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Cyprus: Drawing Russia's Interest

4 MINS READJun 19, 2012 | 11:02 GMT
Cyprus: Drawing Russia's Interest
MARCELLO PATERNOSTRO/AFP/Getty Images
Russia's Black Sea Fleet flagship, Moskva, moored in Messina harbor.
Summary

Official sources within the Central Bank of Russia said June 18 that Moscow was preparing a multibillion-dollar interstate loan to Cyprus. The announcement comes as Cyprus' banking sector is struggling to meet its June 30 recapitalization deadline. Official estimates place the country's bailout requirements at 5 billion euros ($6.2 billion) over the next two years. Unlike other blighted countries on the eurozone's periphery, Cyprus can look beyond the European Union for financial assistance. The country's position as one of Russia's prime offshore banking havens has, in the past, brought Nicosia extensive help — albeit conditional — from Moscow.

But Cyprus' strategic importance has grown in the past year as unrest in Syria threatens Russia's regional military foothold at the Syrian port of Tartus, Russia's only Black Sea Fleet base in the Mediterranean Sea. The Kremlin hopes to use its large liquidity reserves as leverage to develop a substitute base in Cyprus. Should Nicosia choose Russia's offer over a formal EU bailout, which would likely involve strict austerity measures, it would highlight Cyprus' increasing strategic value and indicate that the island is reconsidering its relationship with the European Union.

The Cypriot economy is deeply connected to Greece, so market concerns have increased as Athens hovers near financial insolvency. Cyprus' banking sector in particular is heavily exposed to high-risk Greek assets. Last week, this vulnerability prompted Moody's ratings agency to downgrade two of Cyprus' largest banks and put a third on review for downgrade. The country's largest bank and second-largest lender, Cyprus Popular Bank, needs an estimated 2 billion euros to reach its recapitalization targets by the end of June.

Cyprus' economic links to Greece also have strained public finances. A Cypriot government official said last week that in addition to the cash needed for bank recapitalization, the Cypriot government would need another 2.5 billion- to 3 billion-euro loan in order to meet its financial obligations over the next two years.

The EU Option

An EU member since 2004 and a eurozone member since 2008, Cyprus has been on the shortlist for an EU bailout since at least 2010. However, the country has been reluctant to seek such assistance. Rescues in Greece, Ireland and Portugal have shown that EU bailouts usually come with a string of rigorous conditions.

The European Union requires bailout recipients to balance their budgets, which typically leads to unpopular austerity measures and sovereignty debates. Nicosia wants to avoid having to reform its current cost of living allowance (inordinately high by EU standards), as previous reform attempts have sparked widespread strikes and protests.

EU budgetary restrictions also could limit Cypriot defense spending. Cyprus maintains a robust military in order to counter threats posed by Turkey, which supports the Turkish Republic of Northern Cyprus (TRNC). Tensions have increased over the development of recently discovered hydrocarbon reserves around the island. Exploitation is being done primarily by Israel, which is actively strengthening military, political and economic ties with Cyprus

Russia's Hand in Cyprus

Cyprus is unique among EU member states in its ability to receive support from outside the union. Russian links to Cyprus span several decades, particularly due to the island's traditional role as an offshore banking hub for Russia's wealthy. Alongside legal banking ties, Cyprus has also served as a haven for Russian money laundering and arms smuggling operations.

In exchange for Cypriot cooperation, even during the Cold War, Russia has supported Nicosia's claims against the TRNC. In recent years, strategic and financial relationships between the two countries have evolved. The Kremlin offered a limited bailout loan to Nicosia in 2009 in exchange for banking information about Russian citizens with assets on the island. Two years later, Moscow offered Cyprus a loan of 2 billion euros when the country was shut out from international debt markets. Russia has also attempted to sell weaponry to Cyprus, particularly the S-300 air defense system, that Moscow has been unwilling to sell to other countries. 

Moscow's Geopolitical Motivations

Russia's most recent financial assistance offer is motivated by two major geopolitical shifts at opposite ends of the Mediterranean.

The ongoing conflict around Tartus has prompted the Kremlin to seek alternative Mediterranean ports for its Black Sea Fleet. Cyprus' strategic location and Moscow's traditional ties with Nicosia make the island a natural candidate. In addition, Cyprus is unlikely to ever receive NATO membership, a potential deterrent to a Russian military buildup, due to the island's territorial dispute with Turkey, a current NATO member.

The other trend — the one more likely to push Cyprus toward Russia — is happening in Europe. Greece's political and financial crises are fully erupting, placing Cyprus in its most financially delicate situation since 2008. The European Union's bailout conditions are extremely unpalatable to Cypriot leadership, which has seen the political and social upheaval prompted by austerity in neighboring Greece. In contrast, Russia's conditions for assistance come with fewer short-term financial and political pitfalls for Nicosia. Cyprus is already alienated from NATO, and further insulation from eurozone troubles is beneficial.

The island's strategic position off the Levantine shores, its traditional opposition to Turkey's rise in the region and its potential hydrocarbon resources give it significant potential influence in coordination with Israel and Russia. This position contrasts starkly to its restrictive, generally second-rate membership in the European Union. Russian and Israeli advances to garner influence in Nicosia indicate that Cyprus may have outgrown its position as a satellite of the eurozone's poorest and most troubled member.

Moscow's financial aid will allow Cyprus to retain independence over its budget and will give it strategic leeway to operate at a higher geopolitical level. Thus, Nicosia likely will prioritize the Russian offer, laying the foundation for a new role in the Mediterranean and in broader Europe as Cyprus prepares to assume the EU presidency in July.

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