Philip Hanson
Associate Fellow, Russia and Eurasia Programme

Has the European Union, with its bungled bail out plan for Cyprus, handed Moscow unexpected influence in the island?

There has been a good deal of commentary to that effect, with talk of Russia stepping in to provide finance in return for stakes in Cypriot offshore oil and gas fields and positions on the boards of Cypriot banks. It is quite likely that the Cyprus crisis will lead to Russia gaining a greater degree of influence. But Russian politicians, bankers and business-people face their own dilemmas when it comes to dealings with Cyprus. It will not be smooth sailing for Moscow, by any means.

Significant financial exposure to Cyprus 

To begin with, Russia already has some influence over developments in Cyprus but it is not necessarily of a kind that the Kremlin is keen to encourage. Cyprus is a favourite Russian offshore financial centre – probably the favourite. But officially, at least, Russia's leadership is pushing for 'de-offshore-ization' of the economy.

At present a lot of Russian money goes 'round-tripping' through Cyprus. In 2011 Russian banks and companies' direct investment in Cyprus totaled $22.4 bn, or one-third of total Russian outward foreign direct investment. In the same year inward direct investment into Russia from Cyprus was $13.5bn, or 24% of the total. In the first three quarters of 2012, the last for which data are available from the Russian Central Bank, the picture was broadly similar. Much of this is perfectly legal, for all the talk about money-laundering, but no doubt some is dubious.

In addition to these capital flows, there are large amounts of dividends paid by leading Russian firms to companies in Cyprus. The recipients are the holding companies through which Russian tycoons often control their businesses. For example, most of the Russian steel industry is controlled through Cyprus: Evraz through Lanebrook, NLMK through Fletcher Group Holdings, Severstal through Frontdeal Ltd, and MMK through Mintha Holding and Fulneck Enterprises. 

The original bail out scheme posed a risk to some, though far from all, Russian wealth in Cyprus, to bank deposits in particular. Most estimates put the sum of bank deposits in Cyprus by Russian companies and individuals at €20-25 bn or around a third of the total. Probably most of these are above €100,000, and would have been subject to the levy of 9.9% proposed in the first EU-ECB-IMF bail out plan. This plan included a lower-rate levy on smaller depositors, reportedly favoured at first by the Cypriot government in order to avoid a levy at above 10% on Russian funds. Understandably, the government did not want to antagonize one of the island's major sources of wealth. Instead they antagonized their own population – and then had second thoughts.

The original plan, rejected by the Cypriot parliament on 19 March, was not welcomed in Moscow, either. Putin described it as 'unfair, unprofessional and dangerous' – a judgement many Western commentators concurred with. Russia's Finance Minister, Anton Siluanov, deplored the fact that Russia had not been consulted, and raised doubts about the rolling-over of an existing Russian loan of €2.5 bn to Cyprus. 

Stepping into Russia's orbit

What could Moscow do? Russia has minuscule public debt, a balanced budget and large reserves. Lending the €10-15 bn that Cyprus might be seeking would not be impossible. But what would be in it for Russia?

Repayment could be problematic. The hydrocarbons quid pro quo also looks problematic: stakes in offshore oil and gas fields sound attractive, but there is much more checking to be done before these are well-assessed; in addition, territorial issues with Turkey (in relation to fields offshore from the Turkish-controlled part of Cyprus) would be unwelcome, since Turkey is a strong business partner; there are also complications about the contiguity of possible Cypriot and Israeli offshore claims. As for increased control of Cypriot banks, they are the source of the Cyprus problem in the first place.

Moscow has been gifted an opportunity to have a say in a sensitive intra-EU matter, but making good use of its new-found influence will not be straightforward.