides gave no assurance that Cyprus would strenuously argue for EU action to help its eastern members. He also said "we can do nothing for non-member states in trouble, such as Ukraine." Cyprus OK -------------- ¶7. (C) With very limited exposure to eastern European and Russian risk (less than 5 percent of total assets), Orphanides argued that the Cypriot banking system remains sound. Local deposits continue to grow and foreign deposits are stable. Exposure to the Greek market, 30-40 percent of total assets, could be a problem, but the banks have seen no increase in problem loans in their Greek operations. The real risk is the continuation of the global downturn; "we can only insulate ourselves for so long." To this end, he urged the US to provide more stimulus and certainty to the markets; "why not double the mortgage interest deduction to encourage renewed home buying? Why not completely nationalize Fannie Mae and Freddie Mac and end any uncertainty regarding those institutions?" He finally noted his support for the De Larosiere report ("the best we could do and still get UK support") and urged the US to adopt similar measures as a way to achieve greater global regulatory convergence and oversight. ¶8. (C) Comment: Orphanides feels he has managed to influence outcomes at the ECB despite "being seen as the American in the room" (due to his 19 years at the US Fed). He will continue to battle the concern of some ECB members against zero interest rates ("there is no magic about this, the question is what are real interest rates.") and praised Fed-ECB cooperation "after a shaky time last fall." Orphanides is a pure technocrat, happy to fight for any idea that will achieve the goals, regardless of where they come from. Similarly, he is unafraid to criticize any idea, no matter how powerful its proponent. Urbancic