Cyprus between Germany and Russia

cyprusKindly translated by Anne-Marie de Grazia

The Cyprus crisis is turning into a psychodrama for the Eurozone as well as for Russia, and its own relations with the Eurozone. One may well ask how it could come to this, and how a country, the GDP of which represents merely 0.3% of the GDP of the Eurozone, could create such emotion and such confusion. As matters stand, the latter is largely due to the action of the Eurogroup, the intergovernmental authority of the 17 countries of the Eurozone, whose inadequate decisions have transformed what began as a mere problem of the recapitalisation of banks into a crisis of distinct gravity.

At the origins of the Cyprus crisis

This crisis originates in the restructuration which was imposed on the private creditors of Greece in the Spring of 2012. This restructuration translates into a brutal devaluation of the titles of the public debt held by the banks, those of Cyprus in particular. The Cyprus crisis reveals itself indeed as a collateral effect of the Greek crisis. It is by no means connected to an amount of debt having exploded. As a matter of fact, the public debt of Cyprus, before the restructuration of the banks, amounts to 73% of GDP, that’s significantly less then in Germany and in France.

One hears it often said that Cyprus is merely a banking system implanted in the middle of the Levantine Sea. Granted, banks own assets which are equal to 7.5 times the GDP of Cyprus. This is a lot, the average in the European Union being 3.5 times, but it is a figure equivalent to what is to be found in Malta and in Ireland, and widely inferior to the one in Luxemburg, where the ratio of bank assets to GDP is of 22 to 1. Granted that Cyrus has an overdimensional banking system, it remains nevertheless closer to normal than is the case with tax havens such as Luxemburg, the Bahamas or the Cayman Islands.

This crisis was therefore foreseeable, and it was predicted. As early as June 2012, the island authorities warned the other countries of the Eurozone of the consequences that the restructuration of the Greek debt was having on the banks. The Cypriot governement had consequently asked for a help in the amount of 17.5 billion euros. But the Eurogroup, as is its wont, took a long time to react. Part of the crisis is due to this damnable procrastination, alas so common in European institutions. Warnings were not lacking.The latest to date were the declarations of Alexei Kudrin, the former Minister of Finances of the Russian Federation early in February 2013. As for us, we signalled in several instances during the Spring of 2012 that the restructuration of the Greek debt would necessarily have important consequences for the Cypriot banking system.

These warnings were not heeded, and it is under the pressure of emergency that the Eurogroup, together with what is called the “Troïka,” that is, the European Central Bank, the European Union and IMF, tackled the solution of the Cypriot problem. The agreement with which they came up in the early hours of Saturday, March 16th, 2013 turned out to be a disaster: it foresaw that the European Union would provide 10 billion euros, the IMF 1 billion, and that the rest would be at the expense of Cyprus (6.5 billion), of which a sizable part should come from the notorious “tax on deposits,” the rest from the privatisation of public companies. There were very few precedents to such a measure. Deposits had indeed been taxed in Italy, but to a rate of 0.66%, in the early 1990s. A tax had been briefly introduced on the interests of deposits in Norway in the 1930s. The taxation rates foreseen for Cyprus were out of all comparison, with 6.6% on deposits amounting to less than 100,000 euros and 9.9% on those above.  They provoked the legitimate ire of the population which, as soon as it learned of the news, litterally rose up in protest.

From the Cyprus crisis to the Eurozone crisis

Popular feelings were therefore high as early as March 16th. We have already reported on it1. It drove the Cypriot Parliament to reject the European plan on Tuesday, March 19th and in so doing, rejecting the law introducing the taxation of deposits. It is significant that, of the 55 deputies who compose the Parliament, not one has voted in favor of this law, not even the 19 deputies of the President’s party, who chose to abstain. The Government declared as a consequence that the idea of a tax on deposits had been abandoned. But, rather than recognizing the error they had committed, and abandoning the idea of a taxation on deposits, the Eurogroup and the ECB persisted, thus transforming what was only a localized crisis into a general crisis of the Eurozone. One must read attentively the declaration which M. Jörg Asmussen, one of the members of the board of directors of the ECB, made on Wednesday, March 20th, to the newspaper  Die Welt.

« We are not threatening  [to cut liquidities to Cyprus] but actually we are stressing the fact that we can supply exceptional liquidities only to solvent banks, and that the Cypriot banks cannot be assumed to be solvent if there is no agreement on the program…». Now there is a beautiful example of europeist hypocrisy. In fact, the situation of the Cypriot banks was known for months, as we have already said. There has been no radical change on this point. The threat of the ECB is entirely and purely political. Concretely, the ECB decided to instaure a monetary blockade of Cyprus which will become effective as early as Monday, March 25th. This is a measure of extreme gravity. It results in the interruption of all banking transactions between Cyprus and the other countries of the Eurozone, thus paralyzing their activities, in addition to the activities of all the companies which are using these banks. In fact, this measure could be assimilated to an “act of war” according to international law, and moreover, one decided not by a single country, but by a supranational authority which is irresponsible. This measure has been taken against a sovereign country, the democratic institutions of which had committed the fault of deciding something else than what suited M. Mario Draghi, the President of the ECB.

