Letter to the President and the bankrupt Cypriot political leadership: Solving the Cyprus political and economic problems (Part III)

Geostrategic developments around us as well as common economic sense suggest the need to solve Cyprus’ political, economic and energy problems jointly, as they are intertwined.  A political solution serves as a vehicle for achieving economic and strategic objectives.  For a solution to be stable, it must align interests and allay fears and concerns of all key players in the region.   Politicians have not always acted with common sense.  Reality often defies expectations.  It was expected EU politicians would have helped save Cyprus’ ailing banking system and its economy.  It came as a shock that they considered haircutting insured bank deposits, ignored its gas reserves, and imposed a €9 billion ELA burden on its main bank that along with over €25 billion in non-performing loans (NPLs) risks sinking Cyprus’ banking system and economy in the after-month of signing a troika memorandum agreement.  But powerful players usually look after their economic and strategic interests.  Russia was presented with a historic opportunity to help save Cyprus, enhance its interests on the island and grab strategic assets cheaply.  It refused to even put up €2 billion Russians would have lost in the haircut. Last year Gasprom signed 30-year gas supply contracts with Turkey (its second largest client) at 40% discount.  A €16 billion South Stream pipeline is being built over Turkish waters through the Black sea to Bulgaria. Gasprom also agreed to liquefy (via floating LNG vessel) and export Israeli gas from the Tamar gas field to Asian markets.  In a surprise, Israel apologized last year to Turkey, opening up channels of cooperation and putting at risk the hoped-for Cyprus-Israeli energy alliance and the prospects of Cyprus’ gas.  Turkey and Israel just agreed to start work on the Mediterranean Pipeline Project (Medstream) to build five pipelines that will carry natural gas, oil, water, electricity and fiber optics between Israel and Turkey.  Israel also just agreed to pay restitution of $25 million as damages to the families of the Marmara ship incident, satisfying the last of Turkish demands for smoothing their relations.  The sudden simultaneous triple agreement these days (i) on the joint statement for resumption of Cyprus conflict negotiations (with Eroglu being bypassed by Turkey and literally dragged into it), (ii) with Israel agreeing to pay restitution to smooth out Turkish-Israeli relations, and (iii) with the Medstream plans involving five pipelines between Turkey and Israel serving the entire region’s multiple needs with multiple players is unlikely to be a coincidence. Many big players (from Russia to India) are part of it.  Turkey envisions for itself a strategic role in the region in the midst of broader regional instability.  Turkey initiated discussions with the Kurds, mended relations with Israel, developed economic ties with Russia, and warmed relations with Greece, last year signing 25 cooperation agreements with Athens.  Almost every other major player in the region puts internal politics aside, pursuing their strategic economic interests.  Cyprus is the only exception.  As a result, it is vulnerable and strategically isolated.  Your rhetoric and behavior as Cypriot leaders must live up to the critical circumstances.  You as Greek Cypriot leaders have for decades favored a bi-communal bi-zonal federation.  According to Hurriyet, the two sides agreed during past negotiations that natural resources would be under the federal government.  While the Cypriot Titanic is sinking, even with gas reserves put on the sideline, you fight among yourselves for party power and future votes (e.g., using populist rhetoric like exiting the Euro or being against privatizations).  What would happen if you also have to deal with Turkish Cypriots (especially extremists like Eroglu in the same parliament or a con-federal state) and the gas reserve stakes get high?  Whereas you, the Greek Cypriot party leaders, argue for a federal state (with joint gas rights), it is in the interest of Cyprus that it does the opposite.  The jointly optimal solution for all key players is actually (surprise!) a variant of what Turkish Foreign Minister Davutoglu suggested this past year:  “if Cyprus claims the resources as its own, then it means tacitly that Turkish Cypriots own the resources in the north.  If they behave according to this claim, we are ready to negotiate a two-state solution.  Then these two states will meet in the EU”. (Hurriyet 28/3/2013).  This basic idea of two separate states (with own separate gas rights) can be a viable basis for a solution, with the qualification that the Turkish Cypriot state will be part of the EU and the EU acquis with all laws, principles and regulations will apply to all the territory (including free movement, work, settlement and ownership of property).  This solution has three main benefits.  It will:  (a) Avoid any unnecessary future frictions among the separate states as respective Greek and Turkish Cypriot politicians will no longer have to fight or collude with each other to get laws past (e.g. through the Senate requiring separate majorities) or impose their favorite appointees, fill hiring quotas based on national origin (e.g. 40% Turkish Cypriots in the police force) or fight over kickback schemes in semi-government organizations etc. (b) Ensure application of equal EU citizenship rights and privileges for all citizens: (c) Allow us keep the full benefits from our gas discoveries (initially estimated of the order of $300 billion -- before their value started dropping from adverse developments stemming from our ill-conceived internal choices, myopic strategic decisions and adverse external developments).  