Yes, Cyprus Is Different

Marc Champion writes editorials on international affairs. He was previously Istanbul bureau chief for the Wall Street Journal. He was also an editor at the Financial Times, the editor-in-chief of the Moscow Times and a correspondent for the Independent in Washington, the Balkans and Moscow. He is based in London.
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One lesson from the Cyprus bailout debacle is that it really is different. Not so much because its economic case is unique, but because Cyprus's fellow European Union members see it as an outlier.

This is the EU's third smallest nation with only 1.1 million people. It joined as recently as 2004, with the help of a little blackmail from its patron Greece, which threatened to block the extension of the bloc to Poland and other ex-Soviet countries unless Cyprus got in too.

The others didn't want Cyprus because it wasn't ready. It has been a divided island ever since Turkey invaded and occupied the northern half in 1974. A deal was arranged under which the two sides of the island were to vote on a United Nations-brokered reunification deal in 2004 and then join the EU together. The Turkish-controlled North voted yes; the Greek South voted no -- not least because it knew it would get into the EU anyhow.

Small EU countries tend to keep a low profile after joining the bloc. (When was the last time you heard a story about Malta deciding an important policy?) Not so with Cyprus, which some other EU states have seen as a lobbyist for various Russian interests. It has also led the blockage of entry negotiations for its old enemy Turkey.

Then in 2008, Cyprus joined the euro. As my colleague Jonathan Weil has argued, it wasn't ready for that either. This wasn't Cyprus's fault -- the country's admission shows just how flawed the euro-area's entry criteria are. Miss an inflation target by 0.1 percentage point and you don't get to join the euro. But if your economy is an unsustainable eight times smaller than your banking sector, never mind, you can join -- that's not part of the test.

The Cypriots have a genuinely tough hand of cards to play because they face a territorial dispute with a vastly more powerful neighbor in Turkey, which still has troops on the island. So the Cypriots seek out allies wherever they can, and they've been remarkably good at it.

As already mentioned, Cyprus successfully leveraged its kinship with Greece to get into the EU on its own terms. More recently Cyprus joined with Israel (and therefore gained implicit U.S. backing) to explore for natural gas in waters around the island, despite furious opposition from Turkey.

Perhaps most importantly, after the collapse of the former Soviet Union, Cyprus also secured Russia as a firm ally by becoming the offshore center-of-choice for Russian businessmen. This is only in part about money laundering. Cyprus has been improving its regulations against laundering since at least 2000, when the Organization for Economic Cooperation and Development removed the country from its blacklist of truly awful tax havens. Cyprus, which has an English-based legal system and a 10 percent corporate tax rate, is where important Russians incorporate themselves.

To take just one example, reported by Bloomberg News today, Arkady Rotenberg, the childhood friend and former judo partner of President Vladimir Putin controls his Russian construction company through a Cyprus-based vehicle, Marc O'Polo Investments Ltd. Rotenberg's companies have been awarded at least $7.4 billion of contracts for the 2014 Winter Olympics in Sochi. This is the heart of the Kremlin establishment -- no wonder Putin has attacked the euro-area plan to take 9.9 percent of tax Cyprus deposits above 100,000 euro, and 6.75 percent below. And no wonder Cyprus President Nicos Anastasiades refused to tax high-worth Russian depositors more than 10 percent, even at the cost of penalizing Cypriot voters more than he had to and breaching the principle of depositor insurance.

So when it came time to put together a bailout for a very small country that only recently joined the EU, is seen in some ways as semi-detached and has managed to irritate most important EU members at one point or another, there was a pre-disposition to treat it differently. There were much more important reasons for the bailout debacle, of course, including German politics and bailout fatigue among creditors. Still with a different partner across the table the euro-area leaders might well have stopped longer to think about the wisdom of penalizing euro-area citizens anywhere for putting their savings in a bank.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

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