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Cyprus bailout plan re-ignites eurozone fears

(MoneyWatch) Is Cyprus the fuse that finally burns down the eurozone?

Concerns that a proposed bailout for the small Mediterranean island nation, population 1 million, could re-ignite Europe's government debt crisis appears to be denting financial markets. Stocks in the U.S. opened down, with the Dow Jones industrial average losing more than 50 points in morning trade and the S&P 500 also down slightly after flirting with a new record high on Friday.

Stocks in France, Germany and the U.K. also receded Monday.

Under a plan backed by the so-called Troika -- the European Central Bank, European Union and IMF -- Cyprus is proposing to levy a one-time tax on savers as part of a $13 billion bailout. That would put the burden of rescuing the country on bank depositors, even those with insured deposits.

Eurozone officials have said that the tax is essential and that Cyprus's banks will collapse without it. They contend Cypriot banks' low levels of senior unsecured debt leaves few other options that leaning on depositors. The bailout will also include an increase in the corporate tax rate from 10 percent to 12.5 percent and force sales of state assets.

Investors are worried. "The return of fears that one or more countries may actually leave the eurozone altogether could lead to a sustained correction in the prices of riskier assets generally," Julian Jessop, chief global economist for Capital Economics, said in a research note. Monies raised with the new tax would be used to recapitalize the nation's banks and service the country's ballooning debt.

Although the stock sell-off in the U.S. this morning was not severe, it is a reminder that Europe's sovereign debt crisis is only in hibernation. Promises by ECB chief Mario Draghi last year to backstop ailing economies in the region reassured investors that European officials were committed to the eurozone. But the region's underlying problems, especially slow growth, remain.

The announcement on Saturday of the bailout plan caused anxious Cypriots to rush to ATM machines to withdraw funds. With panic in the air, officials modified an earlier plan that would have hit all depositors and are now considering whether to put more of a burden on larger depositors. Under that measure, people with less than 100,000 euros would pay a 3 percent tax, while those with over 500,000 euros would pay 15 percent. 

Some 37 percent of Cypriot bank deposits are held by foreign account holders, including Russian companies and individuals that hold an estimated 25 billion in Cyprus banks. That led Russia President Vladimir Putin to blast the proposed levy "unfair, unprofessional and dangerous."

The vote on the new tax proposal was supposed to occur today, but Reuters reported that the Cypriot parliament plans to delay the vote until tomorrow, when banks are closed for a planned holiday. If passed, money would be drawn from accounts overnight.

Could the Cypriot actions spread into a broader eurozone contagion? After all, if the tax can be applied in Cyprus, why not Greece, Portugal, Spain or Italy? European officials underscore that Cyprus is "exceptional" and the measures are "unique," because the banking sector there is eight times the size of the total economy. By comparison, the U.S. banking system is roughly one times the size of the economy.

The bailout amount is also massive compared to other bailouts, representing nearly 70 percent of Cyprus's GDP. The bailout arranged for Ireland after the 2008 financial crisis amounted to 40 percent of the country's economy, while Greece's rescue package was 27 percent.

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