Russian Ties Put Cyprus Banking Crisis on East-West Fault Line

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LIMASSOL, Cyprus -- Andreas Marangos, a Porsche-driving lawyer here, had just woken up when he heard the news that threatened to destroy his and Cyprus's most lucrative business: setting up shell companies and providing financial services for wealthy Russians.

He rushed to his computer to check whether the "crazy talk" he had just heard was true -- that his government had agreed last week to effectively confiscate 9.9 percent of the wealth of anyone holding more than 100,000 euros, about $129,000, in a Cyprus bank.

A week later, this Mediterranean island nation is still trying to figure out how to raise the $7.5 billion European lenders say it must have by Monday in return for a bailout. Late Saturday, the tentative plan was to seize a portion of all deposits above 100,000 euros, with the bite set at 20 percent for those banking with Cyprus's biggest bank.

For Mr. Marangos, either plan is bad news.

"Since last Saturday, we are just answering calls from angry clients," said the lawyer, whose firm has helped Russians and Ukrainians set up 6,000 companies in Cyprus so that they can avoid taxes, benefit from a sound legal system and, they hoped, keep their money safe. Cyprus still offers those draws, he insisted, but his clients "thought we had betrayed them."

Accusations of treachery, mostly aimed by poorer nations at Germany for demanding budget cuts and other painful steps in return for help, have become a regular feature of Europe's three-year-old debt crisis. But what began in Cyprus as just another episode in a now-familiar narrative of stingy, rich Northern Europeans versus put-upon, poor southerners has escalated into a bigger drama tinged with cold war-style language and strategic calculations involving not just money but also energy and even military power.

Cyprus had been haggling with Europe for months over a bailout deal to rescue its bloated banks. Last week, the initial plan to seize money from even modest bank depositors sent swarms of panicked residents to automated teller machines to try to withdraw their money. But the crisis involves more than financial considerations.

"There is a geopolitical game going on behind all this," Mr. Marangos said.

With just 860,000 people and a gross domestic product of only $23 billion, the Republic of Cyprus makes an unlikely strategic prize. But it sits atop a web of overlapping and potentially volatile fault lines -- between East and West, the European Union and Russia, and Greece and Turkey, whose troops occupy the northern part of the island. It also has natural gas in the waters off its coast toward Israel. Nobody knows for sure yet how much -- that may become clearer later this year when Houston-based Noble Energy carries out a new round of exploratory drilling.

But just the possibility of significant reserves has raised hope in Brussels, and fear in Moscow, that Cyprus could help break the European Union's dependence on Russian-supplied gas.

"There is a clear danger of this area becoming a platform for confrontation between East and West," said Harry Tzimitras, director of PRIO Cyprus Centre, a research center in the capital, Nicosia.

Cyprus has until now frozen out Russian interests from offshore gas concessions, snubbing a low bid by Novatek, a Russian company whose directors include Gennady Timchenko, a wealthy oil trader and judo club acquaintance of President Vladimir V. Putin's. In talks last week in Moscow over a possible loan to Cyprus, Russia made clear that it expected a piece of the gas pie for its own companies, according to Cypriot officials and politicians.

In Russia's view, Cyprus, which already has two British military bases, a legacy of the country's colonial past, would also be an ideal place to set up a small naval installation should the Kremlin lose access to Tartus, a Syrian port that risks being swamped by that nation's civil war.

The Moscow talks yielded no deal and dashed hopes that Russia might ride to the rescue. But many Cypriots still view Russia as a useful counterweight to bullying by Brussels. "We are not a Trojan horse for Russia in Europe, but we are trying to protect our interests like everyone does," said Petros Zarounas, a diplomatic adviser to the Democratic Party, part of the governing coalition.

According to a recent opinion poll by Cyprus's Sigma television, the public mood has turned decisively against Europe and toward Russia. More than two-thirds of those surveyed agreed that Cyprus should drop the euro and move closer to Russia because of the "behavior of our European partners." Protesters outside Parliament last week waved banners cursing the European Union and Chancellor Angela Merkel of Germany.

With Cyprus's banks closed for more than a week now, fear-driven rumors of secret deals and big power politics have become the main coin of the realm.

As a team of European Union experts set up camp in Nicosia to try to figure out how to resuscitate the bailout package announced in Brussels on March 16 and declared dead on arrival by the Cypriot Parliament, a Russian-language radio station here led its news bulletins with reports of a "direct strike against Russia's position" in the Mediterranean by Secretary of State John Kerry.

