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ECB eyes €120m of Cyprus’s bonds

European Central Bank President Mario Draghi pauses while addressing the ECB news conference

By Stelios Orphanides

CYPRUS IS eligible for a European Central Bank (ECB) bond-buying programme, the ECB indicated yesterday, but the bailed-out island will be required to meet additional conditions.

“Some additional eligibility criteria will be applied in the case of countries under an EU/IMF adjustment programme,” ECB chairman Mario Draghi said.

He was announcing a €60b a month asset-buying by the ECB from the secondary market, starting this March and running until end-September 2016.

The programme would be conducted “until we see a sustained adjustment of the path of inflation which is consistent with our aim of achieving inflation rates of below but close to 2 per cent over the medium term,” the ECB chief said.

Because the ECB’s scheme concerns purchases of investment-grade assets only, tighter eligibility criteria apply to Cyprus and Greece, whose sovereign bonds are rated junk.

The Cyprus News Agency (CNA) reported that, in order to participate in the scheme, Cyprus needs to meet two additional criteria: implement its adjustment programme and get positive reviews from its international creditors.

Cyprus technically has fallen foul of its adjustment programme, after opposition parties – despite repeated warnings from the government – recently passed a law suspending legislation relating to foreclosures of mortgaged properties. International lenders have said Cyprus is not complying fully with its programme, and as a result a full review of the programme has been put on the backburner.

This would suggest that, as it stands, the island meets neither of the two extra conditions to be eligible for the ECB programme.

However, the government said it viewed Draghi’s remarks positively in how they impacted Cyprus.

Subject to compliance with the bailout terms, “as of February 1, Cyprus will be eligible to apply to the programme,” said spokesman Nicos Christodoulides.
This is the date when the suspension of the foreclosures law imposed by the opposition expires.

According to CNA, the ECB would purchase around €120m worth of Cyprus sovereign bonds each month, or 0.2 per cent of the €60b figure announced by Draghi.

The ECB’s expanded asset purchasing programme may help fight deflation and invigorate growth, at least to some extent, economists said.

Alexander Michaelides, who heads the finance department at the Imperial College in London, said the ECB’s €1.1 trillion asset purchase programme, also known as quantitative easing, will help the euro area avoid deflation while it may at least indirectly help the Cypriot economy via a weak euro.

The euro “should not have been so strong” given the euro area’s growth prospects, Michalides said adding that a weaker euro could help the economies of countries like Cyprus exposed to third-country services income, such as tourism from the United Kingdom.

Prices in the euro area rose a provisional 0.6 per cent in 2014 compared to 2013, according to Eurostat. An annual price drop of 0.2 per cent in December, compared to a 0.8 per cent price increase a year before, shows the euro area is closer than ever to entering into a deflation spiral which may further threaten economic growth.

The euro area economy grew 0.2 per cent in July to September compared to the quarter before and 0.8 per cent compared to the respective quarter in 2013, according to Eurostat. The mandate of the ECB, which lowered its interest rates to historical levels in September, is to maintain medium-term inflation rate close to and below 2 per cent.

“The question will be whether this is sufficient but one makes these moves one day at a time,” Michaelides said. “The ECB can always react depending on how events evolve, both in the Eurozone and in other areas around the world”.

Economist Michalis Florentiades, chief economist at XM.com, an online financial services company in Nicosia, said that the purchase package is larger compared to what the market expected, which indicates that Draghi traded risk sharing in exchange of programme size.

“What remains to be seen is how effective it will be,” he said. “As a measure it does help but it alone is not helping win the game, as it alone can’t create inflation and growth,” which require structural reforms in the euro area.

Imperial College’s Michaelides added that the risk sharing compromise which restricts loss sharing to 20 per cent among members of the eurosystem, is a good sign.

“One needs to start gradually with these approaches and I think the chosen approach is a diplomatic way to convince sceptics that in the longer run this will be beneficial” for the euro area as a whole, he said as it is in the ECB’s interest to have the largest possible support to guide the households and businesses of the euro area “out of the deflationary woods”.

“Hopefully the parliament in Cyprus should realise it is even more important to deal with the details and get the troika to come over and give a positive evaluation of the program,” Michaelides said.

In an interview with the Financial Times on Tuesday, former Central Bank of Cyprus governor Athanasios Orphanides said that by avoiding risk sharing by changing the rules, the ECB would damage the effectiveness of its quantitative easing.

Cyprus agreed a €10b international bailout with the troika in March 2013. Under the terms of the agreement, Cyprus agreed to reform its public finances, its banking system and economy.

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