ForexSpace.com - As London-based forex traders weigh up whether to quit their screen and currency charts for the afternoon and, along with the rest of the country, head to the nearest boozer with a big screen to watch the Eng-eerrr-land-v-France, news hits the wires that Cyprus is about to go cap in hand for an international bailout.  Although less than 1/10 of the size of Greece, it just goes to show how the problems have spread. While most people’s attention had been focused at the next domino to fall – something of a toss-up between Portugal and Italy – with the latter far from seeing an ease up on Italian bond yield pressure, Spain’s bailout may have made Italian debt less attractive.

Kathleen Brooks (pictured), head of research with FOREX.com, points to two significant reasons why investors may choose not to buy Italian debt. “Firstly,” she says, “the sovereign debt crisis has been caused by either property crashes (Ireland and Spain) or unsustainable public finances (Greece). In this environment Italy’s 120 percent debt-to-GDP ratio won’t wash with bond investors, thus it’s hard to see a permanent decline in Italy’s bond yields while debt levels remain so high. Secondly, Spain’s bailout has opened a debate about the position of private sector bondholders in the pecking order if Spain one day defaults,” says Brooks, who concludes: “If Spain gets funds from the ESM then private bond holders are subordinate to European institutions – a real turn off for investors. It is not beyond the realm of possibility that Italy may need a bailout one day, hence investors are immediately suspicious of owning Italian debt, hence its 10-year bond yield jumped to above 6 percent at one stage today, which is the highest level since January.”

Italy notwithstanding, and while Cyprus is of course no Italy, (or Greece or Portugal) it has made for a sobering afternoon to hear sources say Cyprus could be seeking cash within days, which would be used not just to bolster the Island’s buckled banks, but also help replenish its depleted coffers. Indeed, Cyprus FinMin Vassos Shiarly has just told journalists: "The issue is urgent. We know the recapitalisation of the [island's] banks must be completed by June 30, and there are a few days left."

In a classic case of interconnectedness - Cypriot banks have big exposures in Greece - Cyprus (already, economically speaking, a basket case) has suffered a colossal economic meltdown, largely by dint of bad loans to building developers who, like in Spain, is now saddled with mountainous unsold and unsellable properties. Shut out of financial markets for a year and running deficits, the island needs the equivalent of 10 percent of its GDP just to prop up Popular Bank, its second-largest lender, looking for an investor willing to fill a €1.8bn regulatory shortfall. Failing this, the government would be forced to come to the bank’s aid. As potential leverage, it is negotiating separately with a third country – suspected as being China – in the hope that it could secure better bailout terms from its EU partners. However, it’s worth noting how Cyprus received a €2.5bn bilateral loan from Russia late last year, sidestepping its EU partners. Neal Kimberley, fx analyst with Thomson Reuters, reinforces this view, telling me he believes Russia might in fact be the first port of call for Cyprus, “given that Moscow extended a loan to Nicosia before. Plus, taking in to account the situation in Syria,” opines Kimberley, “it might suit Mr Putin to keep friends in Cyprus, lest Russia loses access to its naval base at Tartus in Syria.”

‘Ere we go indeed!

Drew Hillier. Editor, ForexSpace.com