Last week, Agence France-Presse reported that debt-burdened Cyprus is desperate to enforce a new wave of austerity measures to avoid a European Union bailout, but it could be a lost cause if its banks have to be rescued from outside.

Cyprus, a eurozone member, is already under pressure from Brussels to slash spending and boost revenues as the government’s budget deficit is almost double the European Union’s ceiling of 3.0 per cent of gross domestic product.

The European Commission predicts it will be near 5.0 per cent in 2012 and, unless tough action is taken, the island faces financial sanctions.

But even if the government puts a lid on the deficit, it lacks the financial clout to support the banks, which need an extra €3.6 billion in capital as a buffer laid down by the European Banking Authority to weather the crisis.

Cypriot banks are badly exposed to toxic debt in Greece, and must face a write-down of Greek bonds, a so-called haircut, of 50 per cent.

On Tuesday, the Bank of Cyprus, the country’s biggest lender, posted an accumulated net loss of €801 million for the first nine months of 2011.

In the results, the bank announced a write-down of €1.06 billion on Greek debt holdings as part of its agreement to take part in the latest bailout of Greece agreed at a eurozone summit in October.

Economist Fiona Mullen told AFP that although Bank of Cyprus may be able to survive the write-downs required to cover the voluntary losses on Greek debt, Marfin Popular Bank will struggle to raise the additional cash needed.

“Marfin at the very least will have to beg for money from the government, which doesn’t have that kind of spare cash,” Mullen said.

“An EU support mechanism is inevitable whatever the government does because the two junk-rated banks will not be able to raise all of the €3.6 billion in capital by June 2012 that has been preliminarily demanded by the European Banking Authority,” she added.

As a bank’s assets fall in quality, regulations on ratios of risk to shareholders’ funds may require a strengthening of shareholder funds, or else the lender concerned has to find ways of reducing the risks it takes on, typically by reducing lending.

Mullen said BoC could use about €890 million in contingent convertible bonds (CoCos), which would reduce its capital requirement to an estimated €600 million, of which it is trying to raise €400 million in a share issue.

But Marfin has only €65 million in CoCos.

Even after including their convertible bonds, Marfin still has to find €2 billion, according to the preliminary figures.

“So the only option will be to ask the EU for assistance,” said Mullen.

Credit agency Moody’s came to the same conclusion last month, saying an EU bailout was on the cards owing to the state of the banks.

Moody’s downgraded the island’s three main banks over exposure to Greek debt amid fears the state would be unable to bail them out if the need arose.

It said the banks’ domestically owned asset base was six times the island’s GDP.

The agency said Marfin was the most exposed bank and in likely need of a state bailout following a Greek haircut of 50 per cent.

BoC and Hellenic Bank, it added, could manage without any external assistance.

Although Cypriot banks have said they can raise the extra capital, others are sceptical.

“Cypriot banks are going to need government money but... how much money the government can provide is a moot point,” retired banker Jonathon Mills told AFP.

“The banking system is in huge trouble... because of Greek debt exposure and branch operations in Greece,” he said.

The former Barclays man said the banks would now be under pressure to shrink the size of their balance sheets, reducing lending and raising lending rates.

Furthermore, the government’s move to establish a support fund for banks and a legal framework for state intervention is opposed by the Association of International Banks, which says the measures could drive its members to leave the island for a more tax-friendly environment such as Malta.

A more pressing issue for the government is slashing the deficit and meeting its EU fiscal obligations.

President Demetris Christofias has called for a consensus for his administration’s austerity drive, saying it was of the “highest national importance.”

Christofias convened a summit on Friday to get the opposition parties − a majority in Parliament − to back stiffer belt-tightening in line with a European Commission demand for a tougher budget by 15 December.

The government is committed to getting the deficit under the EU-approved three per cent, but its task was made more difficult after powerful trade unions and business groups rejected the new proposal.

Marginal growth is expected this year after a munitions blast in July knocked out the island’s main power plant.

Due to liquidity drying up fast, the growth forecast for 2012 has been revised from an initial 1.5 per cent to a mere 0.2 per cent. The EU expects zero growth for next year.

Cyprus’ economic crisis is set to worsen in 2012 making 2011 look like a holiday with both external and internal factors playing havoc with the economy, Shavasb Bohdjalian wrote.

A study by the OECD confirmed IMF forecasts that the world economy is again on a slippery road with the eurozone tipping into a recession. Even mighty China is slowing, Japan’s exports are tumbling, Eastern Europe is starting to crack while the improving economic situation in the US has become clouded as a recovery in factory activity is not matched with an increase in consumer spending.

