Cleanliness meets godliness as Russia reeled into Cyprus

When the leader of the Orthodox Church in Cyprus requested financial assistance for the ailing country last week, he turned east, not west.

Archbishop Chrysostomos II, acting “at the government’s disposal,” said on Jan. 24 he asked his counterpart in Moscow to try to persuade President Vladimir Putin to grant another emergency loan, adding to the 2.5 billion euros Cyprus got from Russia 13 months ago.

Fifteen years after its own default, Russia is reluctantly being pulled into efforts to keep the 17-nation euro area intact because of financial ties with Cyprus that Germany claims involve money laundering. Government support of Cyprus’s banks may push its total aid program to more than 17 billion euros, almost equaling the island’s 18 billion-euro gross domestic product, according to Fitch Ratings.

Cyprus, which requested a financial rescue in June, says it will be able to meet its obligations through the first quarter. The German government is insisting Russia contribute to any international bailout because it argues that Russian capital, legal or illegal, dominates the banking system.

“Cyprus has functioned as a Laundromat for Russia for years,” said Raymond Baker, who heads Global Financial Integrity, a money-laundering watchdog in Washington. “It would be poetic justice if the EU required Russia to throw in some of the stabilization funds.”

Unjust Claims

Eva Rossidou-Papakyriakou, head of the Cypriot agency that combats money laundering, said the country’s rules are stricter than those of some other EU countries.

“Yes, we have money coming from Russians, but they invest in many jurisdictions and all checks are done by the banks and are monitored by the central bank as their supervisory authority,” she said by phone from Nicosia, the capital.

Accusations that Cyprus is a tax haven and a center for illegal Russian money are “unfounded” and “unjust,” Yiannakis Omirou, president of the Cypriot Parliament, wrote in a letter yesterday to his counterparts in the euro region.

A double-tax avoidance treaty and low tax rates have made Cyprus the conduit of choice for Russians moving money into and out of their country: Cyprus is, technically, both the biggest direct investor into Russia and the biggest recipient of Russian investment abroad, according to Russian central bank data.

‘Nobody Knows’

Putin has spoken with Cypriot President Demetris Christofias about the financial cooperation, the Kremlin said in a statement yesterday. Yet while Cyprus serves an important role for Russian companies, “nobody knows” exactly how much Russian money is in Cypriot banks, First Deputy Prime Minister Igor Shuvalov told Bloomberg Television on Jan. 18.

Christofias, who steps down next month, is a Russian- speaking communist who earned his doctorate in Moscow during the Cold War. Russian billionaire Dmitry Rybolovlev is the largest shareholder of the country’s biggest lender, Bank of Cyprus Plc. (BOCY) The Church of Cyprus controls 28 percent of the third-largest lender, Hellenic Bank Pcl (HB), which has a unit in Moscow.

A German intelligence report sent to parliamentarians in November put the amount of Russian money in Cyprus at 26 billion euros, according to Green Party lawmaker Priska Hinz.

Contagion Risk

Such “high” flows raise laundering concerns and necessitate Russia’s participation in any rescue, German Finance Minister Wolfgang Schaeuble said on television and in parliament in Berlin this month. Russia will “act together with the Europeans,” though not alone, Schaeuble’s counterpart, Anton Siluanov, said in an interview near Moscow on Jan. 23.

“Time is running out,” Luxembourg Prime Minister Jean- Claude Juncker, who stepped down as head of a group of euro-area finance ministers last week, told the Austrian newspaper Kleine Zeitung in an interview published today.

“One shouldn’t underestimate the Cyprus problem,” Juncker was cited as saying. “If we don’t solve the Cyprus problem in a decisive manner, there’s the risk of a contagion even coming from this very small economy.”

Cyprus had its credit rating cut two steps to B, five below investment grade, last week by Fitch Ratings. Costs to recapitalize banks may reach 10 billion euros, pushing the bailout total to 17 billion euros, Fitch estimated on Jan. 25.

“The Russians obviously are trying to get a free ride first, because that’s the cheapest solution for them: Let the euro zone take care of Cyprus,” said Joerg Forbrig, an analyst at German Marshall Fund of the United States in Berlin.

Waiting Game

A day before the Cypriot archbishop said he reached out to Patriarch Kirill, Russian Prime Minister Dmitry Medvedev said at the World Economic Forum in Davos that there may be more money available for Cyprus, though it would depend on “when our European partners also give something.”

