Saturday March 16, 2013

BRUSSELS -- European finance ministers sought to hammer out a long-delayed bailout deal for Cyprus in a marathon negotiation early Saturday, in a bid to keep the island nation from a bankruptcy that could rekindle the region’s debt crisis.

If a rescue loan package is agreed on at the extraordinary meeting of the Eurogroup in Brussels, it’s likely to come with tough conditions for Cyprus, including measures to shrink its troubled banking sector, raise taxes and privatize state assets.

The bailout was initially estimated to total up to (euro) 17 billion ($22 billion) but will now more likely cost around (euro) 10 billion.

While that is many times smaller than Greece’s (euro) 240 billion bailout or Ireland’s (euro) 67.5 billion, it is still considered crucial to the future of 17-nation eurozone because a default even by a small country could roil financial markets and undermine investor confidence in the bloc’s weaker economies.

"This is not just about Cyprus, but about the eurozone as a whole," said the Netherlands’ Jeroen Dijsselbloem, president of the Eurogroup meetings of the eurozone’s finance ministers.

But the negotiations proved thorny and there was no end in sight nine hours into the meeting in the wee hours of Saturday.

"It’s much more difficult than we thought," said an EU diplomat, who spoke on condition of anonymity because of the closed-door meeting’s confidentiality.

Cyprus’ prospective creditors -- the eurozone and the International Monetary Fund -- have not explained how they would shrink the size of the bailout (euro) 17 billion to (euro) 10 billion. A key component, however, appeared to be Russia’s willingness to chip in financially. Russian investors have deposited more than (euro) 20 billion in Cyprus’s banks.

Russia is likely to extend repayment of a (euro) 2.5 billion ($3.2 billion) loan it granted Cyprus in late 2011 after the country could no longer tap international markets, but Russia might also provide a new loan, according to Cypriot officials. Cyprus might also look for Russian investors to buy stakes in its troubled banks.

Cypriot Finance Minister Michalis Sarris will hold talks next week in Moscow about Russia’s possible contribution.

To shrink the bailout further, Cyprus’ conservative government, which took power last month, has indicated it will sell state assets and raise its corporate tax rate, the lowest in Europe.

Other more drastic ideas were also under consideration by the creditors to shrink the bailout to a size that wouldn’t leave Cyprus’ tiny (euro) 18 billion economy with an unsustainably high debt burden.

Bank bondholders might have to accept losses on their investments, and an even more radical idea is to force owners of large bank deposits to also share part of the cost through a so-called bail-in. Another option would be to levy a one-time tax on large bank deposits.

Cyprus has vehemently rejected these ideas. Making depositors take a hit would set a precedent that many fear might undermine confidence in other weaker eurozone countries. In a worst case scenario banks in, say, Portugal or Greece could see depositors flying to safer, northern European countries, critically weakening their banks, which might require further bailouts.

At Friday’s meeting, the ministers discussed the recommendations of the so-called troika of creditors for the design of the bailout program.

"That will not be easy," Dijsselbloem said before the meeting. "It is a complicated case but we have to work on that."

EU Officials and some finance ministers said it was important that a deal be reached in principle at the meeting, but Dijsselbloem was more cautious, saying "we will see how far we get tonight."

German Finance Minister Wolfgang Schaeuble also damped hopes that a deal was nigh, saying the point was not about win a little time but to address underlying problems such as Cyprus’ high debt, its outsized financial sector and the lack of growth.

The planned bailout of (euro) 17 billion to keep Cyprus’ banks and government afloat would have ballooned the country’s public debt to about 145 percent of its economy, a level the IMF considers unsustainable. 

The economy of Cyprus, a Mediterranean island of almost a million people, represents less than 0.2 percent of the eurozone’s annual economic output. But even the most reluctant EU partners, such as Germany, have accepted it would be better to bail Cyprus out than to let it go bankrupt, which could rekindle the bloc’s three-year-old debt crisis.

Cyprus, which first applied for a bailout last summer, is not in imminent danger of bankruptcy, as it faces its next bond redemption in June. But the European Central Bank, concerned that prolonged uncertainty over Cyprus could hurt market sentiment across the eurozone, has pushed for a swift deal, even threatening to cut the country’s financial system off from emergency funding.

If the finance ministers reach a deal at Friday’s meeting, it’s likely to be a broad political decision, with technical details left for next week. The bailout would still have to be approved by parliaments in several eurozone nations, though EU officials say everything should be done by the end of the month.

The deal will also be needed to convince Russia to contribute: President Vladimir Putin has said Moscow would only consider helping if eurozone countries had a bailout package ready.

To appease its potential rescue creditors, Cyprus has already accepted an independent audit of its banks, which hold billions in Russian deposits, to soothe concerns voiced by Germany, France and others that they launder dirty Russian money.

Another option to reduce the amount of bailout loans Cyprus needs is making the sizeable Greek operations of its two largest banks, Bank of Cyprus and Laiki, eligible for rescue cash from Greece’s bailout accord. The government in Athens, however, has appeared reluctant.