With Cyprus desperate for bailout help, Russia plays hardball

Russia is worried about an economic meltdown on Cyprus, which hosts both Russian corporations and bank accounts. But so far, it has yet to bite on the Cypriot finance minister's offers.

As Cyprus races against a deadline from Europe's central bank to put its financial house in order or face bankruptcy, the country's leaders are turning to an unlikely champion in hopes of finding some relief from their escalating troubles: Russia.

But the Russians, by most accounts, are playing hardball.

Holding his second full day of talks with officials in Moscow today, Cypriot Finance Minister Michalis Sarris appeared to have little chance of getting the $5 billion loan he hoped would tide the little island state over until it got past its crisis. Instead, he appeared to be offering the Russians stakes in Cypriot banks and offshore gas fields in exchange for urgent economic assistance, experts said.

"We are, of course, seeking assistance, but in a way that would make economic sense for Russia," Mr. Sarris told journalists today.

"A large number of conditions are emerging during the discussion, related to banks, natural gas, and other assets, on which we could base cooperation with Russia," he added.

The crisis began barely a week ago, when the European Union announced a $17 billion bailout plan for Cyprus's struggling banks that required the little country to raise about $7.5 billion of that amount through a one-time levy on bank deposits held on the island.

That plan was turned down – amid fierce domestic protests and noises of alarm from Moscow – by the Cypriot parliament two days ago, leaving the Cyprus government scrambling for some other way to raise the cash. Today the European Central Bank warned that if they didn't come up with a 'Plan B' by March 25, it will pull the plug on Cypriot banks – leaving them to face seemingly inevitable bank runs, followed by likely collapse that could drag down the entire country's economy.

But almost a third of the money in Cyprus banks belongs to wealthy Russians. Tax-evading Russian companies have played a huge role in boosting the little island into a major global financial center over the past couple of decades, and Russian tourists make up the second-largest, and growing, contingent of visitors to the sun-soaked Mediterranean island.

Russia is very worried about an economic meltdown on Cyprus, not only because it might ravage the offshore bank accounts of thousands of rich and influential Russians. The system of shell companies set up by Russian companies on Cyprus, mainly to evade high Russian corporate taxes, has become a vital part of the Russian economy's lifeblood.

According to official Russian figures, more than $114 billion has flowed into Russia since 2007 from Cyprus, almost all of it in the form of dividends paid by Cyprus-registered holding companies. Big Russian firms – including most metals giants, the state-owned banks Sberbank and VTB, and the independent gas producer Novatek – all have important holdings in Cyprus.

"The price of crisis in Cyprus is very high for Russia," says Igor Nikolayev, director of strategic planning for FBK, one of Russia's leading auditing firms.

"What people fear is that when the banks open again in Cyprus [probably next week] it will come with tight restrictions on capital movement. Otherwise everyone will try to claim their money at once.... So, Russia is very, very concerned. And the Cypriot finance minister is here because he knows he can't hope for help from the European Union. But there's still Russia. Russia has money, Russia has business interests in Cyprus, so why not try that?"

According to experts, Mr. Sarris has not given up hope that Moscow might come up with a $7.5 billion loan to bridge its gap with the EU and make the immediate crisis go away. He is also hoping that Moscow might ease repayment terms for a $2.5 billion loan it extended to Cyprus in 2011.

Beyond that, Sarris suggested that Russian companies might be offered sweet terms to invest in the island's banking and tourism sectors, and also in the exploration and exploitation of offshore, deep-water natural gas reserves. But Russian experts say the gas option is problematic due to unresolved legal issues between Cyprus and the Turkish-held northern part of the island, which has had de facto independence since 1974.

Despite speculation in the British press that the Cypriots might offer to host a Russian naval base in exchange for a bailout, there has been no indication in Moscow that such an offer has or will be made.

But even amid its alarm about the Cyprus crisis, Moscow also seems to be enjoying a moment of pure schadenfreude over the troubles besetting the EU.

Speaking to journalists on the sidelines of a Russia-EU conference in Moscow today, former president and current Prime Minister Dmitry Medvedev donned the mantle of a defender of capitalism and declared the EU was acting like "a bull in a china shop" in its dealings with Cyprus.

"All possible mistakes that could be made have been made by them. The measure that was proposed is of a confiscatory nature, and unprecedented in its character. I can only compare it with some of the decisions taken by [former] Soviet authorities, who did not give a thought to the savings of the population," he scolded.

"But we are living in the 21st century nowadays, under market economic conditions. Ownership rights should be respected."