Chancellor Angela Merkel is facing an election in September or October and Germany will be less inclined to agree to a “generous bailout” the closer we get to the vote, said Forbrig. That means Russia can’t hold out for long, he said.

The opposition Social Democrats are likely to portray any rescue of Cyprus as primarily benefiting rich Russians, said Lutz Roehmeyer, a fund manager at Landesbank Berlin Investment.

“If you bail out Cyprus knowing that you bail out Russian and Greek oligarchs that do not pay taxes, you have a fantastic topic for the socialists,” said Roehmeyer, who helps oversee about $19 billion of assets and holds Cypriot bonds.

Invasion

Russia and Cyprus have been allies since Cyprus gained independence from Britain in 1960. Russia has backed Cyprus in its territorial dispute with Turkey, which has held the northern part of the island since a 1974 invasion.

Cyprus, an EU member since 2004, considers Russia the guarantor of its territorial integrity, Foreign Minister Erato Kozakou-Markoulli said in Moscow last year.

Almost 500,000 Russians visited Cyprus in 2012, more than from any other country except the U.K., according to government statistics. The country of 1.1 million has more than 10,500 Russian-born permanent residents.

Cyprus turned to Russia before the EU for emergency aid because the Russians impose fewer restrictions on their loans, government spokesman Stefanos Stefanou said in June.

Euro-area finance ministers probably won’t decide on a course of action for Cyprus until March, after the so-called troika of the European Commission, the European Central Bank and the International Monetary Fund assesses the country’s finances, Juncker said Jan. 21.

Power Change

By then, Cyprus will have a new leader. The first round of elections to replace Christofias, 66, who is retiring after five years, is scheduled for Feb. 17. A second round will be held Feb. 24 unless there’s an outright victor.

Nicos Anastasiades, leader of the main opposition DISY party, will probably win, a poll by LS Prime Market Research for Simerini newspaper shows. Merkel endorsed Anastasiades on a visit to Limassol, Cyprus’s second-biggest city, on Jan. 11.

Russia may feel compelled to join a bailout for Cyprus to preserve its influence inside the euro region after Christofias’s term ends, according to Deutsche Bank AG analysts.

“We could see further Russian involvement down the line, even if the stance of a new Cypriot president is bound to be less Russia-friendly than that of the Soviet-educated Christofias,” Deutsche Bank analyst Peter Sidorov said in a Jan. 18 research note. “For instance, Russian investors could be targeted to take equity stakes in the restructured banks.”

Bank ‘Implosion’

For now, both the Europeans and Russians appear to be waiting for the outcome of the Cyprus elections. The country must be “systemically relevant” to the euro to receive aid, the German Finance Ministry said Jan. 28.

Russia, for its part, wants Cyprus to enact “structural measures” to lower its debt burden and get the budget on a stable footing, Siluanov said in the Jan. 23 interview.

The comments suggest Russia probably won’t give new aid unless Russian money is “threatened by the implosion of some bank,” said Julia Tsepliaeva, head of research at BNP Paribas SA in Moscow. “Why give even more?” she said on Jan. 28. “It would be easier to just buy all of Cyprus.”

Oligarchs

Europe’s need for Russian help in crafting its fifth sovereign bailout since the credit crisis began more than three years ago is in stark contrast to 1998. That year, Boris Yeltsin’s government defaulted on domestic debt after selling some of the country’s most valuable assets at knockdown prices to a group of insiders that came to be known as the oligarchs.

Russia now holds about $530 billion in foreign currency and gold reserves, the most in the world after China, Japan and Saudi Arabia, according to data compiled by Bloomberg.

The country also runs a balanced budget and has one of the lowest debt-to-GDP ratios, less than 12 percent. Debt in Cyprus was expected to rise to 86 percent in 2012 from 71 percent a year earlier, according to the Cypriot Finance Ministry.

Whatever happens, Russia will probably go beyond simply extending the five-year loan it gave Cyprus in December 2011 and offer new money, said Christoph Weil, a senior economist at Commerzbank AG. Given that Russia already stepped in to prevent a Cyprus default and its largest gas producer, OAO Gazprom, appears interested in developing deposits discovered off the coast, a new aid package is likely, Weil said on Jan. 28

“Russia has a strong economic and political interest in the island and would probably help the Cypriot government financially,” Weil said by e-mail from Frankfurt. “Many Russian citizens live in Cyprus and a large number of Russian companies have invested in the country.”

[Bloomberg]