The EU's other bailout: How Cyprus turned to Russia

Locals and holiday makers sunbathe on southern coast of Cyprus on June 3 2012
Image caption Cyprus's beaches are filled with Russian holidaymakers, and its banks are filled with Russian money

He is hardly optimistic, but the head of the Popular Bank might well be understating the scale of the disaster in store for Cyprus.

Then again, it is his institution that brought this small European Union country to the brink of bankruptcy in the first place.

"It's going to be a situation for Cyprus that nobody has ever contemplated," says Michalis Sarris.

"A tough adjustment period for all of us, an extended period of no bank lending. Meanwhile, the real economy will remain unsupported and questions will be raised about the future of Cyprus as a financial centre."

And although Mr Sarris adds that "there is no sense in playing the blame game", his analysis of the latest of Europe's national financial crises implies others are at fault.

The Popular Bank's "bad decisions", as he calls them, amount to massive over-investment in Greek government bonds, especially as the Greek economy crashed and interest rates got progressively more tempting.

But ministers were wrong, he said, to write off the bad investments and not to give the money straight back to the bank as "recapitalisation".

And now, "if the government's fiscal situation was easier, then the task of helping the banks would have been much easier", he says.

In any case, the government did promise to save the Popular Bank by the end of June.

And with that deadline nearly upon it, an EU bailout seems increasingly likely. Coming on the heels of Spain's financial aid package, this has almost escaped international attention.

Good and bad friends

The Republic of Cyprus's recently appointed finance minister, Vasos Shiarly, says Greece is the root of the whole problem.

He points out that his country's budget deficit compares favourably to most other eurozone countries'.

"All the economies have their ups and downs," Mr Shiarly says. "The situation in Cyprus would have been totally under control had it not been for the Greek situation.

"This has happened because Cyprus has a very close relationship, and I do mean a financial relationship, with Greece.

"The Cypriot banks invested in Greek sovereign bonds that were once considered zero risk. There was a supervising authority in Greece as well as at a European level."

Another thing about Cyprus which has gone largely unnoticed internationally is the fact that it has only remained solvent until now thanks to a loan of 2.5bn euros (£2bn; $3.2bn), at the start of this year, from Russia.

The finance minister does not deny that he is investigating the possibility of getting more money from Moscow.

"I think we will get a loan from anybody who offers the best terms," he says.

Russian ties with Cyprus are strong in many fields.

Parts of the biggest city, Limassol, almost look like Russian territory with specialist food stores, restaurants, fur coat boutiques and signs in Cyrillic script dominating on some beaches and streets.

And apart from a booming tourist trade and a resident population of Russian nationals estimated at anything between 8,000 and 40,000, there are cultural, political and business links which make Russian money in many ways preferable to EU money to the government in Nicosia, especially if a deal with Brussels ends up putting Cyprus's cherished 10% business tax rate at risk.

Looking east

Hubert Faustmann, professor of history and international relations at Nicosia University, sheds some more light on the Russian question.

"The Russian business elite are using Cyprus extensively for financial transactions and as a tax haven and they surely do not want to lose those facets," he says.

"A lot of Russian cash is invested in Cyprus and then goes back to Russia.

He says this has the effect of making Cyprus, on paper, one of the largest investors in Russia worldwide.

"There is an important political relationship, too, given that Russia functions as the protector of the Greek Cypriots in the United Nations Security Council," Professor Faustmann adds.

"They are in a conflict with Turkey and the UK and US, the other countries that should be pro-Greek Cypriot, have stronger interests in Turkey so they are not really trusted to prevent any hostile developments in the Security Council."

The outcome of the negotiations going on now to secure rescue money for Cyprus could have profound implications for the future relationship of the republic with Brussels and with Moscow.

But they are taking place behind firmly closed doors. And to ordinary citizens looking at the state of Greece and worrying if they could be next to suffer a similar fate, they offer little in the way of reassurance.

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