It is important here to fully size up the unheard of character of the ECB’s decision. It means that, in the Eurozone, to paraphrase the great British writer George Orwell in Animal Farm: « All countries are soveireign, but some are more sovereign than others».

The government of Cyprus has indicated that it would present a “plan B,” but the latter remains, at this hour (Friday end-afternoon), mainly in limbo. One speaks about constituting an investment fund, leaning on the off-shore gas reserves discovered in Cyprus, in order to guarantee an additional loan. The minister of finances of Luxemburg, M. Luc Frieden, declared on Friday morning to the German radio RBB that the Cyprus question concerned not only Cyprus but the stability of the Eurozone. It’s self-evident. If the risk of contamination,  i. e. of the transmission of the crisis through real mechanisms onto other banks is quite low, the risk of a contagion, i. e. the transmission by psychological and behavioral effects is considerably higher. But this risk has appeared above all else because the bond of trust which could exist between the depositors and the banks has been broken by the agreement imposed by the Eurogroup, which was refused by the Cypriot Parliament. In fact, as long as the Eurogroup and the ECB do not acknowledge the error committed on Saturday, March 16th, this risk will endure.

The refusal of the Cypriot Parliament to bend to the will of the technocrats in Brussels, as well as the refusal of the government to negotiate, seem to have provoked a genuine fury in Germany.  On Friday, March 22nd, a meeting of the Christian-Democrat parliamentary group took place in Berlin in the presence of the Chancellor, Mrs Merkel. The vice-president of the group in the Bundestag, Michael Fuchs, declared at the end of this meeting: “we are not ready to accept phony (ou: baloney) solutions.”2. The Chancellor, after having called Cyprus “a little country of no importance,” reproached the Cypriot government for playing poker with the Eurozone.

We are therefore indeed in a situation of blockage, as the Parliament of Cyprus could hardly afford to make a turn-around, and as Germany has erected as a matter of principle the Cypriot contribution to the salvation of the banks. In fact, Germany’s credibility is at stake.  If Germany, which was the country which pushed most strongly for the solution of a taxation of deposits, were to acknowledge its error in regard to what Mrs Merkel, with her customary delicacy, calls “a little country of no importance,” the whole credibility of the German position about the handling of the crisis would be called into question. Mrs Merkel has boxed herself in in a position from which she can now extract herself only with difficulty, if she is not to compromise her political reputation.

The Russian moment.

At this stage of the crisis, a new factor intervenes, contributing to make the problem even more complex: Russia. The reactions of Russia have indeed changed in nature between the announcement of the plan on Saturday, March 16th and the announcement of the blockade on Wednesday, March 20th.

In order to understand this, we must go back to the nature of Russian assets in Cyprus. Of the 90 billions in deposits, 20 billions correspond to the accounts of physical and moral persons (i.e. entreprises) of Russia and of the CIS. There are in fact 33 billion euros corresponding to foreign assets, but 13 billions correspond to deposits owned by Greeks, Britons and individuals (and businesses) from the Middle-East. This is a fact which tends to be forgotten. Cyprus has always kept up good relations with the countries of the Middle-East.

Granted that the 20 billions in Russian deposits are important, one can hardly say that they “dominate” the Cypriot banking system, as is sometimes stated. In fact, the island of Cyprus plays a particularly important role in financial transactions originating in or destined to Russia. The amounts involved in this case are far larger. They are estimated to 250 billion euros and Cyprus is one of the very first investors in Russia. These are, of course, assets of companies which are not Cypriot, but Swiss, Luxemburgian, British, and which are often the property of Russian oligarchs. This money transits through Cypriot banks, but does not stay there.  Numerous Russian companies have also accounts in Cyprus in order to effect payments or perceive money from the whole of the Eurozone. Such is the case of the main oil and gas companies, but also of Aeroflot. It is in this capacity that Cyprus is a financial place of great importance for Russia.

