The indication that Cyprus might leave the euro zone raises questions on the socioeconomic effects of adopting the Cyprus pound. The current economic crisis facing Cyprus highlights the ripple effects of the discontinuity in economies sharing a common currency. Cyprus exit from the euro zone would allow the country to restructure its economic infrastructure by introducing a domestic currency and floating exchange rates, which would boost exports and minimize the country’s trade balance.
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A floating exchange rate would allow the Cyprus pound to rectify the country’s trade balance because the currency’s value will adjust in respect to Cyprus’ economy rather than as a projection of the entire euro zone (Nixon par. 5). The exchange rate mechanism (EMR) adopted among EU members limits the fluctuations of the value of a country’s currency, which negatively affects the response to deficit differentials in different countries.
Having the Cyprus pound would allow the country to engage in the simulation of the local currency by printing money proportionately. A flexible exchange rate would play a crucial role in correcting the economic inefficiencies facing Cyprus and boost sectors such as tourism to facilitate the country’s emergence from depression and high unemployment. A small economy has a high possibility of recovery from an economic crisis when using an individual currency because of the flexibility in adjusting rates.
For example, a forty percent decrease in the value of the Cyprus pound would translate into a forty percent decrease in the cost incurred by tourists visiting Cyprus. A surge in income generated through tourism can help the country to normalize the effects of high unemployment and increasing spending. Adopting the Cyprus pound would eliminate the main component of Cyprus capital account, which is the transfer of payments from the European Union for investment and capital transfer purposes.
Cyprus would experience an imbalance in its financial accounts due to an excess of the disposal of financial assets because investors would expect a devaluation of the Cyprus pound. Retaining the Euro increases the susceptibility of Cyprus to a fiscal crisis because of the lack of a currency that is responding to the local economic factors.
Having an individual currency eliminates transition costs, which faces countries relying on a major currency such as the Euro. Transition costs have detrimental effects on the operating costs of multinational corporations because of currency conversion, which arouse litigation cases. A multinational company in Cyprus owning a trading partner in Germany would have the challenge of accounting for the debt with Cyprus pounds or Euros.
Exiting the euro zone now would have devastating effects on Cyprus’ economic stability considering the current economic status of the country, which suffers from a large trade balance deficit due to an overreliance on imports. The devaluation of the currency for an economically unstable country may induce a massive withdrawal of deposits from banks due to risk aversion as investors shift to other stable currencies.
The exit of investors would have negative effects on Cyprus current account due to a decline in returns on investment as people transfer their assets to high-return currencies (Eun and Bruce G 213).The withdrawal of investors would counter the supposed benefits of devaluation of the Cyprus pound to enhance competition in the globe in the short-term. Cyprus economy would gradually improve and recover with the inflows on exports and services such as tourism to offset the deficit accrued on imports.
Eun, Cheol, and Bruce Resnick. International financial management. 6th ed. 2011. Boston: McGraw-Hill/Irwin. Print.
Nixon, Simon. “Cyprus Deposits a New Challenge on the Euro Zone.” The Wall Street Journal. Dow Jones & Company, 17 Mar. 2013.