Will Putin attempt a last-minute Cyprus rescue?

By Anatole Kaletsky
March 25, 2013

Vladimir Putin could restore Russia’s great power status and maybe go down in history as the country’s most visionary leader since Peter the Great. He could win respect from Beijing and Washington for averting a second global financial crisis and he could prove that Russia understands market economics better than the EU. His miraculous opportunity to do all this started with the Mafia-style “offer you can’t refuse”  presented by the EU to Cyprus on Sunday. It will end on Tuesday morning, if Cyprus banks then re-open under the conditions imposed by the European Troika, as currently planned.

One of the mysteries of the Cyprus crisis has been the lack of response from Russia, despite the obvious strategic opportunities, not just to protect its offshore deposits, but also to exploit the island’s strategic location and its military and energy potential. A possible explanation is that Europe’s indecision also paralyzed Russia -  until last night.

As long as Europe’s policy on Cyprus kept shifting, it was impossible for Russia to intervene, since any help it offered could be rejected or outbid by the EU. As a chess player, Putin probably understood that his best strategy was to wait for Cyprus to get weaker and more desperate, while the EU, and especially Germany, became more impatient and obstinate. The moment to make his move would be when Europe presented an ultimatum too painful or humiliating for Cyprus to accept. That moment arrived last night.

With the EU’s final offer declared, Putin can now make his bid for Cyprus without fearing an auction with richer EU countries who could easily outbid Russia. But will Putin make such a bid? This depends on his answers to three questions: Could Russia afford to offer enough help to save the Cypriot banking system? Would saving Cyprus be useful to Russia? And would it promote Putin’s own interests?

As always in Russian history, we must start with the leader’s personal interests. If Putin could block the Cyprus deposit levy, he would protect assets still stranded there by his oligarch associates, as well as boosting his popularity among the middle-class Russians likely to be the levy’s main victims. But much more important for Putin would be the personal prestige of helping to avert a global financial crisis and outwitting EU leaders to secure Cyprus as a geopolitical prize and a grateful client state within the EU.

Cyprus is certainly a prize worth a gamble. Everyone now knows about the island’s gas reserves and strategic position as an intelligence listening-post and forward base for Mideast military operations; less familiar are the reasons why Cyprus is more valuable strategically to Russia than it is to the EU. Russian rulers have always dreamt of securing a Mediterranean outlet that would let them face Germany and other historic rivals from the South as well as the North and East. A similar pincer strategy against Turkey was among the motivations for the Crimean War. Turning Cyprus into a dependent ally and persuading its population to replace the British military base there with Russian forces would achieve these historic objectives — plus a new economic goal. Cyprus would give Russia a key stake in energy developments that could challenge its near-monopoly on EU gas supplies.

In sum, earning Cypriot gratitude and dependence would definitely be in Russia’s interests; but that still leaves the question of whether Russia can realistically do anything to help. The conventional answer is No, especially after last night’s ultimatum from Brussels.

It seems that Putin waited too long. Even if Russia offered to inject billions into the Cyprus banks, this would no longer satisfy the EU’s demand for a punitive “bail-in,” slicing 40% off large bank deposits. If Cyprus fails to implement this measure, the ECB will cut the banks’ credit lines on Tuesday. Any Russian capital injections would thus instantly vanish in the bank runs and the Cyprus economy would still then collapse, turning any Putin “rescue” into a laughing stock.

Fear of such an embarrassing outcome may, indeed, have been the main reason for Russia’s reluctance to play its hand. Since Cyprus banks have depended on ECB  credit lifelines, the EU could trump any unwelcome Russian initiative in Cyprus by overwhelming any money offered by Russia with the withdrawal of the ECB’s much larger funds. So Russia could only get involved in Cyprus with EU acquiescence and that meant that Russia could not hope for any geopolitical gains.

As of last night, however, Russia has a sudden opportunity to break the ECB’s stranglehold on Cyprus via its banking system – but this window of opportunity will not last long. Because Cyprus has now been openly threatened with expulsion from the euro by Tuesday  if its parliament fails to implement the EU’s new bailout demands, Putin can offer Cypriots a new option they would never have previously imagined.

Now that the EU has presented a seemingly irreversible ultimatum, Cypriots assume that they have no choice but to slash their euro deposits as demanded by the Troika or see these deposits converted into worthless new Cypriot pounds. But what if instead the euro deposits were converted into Russian rubles, worth exactly the same as the euros they replaced?

A euro-to-ruble conversion could be implemented in 24 hours if backed by liquidity support from the Russian Central Bank plus some modest capital injections from the Russian banks or government or banks similar to the €6 billion originally demanded by the EU. Unlimited amounts of rubles could be supplied by the RCB to Cypriot banks, just as the ECB supplies euros to insolvent banks in Ireland, Greece and Spain. Cypriot banks would then have no problem meeting all withdrawal demands, with no bail-ins, levies or haircuts. And because the ruble is a widely-traded currency, Cyprus bank depositors could exchange their rubles into euros, dollars or any other currency without suffering any losses or haircuts. Thus a euro-ruble conversion would be very unlikely to trigger any panicky bank runs and if there were some temporary withdrawals of bank deposits, these could be easily financed by the RCB and then reversed – just like the bank runs that occurred in Greece, Ireland and Spain last year.

Of course the ruble might weaken against the euro as a result of these exchanges, but this seems unlikely. The ruble has actually been a slightly stronger currency than the euro recently, rising by 1% against the euro this year and by 15% since March 2009. The RCB, far from worrying about currency weakness, has been trying to prevent the ruble from rising, and accumulated $526 billion of reserves. These reserves dwarf the total liabilities of the small Cyprus banking system and could easily stabilize euro-ruble trading during the period of transition from the euro to the ruble-zone. In anything buy the very short term, the huge global flows between the euro and the ruble, compared with the tiny size of the Cyprus banking system, would mean that the ruble-euro exchange rate would continue to be determined by global factors such as the oil price, rather than sentiment about Cyprus banks.

