Banking risks too great to relax capital controls in Cyprus

The Cypriot banking sector is too fragile to fully relax capital controls, according to London-based consultancy Capital Economics. The Cypriot finance ministry has been gradually relaxing capital controls and hopes to remove almost all by 2014. However the restriction on deposits leaving the country remains in place.

Cyprus' economy is still mired in recession however recent data suggests the severity of the contraction may have eased. The European Commission's economic sentiment indicator has improved and tourism has continued to grow.

Even with Capital Controls there have been huge deposit withdrawals and lifting capital controls would result in an "opening of the floodgates."

Capital Economics expect this control to remain in place for some time. The note highlights the fact that the deposit base has continued to shrink and It is feared that the European Central Bank's Asset Quality Review could show further problems in the banking sector. Capital Economics also challenge the IMF growth forecasts, which they believe are too optimistic.

Ben May, European economist:

Whilst controls will continue to be gradually loosened, the government won’t want to fully lift them until the economy is on a more sustainable path. But with a backdrop of weak domestic demand and optimistic economic targets, this will take some time.