Monday, 18 Mar 2013 01:47 PM

By Dan Weil

The 6.75 percent bank-deposit tax that the European Union is requiring from Cyprus in exchange for a bailout, could lead to a financial meltdown, including a Cypriot withdrawal from the eurozone, says Pimco CEO Mohamed El-Erian.

"Europe lit the fuse of two sticks of dynamite Saturday,” he tells CNBC.

As for the first, "by including small depositors, they are risking social unrest, political disorder, and an exit from the eurozone." he explains.

Small depositors should be exempt from the tax, meant to raise 5.8 billion euros ($7.5 billion), and that's what Cypriot ministers are seeking before Tuesday’s vote in parliament, El-Erian says.

"The other stick of dynamite that's been lit is much more complicated and more uncertain," El-Erian notes. "That is a question mark about the sanctity of bank deposits in Europe. And it’s a reminder that Europe has too many objectives and too few instruments."

The political system is "failing Europe," he adds.

Many are worried that not only will Cyprus see a bank run in the wake of the tax, but that depositors in other weak European nations, such as Spain and Italy, will run for the exits too.

While there hasn’t been a run on banks, which is “really good news,” El-Erian explains that “it’s too early to declare victory.”

“Traders and investors are aghast at these measures,” Michael McCarthy, chief market strategist at CMC Markets in Sydney, Australia, tells Bloomberg.

To be sure, European officials are beginning to show some flexibility on the bank tax proposal to avoid sparking a crisis across the continent.

“If the government wants to change the structure of the solidarity levy for the banking sector, the government can decide as such,” says European Central Bank Executive Board member Joerg Asmussen, Bloomberg reports.

“What’s important is that the planned revenue of 5.8 billion euros remains.”

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