The news of a potential sale of South Cyprus’ excess gold reserves first surfaced last week, in a draft EU report that was widely leaked to the press.
Clause 29 of the report states:
“Sales of Excess Gold reserves: The Cypriot authorities have committed to sell the excess amount of gold reserves owned by the Republic. This is estimated to generate one-off revenues to the state of 400 million euros via a pay-cut by the Central Bank”.
However, the Governor of the Central Bank, Panicos Demetriades said that he had no knowledge of the sale and was surprised by the news.
This initial reaction has now been modified after discussions with Greek Cypriot politicians who appear to have reached agreement with the EU but without consulting the Central Bank. There have also been calls by these politicians for the sacking of Mr Demetriades.
Here the picture gets confusing, as is not unusual in Greek Cypriot politics, because Article 7 of the Protocol of the European System of Central Banks guarantees Central Bank independence and freedom from government influence. That is to say, if Mr Demetriades does not want to sell the gold, he can resist government pressure to do so. In this instance, he will find support from head of the European Central Bank, Mario Draghi.
“The decision is going to be taken by the Central Bank,” Draghi said after a meeting of euro-area finance officials in Dublin. “What’s important, however, is that what is being transferred to the government budget out of the profits made out of the sales of gold should cover first and foremost, any potential loss that the Central Bank might have from its ELA.”
ELA (Emergency Liquidity Assistance), a lifeline that can be offered by national central banks in the euro region to commercial banks that can’t get funding.
This sale would amount to some 10 tonnes of gold out of a total of 13 tonnes. The Central Bank’s holdings account for 62% of its total official reserves, according to the World Gold Council, the industry lobby group.
The plan to sell these gold holdings would be the first such sale by a country seeking international assistance since the Asian financial crisis in 1997-98, when South Korea asked the public to donate jewellery to the its central bank for the good of the nation.
It would also mean that South Cyprus is the first Euro member to sell its reserves in the three year Eurozone crisis.
This explains the panic in the market and the tumbling gold price last week. South Cyprus’ Central Bank stocks of gold which had looked to be ring-fenced in the bailout process could now come in to play.
Governments in the Eurozone’s southern periphery tend to hold a large part of their total foreign reserves in gold. The Italian central bank holds 2,451 tonnes of gold, over 70% of its total reserves, while Portugal’s holding of 383 tonnes accounts for 90%.
The market’s concern is that other countries will be forced to sell their gold, thus driving gold prices down.
By way of contrast to South Cyprus, Turkey holds 360 tonnes of gold but this only represents 16% of its foreign exchange reserves.
Starting in October 2011, Turkey’s Central Bank began allowing commercial banks to hold a portion of their “required reserves”, needed to reassure depositors and other creditors they had plenty of money to hand, in physical gold bullion. Starting at 10%, that proportion was then raised to 30%.
Private citizens were similarly encouraged to hold their gold on deposit with their banks. That gold was thus transferred to the Central Bank’s balance sheet. Privately owned gold now backs the nation’s finances. A smart idea, which has coincided with the strengthening of Turkey’s currency, interest rates falling, huge current-account shrinking, and government bonds regaining “investment grade” status.
In the final analysis, even if Greek Cypriot gold reserves are sold, they will only contribute some 3% of the amount the government has to find as it’s part of the bailout package. There is no ‘magic bullet’ here. South Cyprus has many years of austerity yet to come.