Pimco’s El-Erian: Cyprus Capital Controls Are Just 'Circuit Breakers'

Tuesday, 02 Apr 2013 11:09 AM

By Michael Kling

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Harsh capital controls are only a stopgap measure for the eurozone's Cyprus crisis, cautions Mohamed El-Erian, CEO and co-CIO of Pimco.

Capital controls offer a "short reprieve" at best. If not followed by more essential — and probably controversial — decisions, in a matter of weeks the controls will become part of an even deeper problem, El-Erian writes in a guest blog for CNBC.

In an attempt to prevent a bank run, the country's bailout agreement limits how much depositors can remove from bank accounts and take abroad.

Declassified:
‘Financial War’ Could Wipe Out 50% of Your Wealth’

"History tells us that this approach only works if controls are followed by a re-alignment of economic incentives and by offering the population a genuine hope for recovery and return to normalcy," he states. "Otherwise, what is viewed initially as a 'circuit breaker' ends up making the underlying situation worse."

The controls will strangle what little economic growth remains, El-Erian explains.

With less access to savings, consumer spending will plummet. Investment activity will grind to a halt because of substantial disruption in demand. Capital flowing into Cyprus will stop, and capital will only flow out. Even routine corporate activities will be limited, as part of companies' working capital is trapped.

And that's just the immediate impact. Over the long term, Cyprus must find an economic driver to replace its banking business, he says. That will not be easy. Although the country's position is not impossible, finding a mix of agriculture, tourism and light manufacturing will take time.

"Cyprus can hope that its tragic situation," El-Erian notes, "will unlock more generous funding from the 'Troika' of the European Commission, the European Central Bank [ECB] and the [International Monetary Fund]."

Leaving the euro "seems equally unpalatable to Europe given contagion worries," he adds, warning that a spillover could a systemic threat even if limited.

The ECB's options are limited, he maintains. "Wherever they look, Cyprus and its European partners are running out of easy options."

Instead of stopgap measures, they must restore growth and jobs

In an effort to create that kind of growth, Cyprus President Nicos Anastasiades plans to end the ban on casinos, reports the Guardian.

Gambling is legal only on the northern, Turkish side of the island. Anastasiades announced plans for tax exemptions on business profits reinvested in Cyprus, encouraging landlords to reduce rents, encouraging banks to lend for longer terms at lower rates and reducing electricity costs.

Declassified: ‘Financial War’ Could Wipe Out 50% of Your Wealth’

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