A lot more than Cyprus at stake as Russia bares its fangs over crisis

Prime minister Dmitry Medvedev has never been the tough one in Russia’s ruling tandem.

The chubby lawyer has always played Robin to president Vladimir Putin’s Batman, metaphorically holding the judoka and former KGB spy’s briefcase when a little of the rough stuff was required in disputes with domestic or foreign foes.

But Cyprus seems to have changed things.

Now the formerly mild-mannered Medvedev is hurling brickbats at the European Union and stricken Nicosia, and firing off extravagant threats that might make Putin proud as he quietly watches his protege from the Kremlin.

If the usually cherubic Medvedev, perennial good cop to Putin’s bad, is suddenly lashing out at foreign officials, then something must have made Russia very angry – and very worried – indeed.

In the past few days, Medvedev has lambasted the EU’s and Cyprus’ “bull in a china shop” handling of the island’s crisis, and called Brussels’ bailout plans “absurd” and “tantamount to confiscation and expropriation” of a kind not seen since the demise of the Soviet Union.

He has accused EU officials of “incompetence” and making “every mistake that it was possible to make”, and warned Nicosia that it will face an avalanche of court cases if the current bank freeze and possible levy on deposits damages businesses operating on or through Cyprus.

Medvedev has even threatened to scrap Russia’s double-taxation treaty with Cyprus, which would drive billions of euro in Russian cash from the island, and suggested that Moscow may cut the proportion of euros in its foreign reserves, which could drive down the value of the currency.

The anger emanating from Moscow reveals its fears that not only could some of Russia's biggest businesses and richest citizens lose billions in Cyprus, but that the Kremlin could now be locked in a power struggle with the EU that it may not be able to win.

Tightly intertwined
Russia and Cyprus are geographically distant, but tightly intertwined by finance.

Soviet banks set up offices there decades ago, and since Moscow and Nicosia signed their double-taxation treaty way back in 1982, major Russian firms and wealthy individuals have sought to stash money on the sun-kissed island, where taxes are low and regulation light.

In the past 20 years, Cyprus has not only been the destination of choice for a large proportion of the tens of billions of dollars and euro that annually leave Russia in capital flight, but a favourite place to establish holding companies, shells and “brass plates” behind which to do business.

These firms engage in a host of transactions, from trading to accounting, which are cheaper to perform and perhaps less closely scrutinised in Cyprus than they would be in Russia.

A vast number of Russian companies have subsidiaries and affiliates in Cyprus, through which they channel cash to foreign partners or, in many cases, back to Russia.

The Moody’s credit rating agency says Russian firms and individuals have about €24 billion in Cypriot accounts, and Russian banks have as much as €31 billion in outstanding loans to firms registered in Cyprus – many of which are Russian-controlled.

The exposure of firms that are registered as Cypriot but are de-facto Russian is not known, but could be significant.

Russian companies could also face costly problems if Cyprus, as part of a bailout or default, places restrictions on external payments. That would freeze the money that usually flows smoothly from Russia through Cypriot banks, potentially causing major loses and disruption to business.

Medvedev complained bitterly this week that the “operation of all banks on Cyprus is blocked, including the biggest ones and banks with Russian capital that are normal and healthy”.

“These banks perform a huge number of transactions . . . and if their operation remains suspended, they will sustain vast damages and the entire Cypriot banking system will cease to exist.”

He also revealed that "a large number of Russian open public entities are working via Cyprus. They have their money blocked for no particular reason. This money is legal and is used by state-owned entities. That's why we have to take such a tough stance with regard to the events in Cyprus and the Cypriot debt."

Damaged pride
Russia's anger over the handling of the Cypriot crisis is not all about money, however.

It is also about the pride of Putin’s resurgent Russia and its desire to play a key role in shaping Cyprus’ future.

Moscow was furious at not being consulted by Brussels or its old ally Nicosia over the EU bailout, and in response threatened to withdraw an offer to ease the terms of an existing €2.5 billion credit to the island.

Russia was riled further by German chancellor Angela Merkel, who told Cypriot president Nicos Anastasiades that “negotiations are to be conducted only with the troika” – which comprises the EU, the European Central Bank (ECB) and the International Monetary Fund – and not Moscow.

Several northern EU states, led by Germany, have long looked with suspicion at the Russian money that pours through Cyprus, and Nicosia’s willingness to do Moscow’s bidding on a range of issues has seen it dubbed the “Trojan donkey” inside the 27-nation bloc.

Protests in Nicosia against the proposed EU deal, followed by parliament’s crushing rejection of it, show how Cypriot opinion has turned against the EU and Germany in particular.

Both Nicosia and Moscow are feeling put out by how Brussels and Berlin have handled them in recent days, giving momentum to talk that Russia could use this opportunity to shove the EU aside in Cyprus and gain a foothold in a strategic corner of the Mediterranean.

Cypriot officials are in Moscow to discuss whether Russia wants to contribute to a bailout in return for stakes in its stricken banks and rights to develop its major offshore gas fields.

Kremlin-controlled gas giant Gazprom certainly has the cash to save Cyprus, and fresh reserves in the Mediterranean would help tighten its grip on the European energy market, at a time when shale gas from other parts of the world threatens to weaken its position.

Buying Cypriot banks would be more problematic, given the size of their debts and the fact that they would still – as long as the island remained in the euro zone – be dependent on the provision of liquidity from the ECB rather than able to operate solely at Moscow’s behest.

Russia’s navy may also be interested in the prospect of establishing a base in Cyprus, as its only Mediterranean facility – at Tartus in Syria – would probably be closed if Moscow ally Bashar al-Assad fell.

Some Russian officials have also struck a somewhat nonchalant tone about Cyprus, claiming that its woes will in fact prompt large sums of Russian cash to return home, helping turn Moscow into a major global financial centre.

Whatever Cyprus’ fate, it will have repercussions far beyond the island.

If the EU’s bailout prevails, powerful Russians will get burned; if Moscow saves Cyprus, the EU is unlikely to look very kindly upon a Kremlin outpost with an already murky financial reputation; and if Moscow and Brussels join forces, then Cyprus will play host to a unique experiment in east-west co-operation.

“Will this affect our future relations?” Medvedev said of Russia and the EU this week, before answering his own question: “We must wait for the final decisions.”