Big question mark over what Cyprus can do to escape crisis

One solution, a tax on bank accounts, prompted a major backlash among Cypriots. Another solution, a Russian bailout, hasn't emerged yet.

Cyprus is today looking at a “Plan B” to save itself from a catastrophic banking default, though it appears that hopes for an immediate loan from Moscow, explored by Cypriot officials today, will not be forthcoming.

Lawmakers in Nicosia on Tuesday decided against a highly controversial proposed levy on private bank depositor holdings that would impose a nearly 10 percent “levy” or “tax” on private bank deposits in order to secure an EU  bailout.

The possibility of private bank accounts being targeted by a government brought enormous world attention in recent days.

The Los Angeles Times today called the tax an “expropriation” of funds in a piece that warns the Cypriot situation could trigger a larger crisis for the euro.

Now Cyprus still needs to find some $8 billion or find itself in default. It would be the first eurozone member to do so. Cypriot banks are already closed and may remain so this week until a solution is found, causing at the minimum, anger among citizens.

The tiny island represents all of 0.2 percent of the mighty eurozone economy. But its need for a bailout and its personae as a huge offshore shelter for Russian oligarchs – brings speculation that a default will act as a wrench tossed in the mechanism of the EU economy, just as talk of the “eurocrisis” was quieting down.

Today a visit to Moscow by the Cypriot finance minister for a possible bailout of $2 billion to $8 billion, yielded no offers according to Reuters. 

Cypriot political and financial leaders are huddling in Nicosia the capital, even as banks in Cyprus may continue to stay closed in coming days, if no solution is found.

In Europe, the Austrian finance minister claimed that the European Central Bank, which has provided a steady supply of loans in recent years to continental banks to avoid their default, will not do so for Cyprus indefinitely.

The Federal Reserve in Washington said it was committed to continue providing further liquidity and stimulus rather than adopt the kind of financial austerity the EU has shown a preference for. 

As Reuters put its, "If anything, developments in Cyprus, where the announcement of a tax on bank deposits to help fund the country's bailout sent jitters through the global financial system, are likely to reinforce the resolve of Fed officials to bolster the US economy."

New York Times columnist Paul Krugman today cites an exhaustive report by the Financial Times showing the dimensions of Cyprus as an offshore haven for Russians, and speculates the oligarchs will soon realize they don’t need Cyprus and can find shelters elsewhere.

At that point Cypriot officials will give up on the Russian business and, Krugman writes, “a resolution will become much easier. But they’re not there yet.”

The Russian business link is known as “round tripping”:

This link occurs through CIS [Commonwealth of Independent States] commodity-based shell companies that deposit transactional balances of their CIS-based legal subsidiaries engaged in oil, mineral, and metals exports, often involving transfer pricing and other tax minimization strategies. The Central Bank of Russia classifies Cyprus as the largest single source of FDI in the Russian Federation, with a total of $41.7 billion in cumulative inbound FDI into Russia’s non-financial sector between 2007 and 2010 (over 2.7x German levels)… Cyprus is also counted among the top FDI investing nations in several Central Asian countries (likely Russian capital reinvested via Cyprus, a process known informally as “round-tripping”).

Sony Kapoor of the Brussels based reform-minded think tank ReDefine writes that an alarmist response to the Cyprus crisis as causing the fall of the euro is over the top. Spain and Italy are not in the same grooves or orbits as Cyprus and apocalyptic runs on banks in those nations are unlikely.

Mr. Kapoor also suggests that a levy or tax on the deposits of those banking in Cyprus may in fact be a better answer than the effect of a default.

…the alternative of sovereign default would have been much worse; it is impossible to imagine a safe banking system in a sovereign undergoing restructuring of debt. Remember how much capital Greek banks needed after it defaulted? In fact, Cyprus would probably not have needed a bailout if its banks had not incurred huge losses on holdings of Greek debt. Add to this the complication that half of Cyprus’s sovereign bonds are under foreign (English) law that makes a successful restructuring of sovereign debt much harder. Moreover, Cypriot banks hold large swathes of its sovereign bonds, so it would be further bankrupted by any sovereign restructuring.