The Russian authorities, through the voice of President Vladimir Putin and of the Prime Minister have denounced the plan of March 16th and the measure of taxation of deposits, indicating that this measure broke the pact of trust between the depositor and his bank. Vladimir Putin described the plan as “unjust, unprofessional and dangerous.” This is doubtlessly exact as subsequent events fully demonstrated. One can even say that it contradicted the guarantee of 100,000 euros on deposits which is valid in the whole Eurozone.  But, at this time, there is yet no question of Russia intervening in order to save Cypriot banks. The visit of the Finance Minister of Cyprus in Moscow did not result in any agreement. The protest of the Russian government is purely one of principle. The illicit nature of part of the deposits resulted in the fact that Russian authorities felt no desire to intervene. However, with the announcement of the blockade, the tone changes radically.  The Prime Minister, M. Dmitri Medvedev, threatens in response to brutally transform the part of currency reserves held in euros by the Central Bank of Russia into dollars. This declaration also must be read attentively:  “A large number of our public structures operate via Cyprus, and they now see their accounts blocked for incomprehensible reasons (…). If this is possible in Cyprus, what will keep the same scenario from reproducing itself in Spain, in Italy and in others countries experiencing financial problems. To-morrow, it’s in those places thatsavings will be confiscated.”3. This is a very serious threat for the Eurozone. Russia holds probably between 350 and 400 billion euros. Were she to sell off half of it in order to buy dollars or other currencies, the whole fragile equilibrium of the Eurozone would be brutally compromised. The euro would decrease in value in the immediate, but very rapidly interest rates would begin to rise sharply, putting some countries, first of all Italy with her gigantic debt of over 125% of GDP, in a very difficult situation.

The Game of Germany

So that’s where we are. The Cypriot government must present a “plan B,” based on a staggered repayment fund based on future gas resources and excluding any idea of a tax. This plan will be most probably rejected by the ECB and the Eurogroup, if one is to judge by the German declarations. Either the Cypriot government gives in to the pressures of the ECB, and the Parliament re-votes by Tuesday morning a text which will be very close to the one it had rejected last Tuesday, or we will be headed in the  direction of a dramatic intensification of the crisis. Which could well end up in a partial collapse of the Cypriot banking system, a massive flight of capital estimated to 30 billions, and the exit of this country from the Eurozone.

This makes us come back to the logic behind the German position. It is clear that the German leaders, but also the German representatives at the ECB, tend to minimize the capacities of contagion emanating from the Cyprus crisis. But this is not the only reason. The German banks are ailing, and this fact counted for much in the reticence of Mrs Merkel to the project of a Banking Union, of which we know it will only come into effect in 2014. Now, it happens that every time there is a crisis in the Eurozone, we see an important transfer of capital in the direction of Germany, thus improving the situation of the banks. One might therefore consider that the combination of an ideological position, which is an important matter in a pre-electoral period, joined to a latent contempt for Cyprus and the Cypriots, and of well-understood self-interests, are pushing the Chancellor to adopt an intransigeant position on the Cypriot crisis. If this is the case, all conditions are together for this crisis to play itself out in the most dramatic way possible.

Should it come to this, it is possible that an agreement will be finally found with Russia and that the latter, in return, then, for a privileged access to the gas deposits off-shore Cyprus, will accept in fine to substitute for Europe. For the time being, the Russian position consists in saying that the Cypriot question is relevant to the responsibility of the authorities of the Eurozone. But, in the same time, it is clear that the door is remaining open should the crisis lead to an exit of Cyprus from the Eurozone. Considerable loans might be granted in order for the government of Cyprus to recapitalize (and nationalize) the banks which are most in difficulty, against exclusive rights on the gas reserves. This would put Gazprom, and any other Russian company, in a very favorable situation for the energy supply of Europe, but also of Turkey.

Were this to happen, it would be an event of considerable impact which would signify, in the end, the progressive demise of the Eurozone, a considerable weakening of the EU, and an increasing weight of Russia in Europe.


Jacques Sapir, “Cyprus between Germany and Russia”, note published on the blog Russeurope on 24/03/2013, URL:


  1. Jacques Sapir, “Le problème de Chypre et ses conséquences”, billet publié sur le carnet Russeurope le 17/03/2013, URL: []
  2. B. Parkin et T. Stoukas, « Merkel Vents Anger at Cyprus Over Bailout as Deadline Looms », Bloomberg, 22/03/2013, URL : []
  3. []

Jacques Sapir

Ses travaux de chercheur se sont orientés dans trois dimensions, l’étude de l’économie russe et de la transition, l’analyse des crises financières et des recherches théoriques sur les institutions économiques et les interactions entre les comportements individuels. Il a poursuivi ses recherches à partir de 2000 sur les interactions entre les régimes de change, la structuration des systèmes financiers et les instabilités macroéconomiques. Depuis 2007 il s'est impliqué dans l’analyse de la crise financière actuelle, et en particulier dans la crise de la zone Euro.

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