Shaky Cyprus teeters between Moscow and Brussels

NICOSIA, June 15 Fri Jun 15, 2012 5:23pm IST

NICOSIA, June 15 (Reuters) - From the sharp-suited 'biznesmeny' in their black BMWs, to the grocery selling imported vodka and whole smoked whitefish, to its Soviet-educated Communist president, the Mediterranean island of Cyprus speaks with an unmistakable Russian accent.

And as the latest troubled EU nation hurtles towards a seemingly inevitable financial rescue, it finds itself teetering between Moscow and Brussels.

"They have to decide whether they want to be part of the European Union - or of the Soviet Union," said Fiona Mullen, economist at Sapienta, a consultancy.

Cyprus took a 2.5 billion euro ($3.15 billion) loan from Russia last year. It now urgently needs at least 1.8 billion euros by the end of this month to rescue its banking sector, torpedoed by its exposure to its bigger brother, Greece.

The actual bill is likely to be several times as high, and if Greece were to exit the euro zone it could run into double digits, a huge sum for a country with barely a million people.

Many in Cyprus think the only place the country could find that kind of cash would be Moscow. Especially if President Demetris Christofias - the EU's only Communist leader and a fluent Russian speaker from his Moscow university days - wants to avoid the tight conditions Brussels normally attaches to its rescue funds.

Cyprus officials have said they are in discussion with Moscow for a loan of 4-5 billion euros. Russian newspapers have hinted that a deal is in the works, although the finance ministry in Moscow says it has received no such request.

The question is: what would Russia get in return? And how would that effect relations with the rest of the European Union?

If Cyprus, which assumes the EU's rotating presidency on July 1, becomes so deeply in hock to Moscow, it would be an enormous embarrassment, both to Brussels and to many in Cyprus who see its long term future with the West, not the East.

"You don't want to have all of your money owed to one country," said Mullen. "Two thirds of your GDP is owed to Mr Putin? That's something that even worries Russian businesses here, who worry that if Cyprus falls out with Russia they have to do what Moscow says."

Still, others say Russian funding would be easier for Nicosia to accept than funding from Brussels, which would require Christofias to make budget cuts that would hurt the economy and enrage voters before an election next February.

It isn't hard to find reasons why Moscow would be willing to be generous - and more lenient with its terms than Brussels.

Although the debt would be huge, in the long term, loans to Cyprus are probably a safe bet. Despite its dire cash flow problems now, Cyprus expects a windfall of wealth in the next decade, following the discovery of giant natural gas fields offshore in the eastern Mediterranean. Russian firms are among the bidders for gas concessions in coming months.

Nicosia insists the bilateral loan it has already accepted from Russia, and any others it might agree in the future, will have no impact on the bidding process. But firms no doubt will expect Moscow's generosity to be taken into account.

Russia also shares the Cypriot government's desire to protect Nicosia from intrusive fiscal conditions and regulations that might come with a bailout package from Brussels.

With its 10 percent corporation tax - the EU's lowest - Cyprus serves as the perfect off-shore base for Russian money, much of which is then reinvested back in Russia itself, a role it played for wealthy Arabs in earlier decades.

"Cyprus will go for any deal that allows them to avoid changing laws and regulations that make it the tax haven that it is," said Hubert Faustmann, politics professor at the University of Nicosia.

"Common sense would point in the Russian direction rather than Brussels, that the strings attached to the EU loan would be tighter than a Russian loan," he added. "The Russians have a strong interest in Cyprus staying the way it is, as a nice place for Russian businessmen to keep their money and pay low taxes."

It helps that many of the rich Russians who have become residents on the sunny island - they are known for paying cash for newly-built seaside villas - are "close to the power centres in Moscow", Faustmann added.

EITHER, OR BOTH

It may not be a question of either Brussels or Moscow. Cyprus might need help from both.

One solution, said Stelios Platis who runs a financial consultancy in Cyprus, would be for Cyprus to turn to the European Union's EFSF rescue fund to bail out its banking sector's exposure to Greece - a problem arguably not of Cyprus's own making - while continuing to look to Moscow for loans to balance its state budget.

As in the 100 billion euro Spanish bank bailout agreed earlier this month, EFSF money given to recapitalise banks need not come with the intrusive fiscal requirements associated with an EU rescue for public finances.

But it still would add to the country's sovereign debt, so EU officials will probably need assurances that Nicosia has funding for its public finances in place, meaning a bilateral loan could be part of a grand double deal.

And any Russian loans would have to be on terms that Cyprus could still afford to repay.

"It would be optimal for Cyprus to meet some of its financing needs through a bilateral loan, whilst applying to the EFSF for banking recapitalisation," Platis said.

"The devil is in the details. It depends on what the terms are of the bilateral loan."