It seems that every time the problems in the Eurozone and European Union seem to be subsiding, a new crisis emerges and threatens to send the massive trade union spiraling back towards collapse. The European Commission has released a strong warning that conditions in Cyprus are set to worsen as bank deposits are drying up, and more bad loans are about to make their way onto the books. These conditions could adversely affect the nation’s banking system.

Cyprus

Cyprus mortgage crisis

Amid the turmoil in France, Spain, Greece, Ireland, and elsewhere, the continuing situation in Cyprus is often forgotten. When the sub-prime mortgage crisis first broke in the United States, Cyprus’s economy was plunged into a recession. Despite worsening conditions in Europe, however, Cyprus was originally able to bear the storm.

In fact, when the crisis first started, Cyprus had some of the lowest Debt-to-GDP ratios in the entire Eurozone at about 50 percent. Unfortunately, while Cyprus had been doing a reasonable job of managing its debts, the island’s economy relied heavily on off-shore banking, and much of that sector was tied up in Greek debts and other markets that were quickly unraveling.

As the crisis unfolded, it quickly became apparent that many Cypriot banks had huge amounts of bad loans on their books. More and more of these loans became submerged and the country’s financial district was on the verge of collapse by 2012. In January of 2012, the European Union stepped in with a 2.5 billion euro emergency loan. This loan was generally seen as a stop gap measure until a more comprehensive bailout could be put together.

Cyprus still in bad condition

Even after the bailout, conditions continued to worsen. By March of 2012, international rating agencies began to slash Cyprus’s credit ratings to junk status. This made it virtually impossible for Cyprus to raise funding in international markets, and in short order the E.U. was forced to step in with a massive bailout package. The bailout package took several months to negotiate, and required cuts in public spending and increases in various taxes.

Cyprus’s government has been commended for cutting spending and otherwise working with European Union leaders to contain the crisis and correct the economy. Despite its efforts (or as some would argue, because of its efforts) conditions continue to worsen as people withdraw their money from banks. Cyprus has tried to install capital flight controls, but while they have stemmed the bleeding, they have failed to fully contain the crisis.

Cyprus economic crisis

Now, it looks like Cyprus could be plunged back into crisis. The economy is set to shrink by nearly 9 percent through 2013, and an additional 4 percent in 2014. Employment rates have risen markedly to 17 percent, and could hit as high as 20 percent in 2014. Such drastically high unemployment could put a crimp on Cyprus’s economy for years to come and could make a sustained recovery more difficult to achieve.

Still, Cyprus’s economic depression could largely be limited to the island nation itself. Cyprus’s economy is small in comparison to other Eurozone economies, and thus will have less spill-over effect. What could set off a panic, however, is if Cyprus decides to leave the Eurozone. Already, the nation has seriously contemplated such an action and it may only be a matter of time before it finally does so.