The report, on Russian Wave radio, said that Mr. Kerry had telephoned Cyprus's finance minister and told him Washington was ready to help out, as long as Cyprus guaranteed a bigger role for the United States in gas concessions and raised the levy on large foreign depositors, many of them Russians, to 15 percent.

American officials said they knew of no such call by Mr. Kerry, and the radio station's news anchor, Nedezhda Braun, acknowledged that her report might not be true. No matter, she said. Russians here were desperate for information about a crisis that has hit their community hard.

There are more than 50,000 Russian speakers from across the former Soviet Union living in Cyprus, according to the Association of Russian Businessmen in Cyprus. Many live in Limassol, or Limassolgrad, as some now call it. The city has two Russian-language newspapers, dozens of shops selling Russian products and a memorial to Russia's national poet, Alexander Pushkin.

A host of Russian plutocrats have registered shell companies here and some have bought villas, but most fly in for short trips to consult with lawyers and bankers.

A few have even invested in real businesses. Dmitry Rybolovlev, a fertilizer billionaire, is one of the largest shareholders in the troubled Bank of Cyprus. One proposal said to have been under consideration last week in Moscow would have involved Mr. Rybolovlev's increasing his stake and other Russian investors taking over the Popular Bank of Cyprus, an institution that the Cypriot government has since decided to effectively shut down.

The majority of the Russians who live here full time are of modest means, and they resent a widespread view of Cyprus as a haven for Russian crooks and dirty rubles. This view, encouraged by a leaked report from Germany's foreign intelligence agency, underpins much of the resistance in Berlin and other European capitals to any bailout for Cyprus that does not squeeze wealthy foreigners.

"We are not criminals, arms dealers or bootleggers," said Sergey Ivanov, a Russian who runs a wine business here. "There is a generation of Russian businessmen like me who have lost faith in the Russian government, in Russian banks and in Russian laws. That is why we are in Cyprus." He said he was now wondering whether he should go home.

Others have already decided to call it quits, including Alexey Voloboev, who owns Russian Wave radio as well as a Russian restaurant and stakes in other Cypriot businesses. He is so angry with the proposed confiscation of depositors' money and the damage this threat has done to business confidence that he now wants to sell and move to London.

"I knew it would be bad, but never expected it to be this bad," he said. "I thought banks might go bankrupt, but not the whole country."

To avoid that fate, Cyprus has until Monday to reach a new deal with its lenders: the European Commission, the European Central Bank and the International Monetary Fund. The European bank has threatened to cut off vital short-term financing to Cyprus's wobbly banks if no agreement is reached, an action that would upend the country's biggest and already effectively insolvent banks and risk pushing the country toward default.

"This is all a dirty game to create a banking collapse," fumed Yuri Pianykh of the Russian business association -- aimed, he contends, at luring Russian money out of Cyprus to other European countries. He insisted the country had better safeguards to combat money laundering than many other European states and had been the victim of a German smear campaign.

David Officer, a sociologist at the University of Nicosia, said Cyprus had indeed enacted tough legislation to fight dirty money, "but the problem is implementation." He said that "a culture of secrecy" allows billions of dollars from abroad to slosh through the financial services and real estate industries with little supervision.

The dangers this creates are illustrated by the case of Sergei Magnitsky, a Moscow lawyer who was arrested after he helped expose how corrupt Russian officials had stolen $230 million in taxes paid by Hermitage Capital, an investment company formerly based in Moscow. After Mr. Magnitsky died in prison in 2009, Bill Browder, Hermitage's American-born founder, tracked $31 million of the stolen money to various bank accounts in Cyprus.

Any dirty money flowing through Cyprus, however, is dwarfed by funds generated by legitimate businesses looking for easy and legal ways to avoid taxes. There are so many Russian companies registered in Cyprus for tax reasons that the tiny country now ranks as Russia's biggest source of direct foreign investment, most of it from Russian nationals through vehicles registered in Cyprus.

While wealthier European countries object to practices that allow companies to sell their goods in one nation and book their profits in low-tax havens like Cyprus, Mr. Marangos, the lawyer, sees no reason for Cyprus to give up its financial service industry when its other best asset is sunny weather.

"We want to keep this industry," he said. "Otherwise we will be selling ice cream and laying out sun beds."

David M. Herszenhorn contributed reporting from Moscow, and Dimitris Bounias from Nicosia, Cyprus.

world

This article originally appeared in The New York Times.


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