On the evening of March 18, eurozone finance ministers revised their demands regarding the tax on depositors after they realized that the Cypriot Parliament would not approve the package in its current form. The eurozone ministers suggested dropping the tax on savings under 100,000 euros (roughly $129,395) but demanded that the shortfall be compensated for elsewhere. In the latest proposal from the Cypriot government, which apparently still opposes the package by a parliamentary majority, only the tax on savings under 20,000 euros would be dropped, but would not compensated for with higher taxes elsewhere. This suggests that the government is keen to avoid further anger from large, especially Russian, depositors.
Russia has long used Cyprus as its primary offshore financial hub. Russia's financial ties to Cyprus date back to the Soviet era, when Western blockades impeded the flow of Soviet cash through the global financial system. Cyprus opened up to the Soviet Union even further after Moscow supported the country in the Turkey-Cyprus disputes of the 1960s and 1970s.
In 1982, Cyprus was one of the first countries to open its banking system to the Soviet Union, repealing taxes on Soviet money that passed through Cypriot banks. When the Soviet Union and its financial system collapsed in 1991, Cyprus was one of the only countries with the institutions in place to handle Russian money. So in the chaos that followed Soviet collapse, Cyprus was the safest place to hold Russian money, whether it was deposited by the Kremlin, government officials, businesses or criminals.
The majority of Russians still prefer to keep their money in Cypriot banks. Most Russians see the domestic banking system as unstable, corrupt and subject to government or oligarchy caprice. Russian businessmen can more easily hide money in Cypriot banks than they can in Russian banks, in which the Kremlin can fairly easily monitor the details of their accounts. For its part, the Kremlin likewise can hide money in Cyprus.
So when Cyprus began to destabilize financially, Russia was willing to bail it out, first in 2008 and again in 2011. More recently, Cyprus had been expecting another multibillion-euro loan from Russia, but this time Moscow's handout was restricted by another player: Germany.
Abiding By German Wishes?
Germany currently faces mounting pressure to stop using German taxpayers' money to bail out other countries. In Cyprus, German money would be used to protect Russian depositors. Berlin thus would want Nicosia to implement painful reforms to its banking and business sectors, including privatizing state assets, and to submit to external audits in the banks. A Russian bailout would not require any of these measures.
Germany most likely pushed the Russians to back off of a deal with Cyprus. Over the past year, Russia has in fact relented in its support for Cyprus. The Kremlin repeatedly has said it would be willing to bail Cyprus out, but only as part of an EU-Russian plan. Such an arrangement is in keeping with regional dynamics; Germany is Russia's largest energy consumer, and Berlin accommodates Moscow accordingly.
That Russia did not bail Cyprus out is also in keeping with Moscow's current anti-corruption campaign. Part of this campaign includes repatriating offshore accounts to Russia, where the financial sector is now relatively stable. In recent weeks, the Russian government started banning foreign bank accounts for government officials. The ban came as several Russian Duma members resigned over corruption allegations. Rumors meanwhile have circulated that Russian officials are selling off their high-priced assets to avoid unwanted attention from the Kremlin.
The Russian government does not want its people thinking it is blindly bailing out a foreign country, especially if that country is a hub for corrupt Russian funds. But Nicosia's move to take a percentage of Russian depositors' cash further complicates the issue; essentially, it is Russian money being confiscated by the Cypriot government. This will be a massive financial hit to a large group of Russian business and government elite, who were warned to move their money out of Cyprus.
But notably, members of the business elite, such as Prokhorov, as well as thousands of small and medium private businesses, were not subject to this ban, and they will be hit hard financially. Thus the Kremlin has been forced to speak out today against Cyprus' actions because it does not want Cyprus to disrupt its anti-corruption efforts. Moreover, the Kremlin does not want its richest citizens to be any poorer because it does not want investments at home to suffer.
Complicating the issue even further is what Russia will do in its relationship with Germany over the Cyprus issue. Moscow has thus far abided by Berlin's wishes to limit its support for Cyprus. But with Cyprus now acting against Russian interests, Moscow may be forced to break with Berlin's line and find a separate solution to protect Russian funds and interests. Russian media reports suggest that there were exchanges over the weekend between Berlin and Moscow, possibly even between Putin and German Chancellor Angela Merkel, though these reports remains unconfirmed. In one of his first trips in months since suffering an illness, Putin is scheduled to meet with Merkel on April 7, showing the importance of Russia's relationship with Germany.
Gazprombank's rumored attempts to invest in and lend money to Cyprus could indicate the direction Russia will take, though Gazprombank has denied reports of any such attempts. It could be that Moscow is attempting to find a solution for Cyprus without having to give a direct bailout to the island nation, and in doing so, is going against Germany.