Geopolitical implications of a Greek default: The Greece-Cyprus-Israel nexus

The Gaza flotilla tied Israel and Greece closer together. (Photo: EPA)

One under-discussed area of implications of a Greek default is how it could affect Israel.  Greek default could impose ruinous losses on Cypriot banks – which have balance sheets at positively Icelandic levels of 600 to 900 per cent of Cypriot GDP (depending on definitions).  But, more fundamentally, there is unlikely to be much political desire in Cyprus, given its intimate economic and political linkages to Greece, to continue in the euro (and European Union) if and when Greece leaves.

This much is widely known.  What is less widely known is how entangled Israel has recently become with Greece and Cyprus.  Following the deaths in the Gaza flotilla debacle of 2010, leading to tensions with Turkey, and the loss of key ally Egypt in the Arab Spring, Israel has shifted its Eastern Mediterranean focus – building new linkages with Greece and especially Cyprus.

Secular Israelis getting married have for many years used Cyprus as a sort of Vegas of the Eastern Mediterranean – civil (non-religious) weddings in Cyprus are recognised in Israel, where there is no domestic equivalent.  There are also significant real estate ties.  But more recently economic ties have accelerated.

These have included in particular the establishment of a Greco-Cypriot-Israeli Exclusive Economic Zone, in which there is drilling for oil and gas.  Indeed, the expected early 2012 announcements of the results of drilling constitute a joker in the pack of the Eurozone crisis – Israel's 2009 discovery of the large Tamar gas reserve (potentially worth $60 billion) materially shifted the outlook for its energy trade balance.  There is speculation that the Cypriot finds could be larger, and in an economy the GDP of which is only around $20 billion, a find on this scale could be transformative.  Exploitation of these fields has been threatened by the well-known tensions between Greece, Cyprus and Turkey.  But whilst Cyprus remains in the EU, that provides very significant protection, allowing investors and developers confidence to press ahead.

Through 2011, there has been a back-and-forth flurry of diplomatic exchanges between Cyprus and Israel.  To some extent, Israel has attempted to get in ahead of the rush.  Syria and Egypt also perceive Cyprus as a bridge into the EU.  Greek and consequent Cypriot exit from the euro and thence the EU, potentially leading on to internal political turmoil and certainly the loss of the EU shield from Turkey, could destablise these developments.  There could even be large real estate and mining company losses for Israeli firms.

Israel being sucked in to these events could be geopolitically significant.  An Israeli economic downturn could introduce a new and dangerous factor into turmoil in Syria and the delicate balance in Egypt, as well as creating further misery for Palestinians dependent on jobs in and commerce with Israel.

Behind the scenes, Washington could (or perhaps should) be almost as nervous about this aspect of the situation as about more widely-discussed global financial linkages.