A bail-out package for Cyprus, cobbled together on Monday last by officials of 17 eurozone countries that use the common currency, euro, has brought the spotlight back on the euro crisis, which, for many outside Europe, appeared to have been contained.

There are ample reasons why a resolution — if at all one calls that — of the Cyprus problem is beneficial to Europe and the rest of the world, including India. The structural deficiencies in Cyprus’ macro-economic management might not obtain in India but it would be good to understand its dimensions.

One, Cyprus has had a financial sector which is four or five times the size of what is required by its admittedly small economy. Two, its banks have grown big on the back of large deposits from Russia and other countries of the old Soviet Union.

Three, their attraction for Cyprus has been its tax-haven status, low tax, lax regulation and secrecy.

Officially, 37 per cent of the deposits in Cypriot banks are from non-residents. But, according to experts, this is most certainly an underestimation as it does not include wealthy expatriates and people who are nominally resident in Cyprus.

Four, the tax-haven status encouraged the related pernicious but legal practice which goes by the name “round-tripping”. What it means is that the Cypriot banks’ wealthy clients from Russia and other places who enjoy the privileges of off-shore banking, took the money back to their own countries through legal channels.

In practice, therefore, much of the Russian and other non-resident money did not move anywhere: it just became invisible.

A more appropriate name for round-tripping is money laundering. That badge not even the proudest tax haven would like to wear.

However, a small portion of the non-resident money actually came to Cyprus, whose banks made a mess of their investments by buying Greek paper and other risky assets.

It is that bleak scenario that the EU package seeks to address through a series of unconventional steps that nevertheless reflect the desperate situation.

The country’s over-sized banking sector will be pruned. The drastic restructuring includes the closure of Laiki Bank, one of Cyprus’ largest banks. The country’s largest lender, Bank of Cyprus, will be allowed to survive but will take on the liabilities of some failed banks.

An earlier proposal to tax depositors indiscriminately to fund the bail-out has been dropped entirely. The proposal to levy a tax even on deposits below euro 100,000, which are covered by a statutory guarantee scheme, sparked off a universal outrage, and was subsequently rejected by the Cypriot Parliament.

Large depositors, those having accounts with balances of euro 100,000 and over, will, however, have to incur forced losses. Bondholders and many creditors will also take a hit. The exact quantum of losses under each category is yet to be determined.

Cyprus, which accounts for just 0.2 per cent of the eurozone economy, has had the potential to wreak havoc on a much wider scale than seems possible by its size.

The immediate fear was that its banking crisis would set off a contagion in other parts of Europe. Given the extent of globalisation, the threat to the global financial system and, hence, the economy was never far off.

The immediate gain to the Cypriots ought to be the restoration of faith in the country’s financial system. The intensity of the crisis has been such that ordinary citizens started shunning the formal financial system and drifted to a pre-modern economy dominated by cash. Banks in Cyprus have remained closed for nearly two weeks. When they reopened last Thursday, they were subject to severe controls and restrictions.

It is fairly certain that the days of Cyprus as a willing tax-haven are over. Its restructured banks will be a pale shadow of their former selves.

Cyprus’ banking sector has been a significant contributor to its economy. It is difficult to see how other sectors such as tourism will make up for the certain fall in financial sector’s contribution. Cyprus would receive the first payment (of U.S. $13 billion) in early May.

A comparison with India is simply not on. However, in any discussions on the Mauritius tax treaty, echoes of the Cyprus crisis are sure to resonate.

narasimhan.crl@thehindu.co.in