Such a solution approach should be staged.  There could be three phases. Upon signing agreement co-existence could be initiated in a small area. For example, establish a free trade zone (with no taxes) within the walls of old Nicosia center (perhaps also the Famagusta area), to promote cohabitation, development and trade interactions, alleviating Turkish Cypriot fears.  After building confidence from limited co-existence during the first transition stage (e.g. first 3 or 5 years), the free cooperation zone can be expanded to all of Nicosia (and the Turkish Cypriot state can then join the EU).  In the third phase, several years after entering the EU (and full Turkish troop removal), full application of all rights and privileges of EU membership should extend across all of Cyprus, including free settlement and property ownership anywhere. UN and EU troops would police during the transition period.  As part of the broader politico-economic agreement, the parties should take steps to align their long-term economic interests and incentives.  For example, Cyprus could agree to sell half of its natural gas to Turkey (and via Turkey to Europe) via a joint pipeline with Israel, at London market prices and at reasonable (e.g., 10%) discount.  This will alleviate Turkish (and European) energy insecurities. It will also assure a huge customer base for Cyprus’s gas production at low cost. In the second phase (with revenues already accruing from operation of a joint Israeli-Cypriot pipeline to the Turkish coast) Israel and Cyprus might share in the construction of an LNG terminal at Vassilico to liquefy the other half of the joint (Cypriot-Israeli) gas supplies for export to the Asian market at premium prices.  In an adverse future scenario (that local gas supplies turn out low or future gas prices decline as a result of shale gas and other resources flooding the market), a scaled-out contingent strategy should be pursued.  For example, the other half of the gas (not sent through the pipeline through Turkey) could be liquefied via a less costly floating LNG ship in partnership with Russia and Israel (on the same terms as Israel already has with Gazprom on its Tamar gas field.) In this way, the interests of Russia and Israel (and their professional expertise and market power) will also be aligned with Cyprus.  Overall, Cyprus would obtain several benefits from this approach: (a) ensure a huge captive market (Turkey and EU), (b) lower its costs and be globally more competitive (via channeling the gas through the Turkish pipeline jointly with Israel), (c) diversify its geopolitical risks and increase its strategic leverage and flexibility both by allying itself with the interests of other regional and global players (Turkey, Israel, the EU and Russia) and by maintaining dual supply outlets: a less costly distribution channel through the Turkish pipeline for satisfying the huge energy needs of the stable Turkish and EU markets, and an LNG option in partnership with Israel (and potentially Russia) to both target higher –priced Asian markets as well as control its dependence and risks vis-à-vis Turkey.  The latter is not likely to dear go against its own economic interests and upset or endanger its relations with Israel and the EU by causing disruptions in the pipeline. Even if this unlikely scenario might happen under some scare scenario, Cyprus would simply channel more of its gas (than the initial 50%) through the LNG option for export to the Asian markets.  But the EU would not likely allow Turkey to play such games as it would hurt EU’s own economic bottom line.  For a stable global equilibrium, the interests and concerns of all key players in the region need to be addressed (the EU, Russia, Turkey, and Israel).  This is the best hope for Cyprus’ survival, recovery and future development. If you, Cyprus’ leadership, come to recognize which strategic objectives are in the true long-term interests of your own citizens (rather than playing legalistic games with the 3 Singles and other such irrelevancies) and moreover awaken to a win-win way of thinking aligning all the key players’ interests (including your arch-antagonist’s) with your own you can actively shape Cyprus’ own development and future on the most favorable terms. Else – with the €9 billion ELA burden on the main Cyprus bank and more than €25 billion NPLs growing nearly a billion € a month putting the entire economy at risk--major external powers will dictate unilateral terms and we will receive breadcrumbs.   The Israeli gas will likely go through the planned 5 pipelines (Medstream project) and every other big player will likely collaborate with it, irrespective of what we decide to do.  If you can’t bear yourselves to recognize the basic economic reality that is already evident to everyone else that the gas in our region will be cheaper to be channeled (at least partly) to Europe through a pipeline via Turkey and continue to blindly and repeatedly hit your heads against the reality wall, the others will proceed without us and if need be will use the (non) single sovereignty (emanating equally through the two equal bi-communal states)  to pass the above pipeline through (northern) Cypriot waters to Turkey. Everyone else is already aligned and part of this plan. The only thing that stands on the way is your rigidity and blindness. Insisting with your rigid and failed policies to protect your self-image, your (illusive) sense of control or out of political demagoguery in hope of increasing or maintaining your party’s votes in next elections will surely lead to our complete destruction.  