Cyprus Looks to its Past For Economic Reboot

As it grapples with the prospect of years of economic pain, Cyprus will try to draw strength from its not-so-distant experience of invasion - and the fact a whole generation knows what it means to rebuild from scratch.

But it's a tough task.

Any inspiration will be badly needed on the small east Mediterranean island nation of under a million people, as even the most optimistic forecasters predict years of recession and sky-high unemployment.

In many ways, the challenge facing Cyprus now following an international bailout that effectively wipes out a hefty chunk of the banking sector is more daunting than recovery from the events of 1974. Then, the island was split into an internationally recognized, Greek-speaking south and a breakaway Turkish north, following Turkey's invasion in the wake of an attempted coup by supporters of union with Greece.

The country's room for maneuver is limited, given that it has already largely exhausted the potential for development from a primarily agricultural state.

And any reboot of the economy of the Greek-Cypriot side - the part of the island that has joined the European Union and is afflicted by the recent bailout woes - will have to be done within the limitations of a colossal debt mountain, a collapsed property bubble, a sclerotic European economy and a seeming dearth of international sympathy.

"It's an economic tragedy this time and the difference is you don't know where it'll end up," said Andreas Georgiou, 80. "This could stir social unrest, people are worried about their families, putting their kids through school. In 1974, we had support from the outside, our people were willing to go abroad and find work to send money home. But could this happen again?"

Such doubts are on the minds of many Cypriots, even as the resilience shown after 1974 provides grounds for encouragement.

Following the invasion, Turkey ended up with control of nearly 40 percent of the island and much of its economic potential. Greek-Cypriots were largely cut off from the world, losing the historic deep-water port of Famagusta and the international airport in Nicosia, which has since been home to peacekeeping troops from the United Nations.

The Turkish side also ended up with the bulk of the country's pre-1974 agricultural base as well as the lion's share of the burgeoning tourism industry.

And tens of thousands of refugees living in camps had to be rehoused.

The University of Cyprus has estimated that the invasion and division cost Greek Cypriot individuals and companies over 109 billion euros ($140 billion).

"Our homeland has experienced worse," President Nikos Anastasiades said in a televised address in the wake of the bailout on Monday.

Cyprus proved back then it could bounce back.

In spite of the economic devastation wrought by the 1974 invasion, Cyprus found itself on the mend, at least economically, within a few years of the invasion as the government backed a series of emergency economic plans with international support.

Between 1976 and 1997, Cyprus was growing over 6 percent a year, with tourism at the heart of the economy's rebirth. The small fishing village of Ayia Napa was transformed and became the standard bearer of the industry and purveyor of a new nightclub sound.

Businesses, big and small, prevailed as many of the country's youth returned home after getting university degrees around the world, notably from Greece, Britain, and the U.S.

"A lesson that came out of 1974 was that people learnt that you could lose your property, your money, but if you've got an education, you can start again and rebuild," said James Ker-Lindsay, a senior research fellow at the London School of Economics, who has written extensively on modern Cyprus.

However, one unintended consequence of that drive to educate was the unbalancing of the Cypriot economy away from agriculture and tourism towards financial services, said Ker-Lindsay.

The booming financial sector got a further turbo charge from the collapse of the Soviet Union in the early 1990s, and Russian money - some thought to be of dubious origin - started flowing into the country's banks. The influx of capital that further unbalanced the economy.

Membership in the EU in 2004 and the adoption of the euro four years later were meant to solidify the country's advance and set a course for further prosperity.

However, Europe's debt crisis and in particular the problems of Greece tore up the Cypriot economic model and the country eventually had to accept an onerous package of measures to stave off bankruptcy, including the closure of its second-largest bank, Laiki, and a whack on big depositors.

With capital controls likely to be in place for the time being, Cyprus' status as an offshore financial haven is likely gone for a generation at least. And with its banking sector crippled from restrictions imposed, the country will undoubtedly lose a chunk of its credit lifeblood.

"Should the current banking sector instability result in a prolonged breakdown in the domestic payments system, this would lead to a surge in corporate bankruptcy and drive a deeper GDP contraction," the ratings agency Fitch warned.

A severe economic depression looms that many think could see the Cypriot economy shrinking by a quarter over the coming years - equivalent to the contraction seen in the immediate post-invasion period - as companies go bust and unemployment likely rises to Spanish and Greek levels above 25 percent.

The country's European partners know there are grim times ahead. Olli Rehn, the EU's top monetary official, sought to find comfort in the lessons of the past.

"Cyprus and the Cypriots have gone through very difficult times before, and you know what I mean, and the Cypriots have overcome these difficult times," Rehn said Monday immediately after the country's bailout deal was secured.

Given that it's opted to keep the euro, Cyprus doesn't have the option of boosting growth from a lower currency.

So where could growth come from? Much has been made of the country's potential offshore gas reserves but there are doubts as to how that will be brought to market given the interests of other players in the region, including Turkey.

Whatever the form a future Cypriot economy takes, the financial services industry will need to regain trust.

"The fundamentals are still there," said the LSE's Ker-Lindsay. "Cyprus is still a great place to set up business in that region. However, without trust in the banking sector, it's going to be difficult to keep companies there, let alone attract new ones."