Cyprus's request for a bailout greatly raises the fear of contagion

Cyprus has finally run out of quick-fix solutions to save its economy - just as it takes the reins of the EU presidency

Cypriot president Demetris Christofias (R) shakes hands with Stefan Fule, the EU commissioner on enlargement and European neighbourhood policy in Nicosia, Cyprus. Photograph: Katia Christodoulou/EPA

The timing could not be worse. Just days before Cyprus is due to take up the European Union's presidency and the task of guiding Europe out of its financial crises, it has become the fifth eurozone member to request a Brussels bailout.

It does not bode well that a bailout country is now mandated with securing agreement on the financial framework of Europe's budget for the next seven years. The Germans have already started to make noises about Cyprus holding the presidency while trying to negotiate a loan. But the government has chosen to draw attention to itself, and the plight of its economy, by waiting until the last moment to ask for a little help from its friends.

There was time to apply for a bailout in an orderly fashion, but Cyprus waited until it was pushed into a corner – after negotiations for a loan from Russia or China failed – and the world's media is, unsurprisingly, zoning in on the sticky situation – hardly the best way to encourage investor confidence, or show that Cyprus is a capable player on the European stage.

Cyprus is the eurozone's third smallest economy, but has managed to make the whole of Europe twitch over the possibility of the contagion spreading across the single currency bloc.

The Mediterranean island was undone by a banking sector heavily exposed to debt-paralysed Greece and a write-down of Greek bonds, which hit Cypriot banks hard, pushing Nicosia to seek help just as it picks up the six-month rotating presidency.

 

For weeks, if not months, the government – led by communist leader President Demetris Christofias – gave the impression it was doing everything possible to avoid going cap in hand to the EU. But finally, with time running out to recapitalise the island's second largest bank, Cyprus Popular, the cash-strapped government ran out of quick-fix options.

A vocal opposition has already criticised Christofias for dawdling over fresh austerity measures while the economic landscape worsened. In a highly unusual move, former central bank governor Athanasios Orphanides accused the president of trying to destroy the banking system in an open letter, saying he was discrediting the banking system by blaming the island's economic woes solely on exposure to Greek debt. Orphanides – who was replaced by Christofias when his five-year term ended in April – argued that fiscal slippage and delays reforming an unwieldy public sector were part of the problem. The president was also chastised for supporting a severe 75% write-down on Greek debt with his European colleagues.

Cyprus still hasn't ruled out borrowing from a third country to soften the blow of the bailout conditions.

In 2011 the island avoided having to apply for EU aid by securing a €2.5bn Russian loan to cover debt refinancing for that year. But Cyprus's ailing €17.3bn economy is now expected to need an injection of €10bn. The recession-hit economy is struggling with record unemployment of more than 10%, austerity measures, and trying to rein in a deficit which is twice the EU's limit of 3% of GDP. Finance minister Vassos Shiarly has suggested that the bailout cash required is not just to prop up a relatively large banking system but to cover the state's fiscal requirements.

Government spokesman Stefanos Stefanou has tried to allay fears that the terms of the bailout would be harsh for Cypriots, saying the island's cherished 10% corporate tax rate remains safe from European tinkering. Moreover, the Cyprus Central Bank backs the government's move to request a bailout as it would protect its Greek-exposed banking sector from further contagion.

The bailout request was triggered when Fitch Ratings downgraded Cyprus's sovereign ratings, saying this was "principally due to Greek corporate and household exposures of the largest three banks – Bank of Cyprus, Cyprus Popular Bank and Hellenic Bank".

But Cyprus has been unable to borrow from international markets since 2011, after being reduced to junk status by two of the three international credit agencies.

Although the government is committed to reducing its bloated deficit from 6.4% to below 3%, it is reluctant to introduce deeper public cuts to drastically slash the deficit.

Which leaves an island that prided itself on prosperity bracing itself to take its medicine as one of Europe's ailing nations.