The above is the most effective pragmatic solution of jointly solving our political, economic and energy problems in one stroke for the benefit of all parties. Stepping outside your mental box, thinking and playing the regional game pro-actively and strategically is Cyprus’ best (and only) hope.  Tactically, and the immediate way out of the current mess, is to follow up on Mr. Eroglu’s recent statement upon acceptance of the joint statement (repeated numerous times previously) that a joint statement was not really necessary and that negotiations should just move on without preconditions with all issues being on the table. Sometimes we should listen to our adversaries rather than being over-confident with our imagined superiority arising from our narcissism or tendency to hide our head in the ground. Mr. President, just recognize the failure of this tactic (supported unanimously by all G/C leaders), swallow your pride(s) and move on to negotiations without preconditions. Your opponent (unwillingly) gives you a way out that will allow you to maintain the unity of your government and of the G/C front. Focus your energies on the strategic essence of how we envision as Cypriots a new state within the EU, not how it will evolve from the past entities (and consequent complications and limitations).  This requires putting the long-term interest of your people above your ego and face saving (an apparent obsession of your close advisers and image manipulators).  This will also avoid a likely split in your government and preserving the unity of the Greek Cypriot leadership, something that your associates and the Greek PM repeatedly emphasize. Turkish PM Erdogan was doing an excellent job in dividing Turkish society and tearing Turkish democratic foundations apart. If you had given him until the end of the year he would have managed things fine all by himself (see December 27 article herein predicting his downfall). He did not need your current intervention to allow him claim a win –and certainly the Greek Cypriot front did not need an unnecessary split right now out of the blue fighting over 3 irrelevant S’s  that will lead to a dead end anyway.  Gentlemen, if you cannot lift yourselves up to face the critical and complex circumstances that engulf our region, understand the basic economic realities and geopolitical strategies, and how to make contingent decisions under uncertainty, you should all resign before you completely bankrupt the country and ensure its doom.  When a roof of a local supermarket store collapsed in Latvia last November, Latvian PM Valdis Dambrovskis resigned, stating he was accepting “political and moral responsibility” for the deaths.  There had been no public calls for the resignation of PM Dombrovskis, who led his country’s recovery from the 2008 financial crisis through an austerity program that was held as a model for other nations. The investigation of the building disaster had not pointed to any wrongdoing by the government.  The building was built well before he took office. No one asked or expected him to resign.  Latvia was about to join the euro currency zone in a month, reaping the fruits of its disciplined efforts. Mr. Dombrovskis, who was easily reconfirmed twice in the last 3 years, simply said a new government was needed to restore confidence. “I wish to thank Latvia’s society for support during the trying period when the country was battling the economic and financial crisis to return to the path of growth. I also apologize for all that we have failed to achieve”. During the financial crisis, Latvia’s economy contracted by 20% and one-third of government employees were laid off. But now the economy is growing at a faster pace than most of Europe. Mr. Dombrovskis said he hoped the next government would “further strengthen the rule of law and improve the country’s competitiveness.”  This is a far cry from your political ethos. As a latest example, Ministers appointed by a political party in government state that they will stay in place even if that party pulls out its support from the government due to fundamental disagreements on matter of principle. The communist party leadership, after criticizing the government that the current provisions in the joint statement are far worse than what was achieved under their previous government, state they will support the President anyway. A question that arises is why they did not finalize a solution during their term when the terms were more favorable and they faced a more moderate and conciliatory Turkish Cypriot leader? Mr. Anastasiades and his party would likely have given their support also. This is all like the theater of the absurd, except now it is turning into a Cypriot drama.  Gentlemen, respectable party leaders, you have collectively bankrupt the country economically and morally, and you are now headed to hit you heads once again against the global economic and strategic reality wall, this time risking political and strategic catastrophe for our country. When will you rise up or offer your resignations?  Lenos Trigeorgis holds a PhD (DBA) from Harvard University and is the Bank of Cyprus Chair Professor of Finance at the University of Cyprus and President of the Real Options Group.  He has been a Visiting Professor of Finance at the London Business School. He is the author of Real Options (MIT Press, 1996), Strategic Investment (Princeton University Press, 2004) and Competitive Strategy (MIT Press, 2011).