Cyprus: Rescuing a Tax Haven

Alejandro Nadal

It must hurt when you show your hand without anybody calling your final bet. After all, why do you have to give free information to your opponents? This is what the infamous troika must feel right now after revealing its “rescue” plan for Cyprus. The parliament in Nicosia has flatly rejected the strategy, but the troika’s game plan has been unveiled at great political (and possibly financial) costs.

The little island in the eastern Mediterranean is responsible for only 0.2 per cent of the European Union’s GDP. But the architecture of the rescue plan has resuscitated primal fears about the future of the euro. Why is this so?

Cyprus’s economy was badly hit by the financial crisis. The relations of its banking system with the European financial sector form a tightly knit tissue. When Greece restructured its debt (involving a major haircut for its debtors) it was no surprise to see the two main banks in Cyprus go belly up. President Nikos Anastasiades returned from Brussels with a rescue plan for the island’s economy. Preparing a salvage package for Cyprus was not easy because there were no big senior bondholders that could be targeted for a Greek-style haircut. In addition, restructuring the sovereign debt would probably mean destroying the banking system Cypriot banks are heavily exposed in that field. So the troika opted for a new approach.

Cyprus was asking for 17 billion euros. But European negotiators thought this time they could ask the depositors in the banks to share in the rescue plan. This was of course an entirely new game.

In exchange for 10 billion euros the government in Nicosia accepted to impose a special one-off tax on bank deposits. According to this plan, accounts over 100,000 euros would pay 9.9% and below that amount 6.75%. It was expected this would give the government an extra 5.8 billion euros. With the rejection by parliament, the entire scheme is up in the air. But regardless of the course events in the near future, the Cypriot drama has unveiled some very disagreeable aspects of the European crisis and of the neoliberal nature of the monetary union.

Financial services form the basis of the Cypriot economy: the size of the banking sector exceeds 8.35 times the country’s GDP. To be clear: Cyprus became many years ago a huge tax haven, where a bank account can be opened in no time, at a very low cost and with no questions asked. And Cyprus was a gateway to the eurozone, not a benefit to be overlooked.

This is why there are 1,400 Russian firms registered in Cyprus, including some of the largest like Gazprom, Norilsk and Lukoil. Of course, money laundering is also facilitated under this lax regime, and this is why it is thought that Cyprus is favourite spot for the Russian mafia.

Moscow has already announced, in the words of an angry Vladimir Putin, that it opposed the special tax, arguing this was tantamount to confiscation. It is estimated that deposits of Russian firms and individuals in Cyprus amount to more than 30 billion US dollars (approximately 40% of total deposits). So Cyprus was a Trojan horse for Russians interested in getting into the eurozone. My conjecture is that this was the reason the tiny island was accepted to form part of the monetary union in the first place.

Saving depositors’ from losses has always been the dominant rationale for rescuing…the bankers. But something was different this time. Considering that most of the big depositors were Russian, the troika decided that depositors could very well share in the cost of the rescue plan. Thus, it went ahead with the “one-off” tax on deposits, violating what it had always stated was its most sacred principle. The troika also showed it could sacrifice small depositors as well. But most important, it revealed how little it cares for its projected banking union and the regulatory framework that should accompany it.

Rejecting the rescue plan by the Cypriot parliament will keep Russian depositors happy. The real motivation of representatives in the legislative body will perhaps never be known, but it does not require a lot of imagination to think that Putin’s operators spend a lot of time calling and cajoling the MP’s in Nicosia to reject this plan and throw it to the face of Christine Lagarde and Mario Draghi. Perhaps Moscow will now have to end up bearing the full brunt of the cost in Cyprus on-going crisis. Was this outcome coldly calculated by the troika’s negotiators?

All of this appears to be a family disagreement. It seems that everyone has been trying to preserve the tax haven status of Cyprus. The only discrepancy was over who would bear the costs. The message from the troika is clear: we will keep tax havens operating. If need be, we will implement ad hoc rescue plans, even if they show our intentions and reveal that bankers are sacred, but deposits are not.

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