In short, a conversion from the euro to the ruble would resolve the Cyprus banking crisis immediately with no losses to depositors at all. In effect, Cyprus could follow the model for orderly resolution of insolvent banks used in the U.S., Spain, Portugal, Ireland, Greece and all normal countries, with deposits rightly taking precedence over other liabilities and capital injections used mainly to secure deposits, rather than wipe them out. The Cyprus economy could then be quickly revived and the banks could return to business as usual, albeit under new Russian ownership and presumably with fewer of the “patriotic” investments in Greek bonds that were encouraged by the EU and then brought Cyprus to ruin. Russia’s ultimate hope would be to evolve a similar relationship to a self-governing off-shore entrepot in Cyprus as China has established with Hong Kong and Singapore.

Anything approaching such an outcome would be the  biggest geopolitical success for Russia since the breakup of the Soviet Union. If Putin could draw even one small country like Cyprus out of the euro and into a new ruble zone, in the process averting the risk of Lehman-style financial disaster, his global standing would be transformed. He would win immense respect from Beijing and Washington, despite the anger he would provoke in Berlin and Brussels. If he then managed to turn a basket-case economy ruined by EU incompetence back into a prosperous off-shore entrepot, this would send a powerful message to other countries tired of bullying from Germany and the EU. Over time, Cyprus voters could doubtless be persuaded to expel British military bases and avoid too much disruption to European gas markets from new Mediterranean supplies. Most importantly for Putin and his place in history, Russia could reassert itself as a global super-power with the geopolitical vision and the financial acumen to outmaneuver Germany and the EU.

Putin could achieve all this if he made a generous conversion offer quickly enough to divert the Cyprus parliament from voting for the EU’s demands to wipe out bank deposits. But he has to act before the Cyprus banks open. He has only 24 hours.

PHOTO: A Russian man who lives and works in Cyprus holds a tablet featuring Russian President Vladimir Putin during a protest outside the parliament in Nicosia March 22, 2013. REUTERS/Yannis Behrakis

9 comments

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Freegold means that the euro has a gold component and a paper component and puts a “firewall” between both so that gold’s valuation as a wealth-preserving asset cannot be pulled lower by the inevitable inflation of the paper component of circulating currencies. If Putin can offer rubles to solve the lack of euros of some Cyprus banksters, this means that the ruble is convertible – into euro; thus that the ruble is equivalent to the euro; thus that the Russian central bank like the Eurosystem (the European System of Central Banks) marks its gold reserves to market (MTM) not to the model of USD 42.2 like the USA (originally, in 1944, when Bretton Woods came into force, USD 35). This means that Cyprus will be the trigger to fully achieve Freegold. Is the People’s Bank of China taking note?

Posted by IvoCerckel | Report as abusive

Perhaps there’s not as much Russian money at stake as many may think. Perhaps it would also cause a flow of cash back to Russia? Or perhaps with Cyprus being tied to the hip with EU it’s just not worth the mess. Russia may be smart to sit it out.

Posted by StigTW | Report as abusive

I think we haven’t heard the last of Russia in this affair, but one flaw in your thinking above: Cyprus parliament does not, repeat does not have to approve this deal.

Posted by TobiasMaximus | Report as abusive

Such dreams of grandiosity!! Wake up Anatole!

Posted by xpat | Report as abusive

I don’t quite follow that argument.

Given the precarious state of the Cypriot banks, the equivalent of €6bn would have to be contributed as capital (aka ‘gift’ at this stage) not in form of a loan. On top of it, Russia would need to provide significant liquidity – call it €50-150bn equivalent – to cover deposit losses literally overnight.

This liquidity would probably have to provided without any collateral, as it is likely that most is already pledged with the ECB, and would only be released if and when the ECB is repaid, which Russia would also have to do. At this point, Russia would essentially take the full balance sheet risk of the Cypriot banks, and I do not see Russia being prepared to do that.

Last but not least, funding an mainly EUR denominated portfolio in RUR would breach all kinds of regulatory triggers, and unless Russia would effectively also the the fx risk the regulators would have no choice but to wind down the banks anyway.

The way I see it, this whole proposal is a non-starter!

Posted by oditorium | Report as abusive

I think this is a real possibility. If he speaks to Washington, agrees to cut assad loose in return for their aquiescence, the EU really would look irrelevant.

Posted by Urban_Guerilla | Report as abusive

Putin and his thugs will review any opportunity to expand their “business” and that includes killing the people nationally and internationally that disagree with them. If you think that thugs care about history, review Stalinism.

Posted by UScitizentoo | Report as abusive

Just one question that, in my view, makes the entire proposed endeavor quite questionable (pun unintended): why the wealthy Russians kept their money in EUR in Cyprus(!), but not in Rubles in Russian banks?..

Posted by UauS | Report as abusive

If Cyprus cuts ties to the EU – it loses much of its attractivness and stability. Add unresolved problems with a NATO-member Turkey. What about english military bases?
No matter how much money Russian Federation injects into Cyprus, it can never control it. At the same time – it’s too much responsibility. Folks from russian streets (and UralVagonZavod :) will not understand such step either.

I don’t think that BoC and Laiki were so popular among Russians. Their image was damaged long before March 2013. But, there are several subsidaries of Russian banks on the island which are suffering much more from the unexpected bank holidays, than from a failure of local banks (no matter how big they are for the island).
Maybe I am wrong. Just my personal opinion backed with stories read on the internet.

Posted by OWolf | Report as abusive