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Cyprus between Russia and Europe

19/03/2013 07:39
Cyprus is once again at the crossroads between Russia and the West and is called upon to decide in the next two days if its relationship with Europe will deprive a reliable and powerful ally or not.

The dilemma posed last Friday is obvious: With the haircut of deposits, Cyprus disturbs the so far good relationships with Russia, removing a significant part of the assets of thousands of Russians - not only "oligarchs" - on the island.

The Russian government yesterday rushed to send clear messages to Cyprus for the possible consequences from cutting the deposits held by Russians on the island. President Vladimir Putin talked about "unfair, unprofessional and dangerous decision," while Prime Minister Dmitry Medvedev spoke of the need to make "corrections" in the relationship between Russia and Cyprus.

Taking advantage of the favourable agreement with the Soviet Union and the relatively high quality of international services offered by Cyprus, the Russians have a significant presence on the island, which is one of the largest sources of foreign direct investment in Russia.

The Russian investors, as calculated by Moody's, have $19 billion in deposits in Cyprus and the Russian banks have financed Russian companies located in Cyprus with loans estimated at between $30-40 billion.

The strong presence of Russians on the island has given great impetus to international services, which employs thousands of lawyers and accountants and gives significant gains to banks.

In case of a haircut, the sector will receive a fatal blow, as both Russian depositors and Russian companies will withdraw from Cyprus.

Most important, though, is that Cyprus could lose a reliable and powerful ally on the Security Council of the United Nations, with all that this implies for the solution of the Cyprus problem.

It is no coincidence that since Saturday morning the government tries to avoid by all means the haircut of the Russian depositors, knowing the consequences on the field of international service and the relations with Russia.

The bait offered by the Europeans to "cut" the “umbilical cord” connecting the economy of Cyprus with Russia is the unlimited liquidity.

Whether Cyprus cuts uninsured deposits by up to 10 or 15% or decides to put the large Russian deposits to a "bad bank" with possible losses of up to 90%, the European Central Bank promised unlimited liquidity so that the banks face the mass flight of foreign deposits.

The alternative solution may lie in the Kremlin: Russia to grant to Cyprus a loan to cover its debt requirements and capital needs of the banks.

The Russian solution is possible because in addition to the geo-strategic importance and the significant Russian presence on the island, Cyprus has huge reserves of natural gas, which did not go unnoticed by the Russians.

Russian company Novatek – associated with Gazprom - is highest bidder for one of the blocks of the Cyprus Exclusive Economic Zone.

The problem with that scenario is that it does not include unlimited liquidity from the ECB.

The most important is that the Russian solution cuts Cyprus from the European Union and the euro area, reducing chances of future support if Russia decides in the future to change its attitude or if the geopolitical environment is changed.

The dependence of Cypriot banks on the ECB emergency liquidity tools significantly limits the options of Cyprus.

Many in Cyprus still, however, believe that there is also a third way, that followed by Cyprus in recent decades, between Europe and Russia.

They believe there is a way to reduce or eliminate losses of Russian depositors and that Russia could have a role in the rescue package - as was indeed the original plan.

Things are not easy, however. The Russian authorities believe that while they were asked from Europe to support Cyprus, they were not informed on time - neither from the Europeans nor from Cyprus – for the decision to seek haircut of Russian depositors.

The greatest difficulty, however, seems to have historical roots.

Countries that have historically precedents with Russia - such as Germany, Finland and Slovakia - "are thirsty for Russian blood," as said by a person involved in the negotiations on the loan agreement.

These countries insist that in order to make debt sustainable in Cyprus, the island will have to cut the Russian deposits, endangering one of the most historic and politically important bilateral relations that have been developed over the past decades.