It's risk-off again as troika plays with fire in Cyprus

Anyone who thought financial markets had broken out of the risk-on, risk-off cycle that has dominated trading for the last couple of years surely changed their mind yesterday.

In Hong Kong the benchmark Hang Seng stock index tumbled 2 per cent as investors reacted to the proposed bail-out deal for Cyprus by rushing to take their money off the table.

What spooked investors was the attempt by the "troika" of the European Commission, the European Central Bank and the International Monetary Fund to force depositors in Cypriot banks to take a haircut as part of the bail out.

Under the deal announced over the weekend, deposits of more than €100,000 (HK$1.01 million) will be hit with a one-off tax of 9.9 per cent, while depositors with less than €100,000 will pay 6.75 per cent.

Ultimately, in any debt crisis it is always ordinary bank depositors who end up paying. Usually, however, the bill is disguised. For example, the monetary authorities might allow inflation to rise, which shrinks the size of the debts relative to nominal output, but at the cost of a decline in the purchasing power of deposits.

Alternatively, the authorities might hold deposit rates down, keeping the spread between deposit and lending rates artificially wide in order to recapitalise the banks at depositors' expense; the path taken by the mainland authorities following the bad loan crisis of the late 1990s.

But overtly imposing a tax on deposits, as the troika is proposing to do in Cyprus, is highly unusual - and dangerous.

You can see why they thought it might be a good idea. Cyprus has long been the favoured banking centre for rich Russians eager to stash a portion of their wealth offshore.

As a result, the troika was understandably anxious to avoid the accusation that in putting together a deal for Cyprus it was simply bailing out rich Russians.

But in trying to force Cypriot depositors to take a haircut, the troika is setting an unfortunate precedent. It is sending out the message that bank depositors in the euro zone's crisis-hit countries can no longer expect to be protected.

As a result, savers in Greece, Spain, Portugal and Ireland will naturally be prompted to reassess the security of their bank deposits. To be on the safe side, many are likely to decide to shift their money to banks in a more stable economy.

In other words, by trying to force a haircut on Cypriot depositors the troika may have fatally damaged savers' faith in the banking systems of other fragile euro-zone economies.

Suddenly the euro crisis is back with a vengeance, and investors have gone back into risk-off mode.

As newspaper columnist, you get used to being criticised for what you write.

You can even get used to being criticised for things you haven't written. Sometimes the criticism is deserved.

But to be criticised for something you didn't write, when the criticism itself doesn't add up, does rather rankle.

Last week I remarked that a regressive goods and services tax would be unacceptable in Hong Kong where the very rich, who receive their income in the form of dividends and capital gains, pay little or no personal tax.

Some readers interpreted this as a call for a tax on dividends, and roundly condemned me for suggesting such an outrage.

Companies are already taxed on their profits, they argued, so a tax on dividends would hit them twice over.

However, as Financial Secretary John Tsang Chun-wah pointed out yesterday, 90 per cent of companies registered in Hong Kong pay no profits tax.

And those that do are only taxed on profits earned locally, not on profit earned outside Hong Kong.

As a result, there would be relatively little danger of taxing people twice over.

Still, I'm not suggesting anyone tries.

tom.holland@scmp.com