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