Europe, Cyprus look for way out of crisis. Could Moscow save the day?

The now-rejected bailout tax plan has left Cypriots and Europeans alike unhappy. Now Cyprus is looking to Russia for money.

As Cyprus, the eurozone’s third smallest economy, is staring state bankruptcy in the face, European leaders are scratching their heads: How did we end up in this mess? And, more importantly, what is the way out?

In spite of the potentially devastating consequences, the Cypriot parliament on Tuesday vehemently rejected a bailout deal for the technically insolvent country hammered out in Brussels a few days earlier. Under the deal, 10 billion euros ($13 billion) would have come from the eurozone’s rescue mechanism, but it would have obliged Cyprus itself to add another 5.8 billion euros ($7.5 billion). This additional money was meant to be raised through a one-off tax on each account held in Cyprus, and there is some confusion about where the idea for this special levy came from in the first place – Nicosia, Brussels, or even Berlin.

Whatever the answer, everybody is unhappy now.

The Cypriot people, who like the rest of eurozone citizens had lived with the promise that the money in their accounts was safe, feel betrayed by Europe. The Cypriot government is caught between an angry electorate, the threat of big investors taking flight, and the prospect of state bankruptcy. Meanwhile eurozone leaders are trying to gauge what damage the idea of European Union solidarity has sustained through their tough stance on Cyprus.

“We have learnt two things already from this latest chapter in the eurocrisis story,” says Raoul Ruparel, head of economic research at the London-based think tank Open Europe. “They won’t try a deposit tax again after the backlash they have seen in Cyprus. But still Germany will take a much harder line in any future bailout.”

Feeling that Germany might indeed insist on Cyprus paying a part of its own bailout, the government in Nicosia has turned eastwards for help. Finance Minister Michalis Sarris is now in Moscow, in hopes that Russia might offer financial aid, given that at least 20 billion euro ($26 billion) of the 68 billion euros ($88 billion) in Cypriot accounts belong to Russians.

Cyprus already owes Russia 2.5 billion euros ($3.2 billion) from a loan granted in 2011, so the expectation was that Moscow might be prepared to ease the conditions on interest rates and payback date, perhaps even offer fresh money. A first meeting with Russian finance minister Anton Siluanov brought no concrete results.

But the meeting in Moscow is watched with concern in European capitals.

“I am worried that Russia might use the situation to put a claim to the substantial natural gas resources that have been found off the Cypriot coast,” says Jürgen Hardt, a member of the German parliament for Chancellor Angela Merkel’s governing Christian Democrat Party.

In the meantime, Cypriot President Nicos Anastasiades has been in emergency meetings with his cabinet and representative of the so-called troika of the European Union, European Central Bank, and International Monetary Fund to come up with a Plan B after the bailout deal has been rejected.

Plan B, it emerged Thursday morning, includes setting up a state investment fund, which would tap for instance into the country’s pension funds and possibly even capital owned by the Orthodox Church; a special bond issue; and increases of capital gains tax and corporate tax rates. There is no talk anymore of a tax on deposits.

The new plan now needs to go to parliament for approval. Cyprus has to be quick, since the ECB warned it might halt emergency funding for the country’s biggest banks on Monday, triggering bankruptcy. So far the only measure though that has been announced is to keep Cypriot banks closed until at least Tuesday next week.