EU rescue may tilt Cyprus from Moscow in regional power shift

BRUSSELS Fri Mar 22, 2013 10:42am EDT

BRUSSELS (Reuters) - On a hot morning in July last year, Cypriot President Demetris Christofias sat with a group of journalists on the stage of the sleekly modern National Theatre in Nicosia and beamed as he talked about his warm ties with Russia.

The communist party leader, who met his wife and earned his doctorate in Moscow, told the Brussels-based reporters that Cyprus could easily overcome its financial troubles with help from both Russia and the European Union.

"The Russians, as good friends of Cyprus, want to take care of us," he said breezily, dismissing a question with a wave of his hand and smiling, his dark eyebrows rising with amusement towards his thick grey hair.

"We could combine both," the 66-year-old said when asked if he would rather take aid from Russia or the European Union.

Nine months on, that confidence appears to have been dangerously misplaced.

NO RUSSIAN BEARHUG

Christofias, whose government took a 2.5 billion euro ($3.2 billion) loan from Moscow in 2011, is no longer the president of Cyprus and is not involved in the torrid efforts to try to agree a bailout package with the EU and IMF.

But the gap between his perception of events then and the current state of affairs is illustrative of the dilemma facing this small island, where the geopolitical interests of Russia, the EU, Greece and Turkey collide.

If Cyprus had any hopes left that Moscow might provide funds to help bail it out, they were dashed on Friday when Cypriot Finance Minister Michael Sarris left Russia empty handed after days of negotiations.

"The talks have ended as far as the Russian side is concerned," Russian Finance Minister Anton Siluanov said, with no agreement even to extend the existing, 4-1/2-year loan.

That leaves Cyprus isolated, having earlier rejected Europe's bailout plan. To prevent its banks collapsing, it must now return cap in hand to Brussels.

"It was very naive of Cyprus to think that Russia was going to help it out," said Jana Kobzova, a policy fellow and Russia expert at the European Council on Foreign Relations.

Nicosia seemed to calculate that because of the vital role Cypriot banks play as a base for Russian funds, Moscow could not afford not to help out, she said. At the same time, it thought Russia's involvement would prompt the EU to compete for influence, allowing Cyprus to secure better EU aid terms.

"Both assumptions were not based on reality," said Kobzova.

The net result is a divided island - Turkey has occupied the northern third since 1974 - sitting in the south-eastern Mediterranean, where 800,000 people face the prospect of an economic implosion that could leave them destitute.

Its business model, based on low corporate taxes, attractive banking terms, tourism and real estate, is effectively finished, with German Chancellor Angela Merkel telling members of the German parliament on Friday that it had to change.

GEOPOLITICAL FALLOUT

But a miscalculation over Russian and EU aid is not the only issue for Cyprus. The crisis may change the influential role it has played in geopolitics for the last 60 years.

Britain, Russia, Turkey, Greece, Lebanon and Israel all have interests in Cyprus, whether military, cultural, historical, economic or political. While a member of the EU, Cyprus is not in NATO, yet has good ties with most NATO powers except Turkey.

Whether it is the conflict in Syria, with the EU suspecting that Russian arms have been shipped to Damascus via Cyprus, or Israel's conflict with Hezbollah in 2006 which saw tens of thousands of Lebanese refugees flee to the island, Cyprus often finds itself drawn into global affairs.

The fact Russia has decided against providing aid makes it all but certain that the final bailout agreed for Cyprus will be a solely EU-IMF affair - unless Nicosia takes the decision to go it alone, which would mean it would probably have to leave the euro currency and the EU.

If Cyprus accepts an EU-IMF package, it means that for the next 3-5 years its economy will be closely monitored by EU officials, with the banking sector greatly wound down and the overall business model for the island changed.

That could prompt Russian investors - and other wealthy external depositors - to pull out, leaving Cyprus ever more in the bosom of the European Union.

Developments in Cyprus could prove significant for Turkey too. It has been looking to join the EU for decades. Cyprus objects. A more pliant Cyprus under an EU-IMF programme may open they way for a resolution of the 40-year standoff with the Turkish Cypriot north of the island, which in turn could alter the balance of EU-Turkey relations.

(Writing by Luke Baker; editing by Janet McBride)