Thursday, 21 March 2013

Cypriot economy stuck between Brussels and Moscow

The small Mediterranean island of Cyprus is suddenly became newsworthy across the globe this week, for all the wrong reasons.  Their financial situation is dire, which is why Nicosia asked for assistance from Brussels, but it is the sudden spotlight on the island’s relationship with Russia which is turning many heads.

This week, after Brussels preliminarily agreed to some form of bailout package for the island nation, it is the depositors instead of creditors feeling the heat in the troubled European Union for a change. After Tuesday evening’s vote in the Cypriot parliament, not a single official voted in favour of Brussels’ strict bailout package.

The unpopular tax on bank deposits in Cyprus along with a special levy would have gone some way in collecting revenue for a struggling Cypriot government preparing the country for a proposed €10 billion in International Monetary Fund aid. But the bulk of the proposed austerity measures were to be lumped on foreign investors, many of them Russian. Punishing depositors could be fatal for Cyprus’ economy.

Cypriots protest an EU bailout deal outside the parliament in Nicosia. AFP/Getty Images
Brussels’ austerity measures for the bailout package could be an attempt to fathom the great deal of Russian investment in the island’s banking sector. Russian President Vladimir Putin said as much when he purportedly called the European tax on bank depositors in Cyprus unfair, unprofessional, and dangerous. While Russian Prime Minister Dmitri Medvedev and Russian billionaire Mikhail Prokhorov darkly called the measure an affront to people’s private property and a confiscation of other’s money.

The Cypriot banking system is closely intertwined with the Greek system and was extremely hurt after Greece suffered a write-down on sovereign debt holdings in 2012. Cyprus is now the fifth European country to request a bailout with ripples spreading through Europe, Russia, and the global economic system with the potential to place significant pressure on relations between Berlin and Moscow.

Cyprus has for many years been at the intersection of worlds. The country is split down the middle between Greek and Turkish interests. But it is with heavy Russian investment that Cyprus traditionally has danced with geopolitics.

The lucky island nation weathered the worst of the financial crisis gripping the bulk of the European mainland. Even though Nicosia will require €5 billion over the next two years just to keep afloat, it has historically been able to look outside of Brussels for assistance, especially to their old partner Moscow.

As well as being strategically located to compensate for a potential loss of control over the Syrian port at Tartus, of which Russia holds a long term lease for its Black Sea fleet, Cyprus is also an extremely popular offshore banking haven for rich Russians and shady Kremlin officials.

Russian involvement in Cyprus stretches into the decades and has evolved over time. Looking to diversify their assets, Russian elites have used the island as a banking thoroughfare taking advantage of some especially favourable legal banking ties. Underground, Cyprus is also relatively well-known as a useful country for Russian money laundering and arms smuggling operations.

But it is not all one way traffic on Cyprus. A loan extended to Nicosia in 2009 by Moscow reportedly came with the attached strings of supplying banking information about wealthy Russian assets on the island. In return Russia helped Cyprus financially when it struggled again in 2011 and sold the country advanced surface-to-air missiles which Moscow refused to sell to anyone else.

During the Cold War, Cyprus and Russia worked closely in political matters and after 1991 the island’s banking industry was one of the few places to continue handling Russian money and investments. Today domestic Russian banks are still unpredictable, with many Russians preferring to maintain the old tradition of diversifying assets into Cypriot banks to keep out the prying eyes of the Kremlin.

Russian investments in Cyprus are estimated to range between €15 to 30 billion, or about half of total deposited money in Cyprus. In the past, deposits of 100,000 euros have been protected by European states to avoid bank runs, so the announcement of austerity took many Cypriots and Russian investors by surprise. After the depositor’s tax was announced, the Kremlin warned Russian business leaders to pull their money out of Cypriot banks.
Cypriot flag fluttering next to the European Union flag in Nicosia. (AFP Photo)

Nicosia was already uncomfortable with the extreme austerity measure tacked on to the proposed European bailout fund. Moscow represents an alternative option for Cyprus, an option which could still be just as unpalatable for the financially besieged nation.

Russia has assisted Cyprus financially in the recent past. The austerity measures Berlin and the EU could soon be enforcing on Nicosia also include pressure to privatise state assets and submit to painful external audits. Ideally Cyprus wishes to receive aid from Russia, who requires none of these provisos, but Russia could be quietly backing away.

One reason for this is the growing partnership between Germany and Russia; another is Moscow’s important strides to stamp-out endemic government corruption. Offshore accounts held by government officials, in Cyprus for instance, are increasingly being examined as Russia attempts to create a culture of trust in its own stabilising banking sector. The Kremlin has even started to ban government officials from holding foreign bank accounts.

In initially submitting to a Berlin-led austerity and bailout package for Cyprus, Moscow sent a clear message to its own citizens that the days of corrupt funds safely sitting in overseas accounts will be coming to a close.

However, Brussels’ austerity measures threatened to confiscate mostly small to medium sized Russian depositor’s funds, potentially causing hardship to a lot of very wealthy and powerful business elites. After the Kremlin recently moved to ban offshore bank accounts for government officials, many Russian elites will have been warned to move their money out of Cyprus before it is too late.

So while initially cooperating with the EU aid package to Cyprus could strengthen the relationship between Russia and Germany, Moscow has to balance an important anti-corruption campaign at home with a potentially heavy hit to equally important Russian investors.

Russia will suffer politically with Europe if it circumvents Brussels’ bailout agreement and chooses to offer its own aid to Cyprus. Yet a powerful group of government officials and businesspeople in Russia stand to suffer financially if the EU package is finalised.

Either way, the strain on Moscow’s relationship with Berlin will intensify, while Cyprus is again left sitting in the middle of two much larger power centres battling for economic security. But without funding Cyprus could face bankruptcy.

1 comment:

sustainable development said...

Cyprus is potentially setting itself up for an even greater fall at an indefinite point in the future when Russia decides to ignore them and rather focus in their own problems.