Europe weighs Cyprus’s fate after lawmakers reject deal

European policy makers must weigh how far to push Cyprus after lawmakers in the Mediterranean nation rejected an unprecedented levy on bank deposits, throwing into limbo a rescue package designed to keep it in the euro.

Luxembourg Finance Minister Luc Frieden called for the 17 euro-area finance ministers to reconvene “as soon as possible” to cobble together a new package. The European Central Bank, whose Governing Council meets today in Frankfurt, will also have to decide whether to give Cyprus more time or consider cutting off liquidity to the country’s banks.

“This is not a good result — neither for Cyprus, nor for the euro zone, and we have to look together for alternatives to the negotiated package,” Frieden said yesterday in a phone interview from Frankfurt. He called the vote “very sad news,” though said the decision by its parliament must be respected.

Cyprus’s rejection came after days of recrimination sparked by European plans to force depositors in the country to shoulder part of the bailout with their savings. Cypriot President Nicos Anastasiades returned from marathon talks on March 16 saying the alternative would be the “indescribable misery” of the ECB cutting off funding to one of its banks.

“What matters now is to undertake all necessary measures to ensure the stability of the euro zone,” Frieden said.

Officials from the so-called troika of the ECB, the International Monetary Fund and the European Commission are in Cyprus discussing further capital controls and the possible extension of a bank holiday through to the end of the week, a European official familiar with the talks said on condition of anonymity because the discussions are confidential.

Stocks dropped and the euro fell to almost a four-month low against the dollar at the prospect of impasse in Cyprus. While the country accounts for less than half a percent of the euro economy, the fight over the bank tax risks triggering new turmoil in the financial crisis that began in 2009 in Greece.

Cyprus “has some symbolism impact on Europe, but it’s not a really major economic issue,” Laurence D. Fink, the chief executive officer of BlackRock Inc. (BLK), the world’s largest asset manager, said in a Bloomberg Television interview in Hong Kong today. “It does remind us of the frailty of Europe. It does remind us that the European fix will be multiple years.”

Protesters cheered outside the parliament in the Cypriot capital, Nicosia, as lawmakers voted against the proposal by 36 to none in favor. There were 19 abstentions. Hammered out by euro-area finance chiefs last weekend, the deal sought to raise 5.8 billion euros ($7.5 billion) by drawing funds from Cyprus bank accounts in return for 10 billion euros in external aid.

While he “regrets” the result of the parliamentary vote, Cyprus is a “unique case” and sets no precedent for deposits elsewhere, German Finance Minister Wolfgang Schaeuble said in a statement. “We’ve taken adequate precautions to ensure that today’s decision in Cyprus will have no negative effect on the rest of the euro zone,” he said. The offer made by the group of finance ministers “remains on the table,” he said.

Dutch Finance Minister Jeroen Dijsselbloem, who chairs the meetings of finance ministers, echoed those comments, saying in a text message that the euro group “stands ready to assist Cyprus in its reform efforts.”

Junk Status

Anastasiades is due to meet with political party leaders in Nicosia at 9 a.m. today, his office said before the vote. Cyprus’s banks and stock exchange will remain closed.

The ECB’s support for Cyprus’s banks could now come into focus. Cypriot government bonds became ineligible as collateral in refinancing operations in June last year, after all three major ratings agencies had downgraded Cyprus to junk status.

That forced Cypriot banks to turn to so-called Emergency Liquidity Assistance from the Central Bank of Cyprus. Under ELA, the national central bank may continue to lend to commercial banks at a higher interest rate and only with the permission of the ECB’s Governing Council.

Should the ECB consider the situation untenable, it could refuse to sanction the provision of further liquidity. The central bank said in a statement after yesterday’s vote that it would continue to provide funding as needed “within the existing rules.”

Deposit Levy

The deposit levy, championed by Germany and pulled together in a 10-hour negotiation session in Brussels, drew worldwide criticism that it broke a taboo over the safety of bank-deposit savings and risked launching a bank run in other European countries. Cypriots awoke March 16 to find bank transfers blocked, prompting images of long lines at ATMs.

“It seems at this moment there is no third way,” Averof Neophytou, vice-president of Anastasiades’s Disy party, told the chamber before the vote in which his party abstained. “But we must try to find a different path.”

Outside, the parliament was surrounded by demonstrators singing the national anthem and chanting “this will not pass.” The crowd cheered their approval when the results of the vote came through. Euro-area finance chiefs had urged Cyprus on the eve of the vote to spare small-scale savers, as they maintained the size of their total demand on account holders.

Anastasiades spoke by phone with Merkel yesterday for the second time in as many days, German government chief spokesman Steffen Seibert said in a text message, declining to give details of the conversation. Seibert didn’t respond to messages seeking comment on the vote.

“This is not the end of the process, but instead kicks off a further round of negotiation with Moscow and Berlin,” Alexander White, a European political analyst at JPMorgan Chase & Co. in London, said in a note. “The Cypriot authorities wanted to conduct the vote so that they could reaffirm the extent of their difficulties to the Europeans.”

Cypriot Finance Minister Michael Sarris missed the ballot as he flew to Moscow to hold talks about financial assistance. Russian companies and individuals have $31 billion of deposits in Cyprus, according to Moody’s. Russian President Vladimir Putin called the tax “unfair, unprofessional and dangerous,” according to a statement posted on the Kremlin website.

“Cyprus has rebuffed the outstretched hand” of its partners, Hans Michelbach, a German lawmaker from Merkel’s Christian Democratic bloc and its ranking member on parliament’s finance committee, said in an e-mailed statement. The vote is “an act of collective unreason” and “the people of Cyprus must now pay a high price.”

[Bloomberg]