The question of what would happen if Cyprus were to leave the euro with a sharply devalued national currency has been much debated in recent days. Krugman and others arguing for it note that nations outside the euro such as Iceland recovered better from banking crises after a year or two lag than those tied to broader currencies. Argentina may have had a GDP decline of 10% the year it unhooked from the dollar with a massive devaluation, but grew well after that. For Cyprus to gain from a devaluation, although it looks likely Cyrpus will stick with the euro, its exports would need to surge.
As it is, Cyprus is a very open economy. Of its 24 billion euro GDP, nearly 40% is exports. Important sectors in this are refined petroleum products, agriculture, particularly citrus fruits and potatoes, semin-conductors, pharmaceuticals, and some textile products. However, Cyprus has traditionally run a trade deficit in most years. Greece has been by far the leading destination of exports as well as supplier of imports. Egypt and Germany are second and third as export destinations, with China and Israel second and third for import suppliers.
While it is not part of the trade account, important to the current account is tourism, which is about 10% of GDP and is the largest single sector of the Cypriot economy. Certainly a surge of tourism would be necessary to prop up the economy in the case of a devaluation. Russians, British, Germans, and Swedes are the top tourists, although Russians might be less inclined to come after being hit for uninsured deposits in Cyrpriot banks.
Further down the road is the prospect of natural gas production and exports. There are mixed accounts of how much natural gas there is, but it may be as much as $400 billion worth. However, there are several caveats. One is that this is not likely to get into production prior to about 2020. Another is that there are disputes over who owns portions of the large gas field of the Eastern Mediterranean, with this getting tangled up in international politics.
In particular, the matter of relations with Turkey are very important. Part of the problem is the ongoing split of Cyprus, with Turkish-dominated northern Cyprus claiming a portion of the fields. But there is also the matter of markets for the gas, particularly with rising production in the US. The obvious market is Turkey itself. That Turkey and Israel have recently made up does not help Cyprus in this either.
Indeed, there is a not-so subtle view that part of why the Eurozone leaders are being so hard on Cyprus has been in fact that Greek-dominated Cyprus is viewed as the holdout on resolving the long-running division of Cyprus that many in Europe would like to see resolved. It may well be, that whatever Cyprus does about the euro, it will need to make peace with Turkey and the northern part of itself if it wishes to fully develop and sell its natural gas down the road. Maybe peace in a part of the Eastern Mediterranean may well yet be one outcome of this financial crisis that has hit Cyprus so hard.