By Lidia Kelly and Douglas Busvine
MOSCOW, March 21 (Reuters) - Cyprus is in talks with Moscow on raising billions of euros in investments from Russia as an alternative to imposing a tax on Cypriot bank deposits, hoping to lift the barrier to an EU bailout.
Finance Minister Michael Sarris, in Moscow for a second day of talks on Thursday, said Cyprus' banks and its offshore gas riches were areas in which Russia could invest.
"The banks are the ultimate objective in any support we get," Sarris told Reuters. "There are no stumbling issues - there is just work to be done."
Political and financial sources say Russian state development bank VEB could be used as a vehicle to raise up to 5.8 billion euros ($7.5 billion) in new funding secured against real assets that could later be sold off.
That is the sum Nicosia needs for the 10-billion-euro EU bailout to go into force without having to impose a hefty tax on bank deposits - much of which are Russian money.
The Cypriot parliament on Tuesday threw out a package that would impose the 9.9 percent levy on deposits of more than 100,000 euros, in a move unprecedented in the history of the euro.
Sarris said he was also seeking to extend an existing 2.5 billion euro bailout loan from Russia, and lower the interest rate it pays to 2.5 percent from 4.5 percent.
Additional Russian funding could help keep Cyprus within borrowing limits that would let the International Monetary Fund back a rescue.
"It seems to me there is a potential deal structured so the loan is turned to equity over time, in a way that would be compatible with the IMF's requirements," said Jacob Nell, an economist at Morgan Stanley in Moscow.
Precedents include Russia's own 'loans for shares' privatisation scheme of the 1990s, where investors funded Boris Yeltsin's teetering government in return for a pledge of assets that later created the fortunes of its billionaire oligarchs.
Russia has also provided similar secured financing to its ex-Soviet neighbours, Ukraine and Belarus, after they fell into financial difficulties.
Finance Minister Anton Siluanov said talks with the Cypriot delegation in Moscow would continue. The European Central Bank has set a Monday deadline for Cyprus to raise billions of dollars or face losing emergency funds and inevitable financial collapse.
It was unclear whether the Moscow talks would lead to an agreement or merely marked an attempt by Nicosia to extract less onerous terms from Brussels. But a significant side deal between Cyprus and Russia should not be ruled out.
DEVELOPMENT BANK TO LEAD?
VEB - short for Vnesheconombank - is not a regulated bank, but functions more as a financial-industrial group representing the interests of the Kremlin.
Its balance sheet of around $100 billion could support such an operation where Russia's large state banks - Sberbank , VTB or Gazprombank - would find themselves hitting prudential limits on their exposure.
"All the large Russian banks have denied any possibility of bailing out Cyprus - VTB, Sberbank, Gazprombank," said Eugene Tarzimanov, a senior credit officer at Moody's in Moscow.
"I haven't heard anything about VEB."
VEB did not comment but said it had no exposure to Cyprus.
Russian energy firms, led by state gas export monopoly Gazprom, are interested in offshore gas reserves that Cyprus estimates at 60 trillion cubic feet. But the strategic lure of the largely untapped reserves may not be supported by hard economic logic.
"Even if Cyprus has the scale of resources they hope for, they face major technical and marketing challenges ahead," said Bill Farren-Price, of UK-based consultancy Petroleum Policy Intelligence.
"The devil is in the detail - but it looks like a stretch to collateralize a 6 billion euro loan against unproven offshore gas."
Discussing the possible structure of a deal, a senior Moscow lawyer said Russia could provide 6 billion euros to fund a securitized pool of Cypriot offshore gas, land, real estate and banking assets that could later be sold off in an orderly way.
"I think it's a politically acceptable solution," said Dmitry Afanasiev, chairman of Russia's largest law firm, Egorov Puginsky Afanasiev & Partners. "Then private investors can end up owning the securities and it will in effect drive the economic growth of Cyprus."
The vehicle could securitize the assets and then become publicly owned, allowing Russia to exit, preferably at a profit, over a period of about four years, he said.
Afanasiev sits on the board of UC Rusal, the world's largest aluminium producer that is controlled by billionaire Oleg Deripaska, one of Russia's billionaire tycoons with close ties to the Kremlin.