Why Russian elites care so much about Cyprus

COMMENT

The small Mediterranean island of Cyprus is suddenly became newsworthy worldwide this week – and for all the wrong reasons. 

The tiny nation's financial situation is dire, prompting Nicosia to ask Brussels for assistance, but it is the sudden spotlight on its relationship with Russia which is turning many heads.

Not a single Cypriot parliamentarian voted in favour of Brussels’ strict bailout package.

The unpopular tax on bank deposits in Cyprus, along with a special levy, would have gone some way in collecting revenue for a struggling government preparing the country for a proposed €10 billion in International Monetary Fund aid.

But the bulk of austerity measures were to be lumped on foreign investors, many of them Russian, which could have been fatal for Cyprus’ economy.

Brussels’ austerity measures for the bailout package could be an attempt to fathom the great deal of Russian investment in the island’s banking sector.

Russian President Vladimir Putin said as much when he was reported as labelling the European tax on bank depositors in Cyprus unfair, unprofessional and dangerous.

Prime Minister Dmitri Medvedev and Russian billionaire Mikhail Prokhorov darkly called the measure an affront to people’s private property and confiscation of their money.

The Cypriot banking system is closely intertwined with the Greek system and was badly battered after the Greeks suffered a write-down on sovereign debt holdings in 2012.

Cyprus is now the fifth European country to request a bailout, spreading throughout Europe, Russia and the global economic system, and with the potential to place pressure on relations between Berlin and Moscow.

Close banking ties with Russia

Cyprus had weathered the worst of the financial crisis gripping the bulk of the European mainland.

Even though Nicosia will require €5 billion over the next two years just to keep afloat, it has historically been able to go outside of Brussels for assistance, especially to old partner Moscow.

Looking to diversify their assets, Russia's elite have used the island as a banking thoroughfare, taking advantage of some especially favourable legal banking sector ties. Cyprus is also relatively well-known in some quarters as a useful country for Russian money laundering and arms smuggling operations.

But it is not all one-way traffic. A loan extended to Nicosia in 2009 by Moscow reportedly came with the attached strings – the supply of banking information about wealthy Russians on the island.

Russia again helped Cyprus financially when it struggled again in 2011 and sold it advanced surface-to-air missiles Moscow had refused to sell to anyone else.

During the Cold War, Cyprus and Russia worked closely in political matters and after 1991 the island’s banking industry was one of the few countries to continue handling Russian money and investments.

Today, domestic Russian banks are still unpredictable, with many Russians preferring to maintain the old tradition of diversifying assets into Cypriot banks to them away from the prying eyes of the Kremlin.

Russian investments in Cyprus are estimated to range between €15 billion to €30 billion, or about half of total deposited money in Cyprus. In the past, deposits of €100,000 have been protected by European states to avoid bank runs, so the announcement of austerity took many Cypriots and Russian investors by surprise.

After the depositor’s tax announcement, the Kremlin warned Russian business leaders to pull their money out of Cypriot banks.

Underlying Russian tensions with Berlin

The austerity measures Berlin and the EU may soon enforce on Nicosia also includes pressure to privatise state assets and submit to external audits. Ideally Cyprus wishes to receive aid from Russia, who requires none of these provisos, but the Kremlin could be quietly backing away.

One reason for this is the growing partnership between Germany and Russia; another is Moscow’s important strides to eliminate endemic government corruption.

Offshore accounts held by government officials, in Cyprus for instance, are increasingly being examined as Russia attempts to create a culture of trust in its a banking sector which is slowly stabilising.

The Kremlin has even started to introduce a ban on government officials holding foreign bank accounts.

However, the EU austerity measures threatened to tax mostly small- to medium-sized Russian depositor’s funds, potentially causing hardship to a large group of wealthy and powerful business elites.

The Kremlin will suffer politically with Europe if it circumvents Brussels’ bailout proposal and chooses to offer its own aid to Cyprus. Yet if it goes ahead a powerful group of government officials and businesspeople in Russia stand to suffer financially.

Either way, the strain on Moscow’s relationship with Berlin will intensify, while Cyprus is again left sitting between two much larger power centres battling for economic security. But without funding it will likely face bankruptcy.

Nathan Smith has a Bachelor of Communications in Journalism from Massey University and has studied international relations and conflict