Cyprus rejects bailout deal leaving eurozone facing fresh crisis

Cash-strapped nation expected to seek funding lifeline from Russia after dramatic no vote in country’s parliament

 in Nicosia and 
The GuardianTuesday 19 March 2013 21.09 GMT

Protesters outside Cypriot parliament

A Cypriot protester outside the country’s parliament after hearing news that MPs had rejected the bailout deal. Photograph: Filip Singer/EPA

The Cypriot parliament has thrown out a controversial plan to skim €5.8bn from savers’ bank accounts, in a move that risks plunging the eurozone into a fresh crisis and heightens expectations that the cash-strapped nation will seek a funding lifeline from Russia.

Cyprus has just 24 hours to find a solution to its funding gap before its banks are due to reopen following the dramatic no vote on Tuesday night, which failed to support a hastily renegotiated change to the original deal.

With the crisis escalating, an RAF flight carrying €1m (£850,000) in low denomination notes set off for Cyprus to provide cash for 3,000 British service personnel based on the Mediterranean island.

The banks have been shut since Friday and electronic transactions halted, although cash machines are still working and the Ministry of Defence said the euros were being flown in as “contingency measure”.

About 2,000 of the military staff, who typically serve out 18- to 24-month postings to the island, have their salaries paid into local accounts. The MoD said it was “approaching personnel to ask if they want their March, and future months’ salaries paid into UK bank accounts, rather than Cypriot accounts”.

Even before the no vote was announced, the euro had already slumped to its lowest level in four months after speculation that the Cypriot finance minister, Michalis Sarris, had resigned.

Sarris, who was in Moscow ahead of his meeting with his Russian counterpart on Wednesday, was forced to text-message Reuters to deny the quick-spreading rumours that he had quit.

There were also reports that the banking arm of the Russian energy company Gazprom might pump cash into Laiki, Cyprus’s second largest bank, which is in urgent need of a capital injection. Gazprom officials insisted this was not being planned.

Russia has already lent €2.5bn to Cyprus and has close ties to the country after its nationals flooded the island’s banks with cash to take advantage of high interest rates and a lax approach to account vetting.

The 56-member Cypriot parliament rejected the bank tax by 36 votes with 19 abstentions (one MP was absent) even after the proposal had been tweaked during the day to remove any levy on savings below €20,000.

Accounts holding €20,000 to €100,000 still faced a 6.75% levy, and any account with more than €100,000 a tax of 9.9%, despite calls by Cyprus’s eurozone partners not to tax accounts below €100,000 – the level at which aEuropean Union-wide guarantee kicks in if an EU bank goes bust.

In return for the levy, savers would be given shares in Cyprus’s banks and possibly a share in the nation’s gas reserves – once the country is back on its feet.

Cypriot MPs had called the levy blackmail and a disaster for Cyprus and the president, Nicos Anastasiades, had been promising to discuss a possible plan B even before the no vote, which had appeared inevitable ever since the bailout terms were revealed on Saturday.

“It would have been a very weird thing to legitimise confiscation of savings; it has never happened anywhere in the world and would set a dangerous precedent for Europe,” an MP from the Cyprus opposition communist party, Akel, told Sky News.

Before the vote, hundreds of demonstrators gathered outside the Nicosia parliament chanting “No” and holding banners such as “Cyprus today, who’s next tomorrow?” in reference to eurozone partners such as Spain and Italy.

Officials in Brussels insist the Cyprus savings tax will be a one-off and the guarantee stands across the rest of the EU.

The conservative ruling party aligned to Anastasiades had attempted to postpone the bill for another day but opposition MPs insisted a vote went ahead. The 19 members of the president’s party abstained even though the government had signed up to Saturday’s bailout to release €10bn of eurozone funds and raise €7bn through a combination of the bank levy and a fresh round of austerity measures.

Russia has expressed its anger about the levy, which would hit its nationals, some 30 of whom are reported to have been granted Cypriot citizenship after depositing at least €17m into local banks, making investments of €30m or registering businesses on the island.

Vladimir Chizov, Russia’s envoy to EU, likened the levy to a “forceful expropriation” that could wreck Cyprus’s financial system. “When the banks open, people will rush to withdraw their deposits – that’s another threat – and then the whole banking system can collapse,” Chizov said.

Russian officials also moved to avert concerns that its own banks could face difficulty if the taps remained turned off in Cyprus. The ratings agency Moody’s estimated that Russian banks had extended up to $40bn in loans to companies in Cyprus.

The markets will now be looking to the European Central Bank to provide crucial liquidity lifelines to the Cypriot banking sector, which has expanded to eight times the size of the nation’s €17bn economy as a result of the Russian cash deposits.

An ECB spokesperson said: “The ECB takes note of the decision of the Cypriot parliament and is in contact with its troika partners [the European Union and the International Monetary Fund].”

Analysts will also be looking for evidence that Germany – the country that holds the eurozone purse strings – is willing to release more funds to Cyprus, which is the fifth eurozone nation to require a bailout, but the only one to force its savers to pick up part of the bill.

Alex White, analyst at JP Morgan Chase, said: “If it is not ultimately reversed, we think the treatment of Cyprus will come to look like a watershed for the region.

“The objective in this case is to remove the implied support for the Cypriot banking system, so that it can no longer function as a large offshore financial centre whilst receiving a European backstop.”

Yields – a measure of the cost of borrowing – on Italian government bonds edged above 5% on Tuesday, a sign of potential tensions in the eurozone while yields on British government bonds, gilts, fell to their lowest levels in 2013 of 1.82% as the UK appeared a relative safehaven. Brent crude dropped by $2 to €107.45.

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