It's a small island with less than a million people, but the tensions created this week over conditions for a bailout package for Cyprus have brought renewed urgency to the euro crisis. Nearly one week after the European Union agreed to a €10 billion rescue for the country, the Cypriot parliament still hasn't approved any compromise deal. On Friday, the troika also appeared to have rejected an alternative proposed by Nicosia.
Under the original plan, Cyprus' partners had demanded that a one-time levy be applied to bank accounts in the country, requiring all depositors to participate in the bailout. The move proved enormously controversial across Europe and it was rejected in Nicosia.
Under the so-called "Plan B," Cyprus would abandon the controversial bank levy and instead attempt to raise its €5.8 billion share of the bailout through a fund based on a portfolio of government assets. It is this plan that has reportedly been rejected by the troika, comprised of the European Commission, the European Central Bank (ECB) and the International Monetary Fund (IMF). Cyprus' receipt of a €10 billion emergency loan from the European Stability Mechanism, the euro-zone bailout fund, has been made contingent on Nicosia coming up with almost €6 billion on its own. The fund it designed to do so would include money from the Orthodox Church, pension funds and other institutions that would back government bonds that would then be issued. The Cypriot central bank is also expected to contribute to the fund with its gold reserves.
Early Friday afternoon, Greek TV station Skai-TV and the newspaper Ta Nea reported that the troika has rejected the proposal following a meeting with Cypriot President Nicos Anastasiades. Troika officials reportedly told the leader it was unlikely the country could raise the funding shortfull with the plan. They are reportedly sticking to their demand that Cyprus impose a deposit tax, but only on accounts holding sums of €100,000 or more.
The levy idea was in part created so as to avoid saddling Cyprus with an unsustainable level of sovereign debt -- a concern not addressed by the "Plan B" Cypriot lawmakers presented this week.
Irritation in Berlin
The German government is reportedly very critical of developments in Nicosia this week. Participants in a special meeting of Chancellor Angela Merkel's party group in parliament on Friday said the German leader has warned that Cyprus' partners may soon lose patience and that the country should not try to test the troika. She also criticized leaders in Nicosia for not having communicated with troika officials in recent days.
For her part, Merkel opposes any plan that would tap Cypriot pension funds in order to fix the country's banking problems . Participants in the meeting quoted Merkel as saying that EU social principles could not be abandoned. She also reportedly stated that Cyprus appears not to have recognized that the business model it has used up until now has ended. At the same time, she added: "We want Cyprus to remain the euro zone." She is also reported to have said that she hopes the situation in Cyprus doesn't lead to a "crash".
Both Merkel and German Finance Minister Wolfgang Schäuble have called for major structural reforms in Cyprus. Merkel has noted repeatedly that depositors at Cypriot banks are provided with higher interest rates than those at German financial institutions. She is also a proponent of the one-time bank account levy included in Saturday's bailout deal, although she opposes applying the tax to small-scale savers.
Meanwhile, Volker Kauder, the party whip of Merkel's conservative Christian Democrats said, "We cannot accept that peoples' pensions will be put up as collateral." He added that "we want Europe to remain as a whole," but that Cyprus "is playing with fire."
Meanwhile, talks between Cyprus and Moscow over possible Russian aid have collapsed, leaving Nicosia with few remaining options. Russian Finance Minister Anton Siluanov told the news agency Interfax on Friday that the country had not been interested in proposals made by his Cypriot counterpart Michalis Sarris. Siluanov said Russian investors weren't interested in Cyprus' offshore gas reserves or its financial sector. Given close economic ties between Russia and Cyprus and the fact that so many Russian investors have parked their money on the island, many observers had believed Moscow would ultimately participate in the bailout.
Fears of Run on Banks
Across Europe, concerns are growing that the impasse could lead to a run on banks and possible bankruptcy for the Mediterranean country. Germany's respected business daily Handelsblatt is reporting that the European Central Bank (ECB) is preparing to take steps to prevent a run on the banks in Cyprus and a massive capital flight from the country. According to the report, the ECB is considering placing limits on the amount of money residents can withdraw from ATM machines. The rules would also entail freezing deposits on accounts and requiring that any wiring of money be pre-approved by the national central bank. Handelsblatt said the ECB had not determined how long such a freeze on accounts would be put in place.
The newspaper said that the Cypriot government had similar plans and that parliament would likely approve a freeze on accounts and other measures to prevent capital flight on Friday. In the history of the European Union, only two banks have ever limited money transfers -- Belgium's Dexia and Britain's Northern Rock, both at the height of the global financial crisis.
Banks in Cyprus have been closed since Saturday in order to prevent a run on the banks, although money has been available in ATM machines for customers. Under current plans, they are scheduled to reopen next week. Without a bailout package and without liquidity from the ECB, several banks will likely go bankrupt. On Thursday, the ECB threatened to suspend liquidity aid on Monday if a bailout agreement hasn't been reached by then.
According to the report, the ECB also wants to regulate capital flows even if Cyprus comes to an agreement with the troika over the terms of a bailout early next week. "The is a great danger there will be a run on the banks when they reopen next week," an ECB source told the newspaper. The paper said the ECB plans to implement the controls in a way that will ensure that all citizens of Cyprus are given access to the money they need to live and that payments of pensions and other social services will continue.
Handelsblatt notes that the Lisbon Treaty governing the EU includes provisions allowing limits on the free flow of capital across the bloc. Limits in the interest of "public security" are permitted, it notes, and a country doesn't even require permission from Brussels to implement them.