Cyprus Banking Crisis: Will Russia Ride to the Rescue?

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The Cyprus government is scrambling to find alternative ways to fund its part of an E.U. bailout, including asking for help in Moscow, after the island’s parliament resoundingly rejected the terms initially agreed. The lawmakers’ vote was seen as a complete denunciation of the controversial plan to levy a one-time tax on bank deposits of Cypriots and non-Cypriots alike.

Despite the international uproar that the bailout has generated, the E.U. shows no sign of budging from its insistence that Cyprus itself must fund a part of its own rescue package. Together with the International Monetary Fund, the E.U. has said it is willing to put up $13 billion — but only if Cyprus itself contributes about $7.5 billion in revenue. German Finance Minister Wolfgang Schaüble told a TV interview on Tuesday evening that he “regretted” the parliament’s decision to reject a package that had been worked out together with the government.

If public indignation wasn’t already palpable over the E.U. deal, which was agreed upon this weekend after a 10-hour negotiation process between euro-zone Finance Ministers, the plan was put up for a parliamentary vote Tuesday in which not a single member of the 56-strong Cypriot parliament voted to endorse it: 36 deputies voted against, 19 abstained and one wasn’t present.

The island has run into serious financial difficulty because its banks were heavily exposed to Greek debt. But the government can’t afford to bail out the banking system on its own. In the parliamentary debate, Averof Neofytou, the deputy head of President Nicos Anastasiades’ party, warned, “We are on the brink of an unruly bankruptcy.”

Bankruptcy would be the worst outcome for all of Europe, since it would once again put at risk the continent’s single currency, the euro. However, the European Central Bank says that, for the moment at least, it is continuing to provide liquidity to Cyprus’ banks in accordance with its usual rules and procedures.

In reality, the Cyprus government has precious few options. One is to revamp the proposed levy in order to exempt small depositors, although that would mean taking a substantially larger proportion from those with more than $130,000 in their accounts. The original deal called for those with deposits in excess of $130,00 to pay a 9.9% levy, while those with less would be taxed at a 6.75% rate. Exempting those with less than $130,000 would mean raising the rate to over 15% for the others, Cypriot and non-Cypriot alike.

The fear that the levy would impact international depositors just the same has inspired the government to look to the possibility of finding other sources of funds altogether. To that end, Finance Minister Michalis Sarris flew to Moscow on Tuesday night, and President Anastasiades held a phone conversation with Russian President Vladimir Putin. From the official comments, it’s not clear that any specific proposals were discussed. Putin’s spokesman Dmitri Peskov said only that the two leaders had “analyzed the economic situation in Cyprus in light of the Eurogroup’s bailout proposals,” and that Putin had “reiterated his concern about any measures that could harm the interests of Russian businesses or individuals in Cyprus.” Moscow in 2011 granted a $3 billion loan to Nicosia, and one possibility is for that loan to be extended or increased.

Russia is a major player in the Cyprus banking scene, with at least one-third of all bank deposits being made by Russians. Indeed, Russia has turned the island into its preferred offshore banking center over the past 20 years; Cyprus is today a major foreign investor in Russia, a reflection of the money that transfers in and out from Russia through the Cyprus banking system.

Russians depositors would be especially hard hit by any levy, and the Kremlin has expressed undisguised anger at the E.U. plan. Putin on Monday described the move through a spokesman as “unfair, unprofessional and dangerous,” while Prime Minister Dmitri Medvedev called it “confiscation.” For days now, there has been rampant speculation in the Cypriot media that a major company like oil-and-gas giant Gazprom might propose a deal to salvage Cyprus’ finances in exchange for oil-drilling rights. So far, none of these reports have been confirmed, and they may simply be wishful thinking by desperate Cypriots as serious options look scant.

The parliament’s rejection of the deal leaves Cyprus as a whole in a very exposed position. The government can’t risk reopening the banks, which have remained closed this week, since there would almost certainly be a huge bank run as everyone, ordinary Cypriots and international depositors alike, attempted to take their money out. The government and the central bank also need to find a way to recapitalize their banking system. The jitters on world markets that followed news of the bailout look set to continue.