Why a Russian Bailout of Cyprus Is Such a Bad Idea

A Russian market in Limassol, Cyprus Photograph by Barbara Laborde/AFP via Getty Images

Russia could be Cyprus’s savior, after all. As plans for a European-led bailout fell apart on March 19, Cypriot Finance Minister Michael Sarris hopped on a plane to Moscow to seek a financial lifeline to pull the Mediterranean island nation back from the brink of default.

At first blush, it seems only fair that the Russians pony up. After all, the tens of billions of euros that Russians have parked in Cypriot bank accounts helped trigger the island’s financial crisis. And Moscow protested loudly when some European leaders wanted to levy stiff taxes on Cypriot bank accounts, a plan that now has been scuppered. Cyprus now is almost €6 billion ($7.7 billion) short of the money it needs to cut a deal with the so-called troika of European creditors and the International Monetary Fund.

But counting on aid from Russia is a bad idea for Cyprus—and for the rest of Europe. Cyprus has already gotten a €2.5 billion ($3.2 billion) loan from Moscow, and it can’t borrow more without greatly increasing its debt ceiling, something the troika won’t permit. Instead of offering a loan, Russia might ask for rights to natural gas fields in the Mediterranean south of Cyprus. Europe already depends heavily on Russia for natural gas, and extending Russia’s control over future supplies would almost certainly boost gas prices across the region, Athanios Orphanides, a former governor of the Central Bank of Cyprus, told Bloomberg Television this morning. “It would be a huge economic cost,” he said.

Moreover, Cyprus doesn’t have much leverage to demand favorable terms from Moscow. It’s true that Russia has significant financial exposure to Cyprus. Russian deposits in Cypriot banks total about $31 billion, according to Moody’s Investors Service, and Russian banks have as much as $40 billion in outstanding loans to Cyprus-based companies. Yet Moscow-based VTB Group, the bank with the greatest exposure there, said on Wednesday that its potential losses are “insignificant.” And while Russian depositors would suffer in the event of a default, Moscow could ultimately benefit because tax receipts would rise if money parked in Cyprus were repatriated.

What’s more, the collapse of Cyprus as an offshore banking haven could further Moscow’s ambitions of becoming a global financial center. The turmoil in Cyprus “has totally changed the perception of Cyprus, and it’s a good thing for Russia,” Sergey Cheremin, head of Moscow’s department for economic and international relations, told Bloomberg News in New York on March 19.

The bottom line: “Cypriot officials have a very weak hand,” says analyst Alex White of JPMorgan Chase Bank in London. If Russia offers a deal, it might require Cyprus to walk away from the troika altogether, White says. “This could effectively be an invitation to leave the euro area and step firmly into Russia’s orbit.”

All this, when European leaders themselves bear considerable blame for letting Cyprus get into so much trouble.

Former Cyprus central banker Orphanides, now a senior lecturer at MIT’s Sloan School of Management, says it’s no surprise that the country would seek help from Russia, with which it shares longstanding religious and cultural ties. But, he says, “the governments of other European member states are driving the government of Cyprus to seek help from Russia. This is a disaster for the EU. How European leaders handle Cyprus indicates whether the European project and the euro area can lead and prosper.”

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