Will The IMF’s Solution For Cyprus Include Tax Hikes?

IMF LagardeChristine Lagarde, managing director of the International Monetary Fund, issued a statement on Wednesday revealing that the IMF reached a staff-level agreement to contribute 1 billion euros ($1.3 billion) to Cyprus’s bailout program.

The rescue package for Cyprus was constructed jointly by the Troika — a coalition consisting of the IMF, the European Commission, and the European Central Bank effectively tasked with ensuring euro zone economic stability. As Lagarde described it: “A combined financing package of 10 billion euros (about US $13 billion) is designed to help Cyprus cover its financing needs, including debt obligations, while it implements the policies needed to restore the health of the economy and regain access to capital market financing.”

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In her statement, Lagarde highlights three policy steps that Cyprus has taken that the bailout program builds off of. The first is addressing the problems that grew rampant and the nation’s largest banks in a way that protects insured depositors, or more than 95 percent of total account holders in the two affected banks.

The second is what Lagarde describes as “substantial fiscal consolidation measures” that were introduced in this year’s budget and will stretch through 2015. The third is “a significant reform of the public wage indexation mechanism as well as important steps to improve the pension system’s long-term viability”…

The first policy step mentioned was the most important. Cypriot policymakers initially, and nearly unanimously, rejected bailout conditions that called for a 6.7 percent charge against deposits of less than 100,000 euros. Uninsured depositors incurred substantial losses as a result of the bailout, and the idea that average depositors could be at risk shocked market participants around the globe. The second and third policy steps are more standard but are equally critical to the overall goals of the program, which Lagarde describes as “to stabilize the financial system, achieve fiscal sustainability, and support the recovery of economic activity to preserve the welfare of the population.”

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Lagarde outlined some changes that Cyprus can expect to see: “In addition to the fiscal consolidation already underway—estimated at about 5 percent of GDP— an additional 2 percent of GDP in measures will be implemented during the program period, including by raising the corporate income tax rate from 10 to 12 ½ percent and the tax rate on interest income from 15 to 30 percent.”

Meanwhile, Cyprus named Harris Georgiades its newest finance minister. Reuters reports that he told reporters on Tuesday: “We shall implement the [memorandum of understanding] fully, and without any derogations. We shall meet all timeframes, we will meet all targets.”

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