Against this uncertain backdrop, financial markets are likely to remain volatile as the European debt crisis widens and across the Atlantic, US lawmakers cannot agree on a formula on slashing the budget deficit.

The biggest problem facing the eurozone, which will have a direct impact on Cyprus, is the inability of member states to rollover their debt at affordable levels. If during 2011 the problematic states were the so-called PIGS – Portugal, Ireland, Greece and Spain, the situation will worsen as Italy, France, Belgium and even mighty Germany will need to pay a higher price to rollover their maturing debt.

With the economies of the eurozone and other EU members in recession, the additional cost of refinancing will hurt efforts to reduce budget deficits, resulting in more austerity by member states, which will add to the economic pain.

Cyprus will be no exception. It faces billions of debt refinancing and even if it manages to secure the €2.5 billion loan from Russia at favourable rate, it will still pay excessive rates to rollover other maturing debt.

Goldman Sachs warned on Friday that the public sector funding problems, which are hurting bank profits, are restricting household and corporate credit in Europe. This “could turn the moderate recession we are forecasting into something more akin to the 2008/09 experience” Reuters reported quoting the GS report.

Lack of credit is the next big issue facing Cyprus and other countries. With 95 per cent of all businesses in Cyprus having little capital, all are dependent on the banks to extend them credit facilities against mortgaged property or personal guarantees. Since banks have toughened up their lending rules, and faced with declining sales and losses, companies are finding it increasingly difficult to secure additional loans from the banks to stay afloat. The pace of business closures is sure to intensify in 2012 resulting in layoffs, reduced consumer spending, lower taxation and hence the need for more austerity.

Efforts by Finance Minister Kikis Kazamias to impose a two-year civil service wage freeze is also likely to have a negative impact on consumer spending considering that the 70.000 strong civil service employees are the best paid group after bank employees. But even the bank employees will be affected as banks, facing the threat of passing into state hands, will have to proceed with broad-based wage freeze and probably with pay cuts to shore up capital.

In view of the crisis, the government, major corporations and other countries with whom Cyprus has close economic ties will need to proceed with austerity measures which will only add to the current woes facing the public.

The problem with new austerity and revenue raising measures when combined with recessionary situation means higher taxes, so there is a good chance that the government will come back with a request to increase the corporate tax rate, in an effort to cover the budget hole, which will force many international companies to flee Cyprus and probably cause business closure and job cuts in the once-booming financial services sector.

Unfortunately, there is no quick cure to fix all the problems and this is why one should prepare to face a much tougher 2012, and certainly much worse and painful than 2011.

While the above quotes come from unimpeachable Cypriot sources and media, a confirmation of all that this implies was coming last week from a completely different source.

At the Chamber of Commerce in Valletta, law firm Fenech & Fenech is celebrating its 120th anniversary.

When Costantino Fenech, a legal procurator, set up the firm in 1891, thus making it the oldest law firm in Malta, and when a few years later he was joined by his nephew, the legendary Sur Tumas, Malta was a British colony, a trading post on the route from Great Britain to India.

Since then, a lot has happened, not just to the firm but also to Malta. Two world wars, a global depression, independence, Malta is now in the EU and in the euro area and a firmly established financial services centre.

While the firm originally was involved in rural and commercial litigation, it is now fully involved in areas the two original Fenechs never even imagined – ship and plane registration (the firm antedates the Wright Brothers by some 20 years), IT legislation, financial services.

As Managing Partner Ann Fenech put it, and as can be confirmed by the two quotations reproduced above, the more there is crisis in other jurisdictions, and the more our financial set-up is made top-notch, the more will firms, companies, banks, even, flock here as to a haven from all the chaos outside.

There are now, as partner Joseph Ghio pointed out, 25 credit institutions, the 14 financial institutions of just three years ago have become 52, there are 700 investment sub-funds registered on the island and 122 licensed trustees.

Financial services now account for 7.5 per cent of GDP and this sector saw a 30 per cent growth just in 2010.

All this was done in our lifetime, ever since MIBA was set up in 1988, opening up Malta as an offshore centre, which was changed to onshore with the creation of MFSC (later MFSA) after 1994 and all the subsequent legislation.

Of course we have our own problems, of course there are still areas of poverty and people on the breadline, of course there are many cases where, as highlighted in Parliament yesterday, people are made to work part-time on full-time jobs, or register as self-employed when in reality they are employed by someone else.

Nevertheless, as we look at other countries, and Cyprus is not just another Mediterranean island-state but also shares some of our history, we can also look back and see how we’ve gone places. And there’s much more to be done and we can do even better.

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