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The island's economy has been dragged down by the recession ravaging Greece, with which it has close business ties. In addition, Cypriot banks bought billions of euros in Greek government bonds that are practically worthless now. The banks have already had to write off large portions of their investments, and are in trouble as a result. This prompted the government of President Dimitris Christofias to make a pre-emptive application for EU aid in the summer. Russia had already provided a loan of €2.5 billion. That money has been used up and Russian President Vladimir Putin is reluctant to provide a further €5 billion.
Now the euro countries, and especially Germany, will have to step in with a €10 billion aid injection to prop up the island's banks. That will confront German Chancellor Angela Merkel, Finance Minister Wolfgang Schäuble and their European colleagues with a major dilemma because a secret report written by the German foreign intelligence service, the Bundesnachrichtendienst (BND), outlines who would be the main beneficiaries of the billions of euros of European taxpayers' money: Russian oligarchs, businessmen and mafiosi who have invested their illegal money in Cyprus.
Angela Merkel has become a firm believer in the domino theory, which in this case would take on the following shape: allowing Cyprus to fall would put the entire eurozone at risk of collapsing. It would be a disastrous message to send to financial markets. Why should the Europeans save Spain or Italy if they can't even bail out a dwarf like Cyprus?
The German government is in an awkward position. It is forced by overriding considerations to make decisions that it can't really justify. There are considerable political risks. "A rescue package for Cyprus could be very incendiary", one member of her government admitted. Merkel is in danger of discrediting her entire euro policy by agreeing to bail out Cyprus.
Money laundering is facilitated by generous provisions for rich Russians to gain Cypriot citizenship, according to the BND which found that some 80 oligarchs have gained access to the entire EU in this way. In 2011 alone, some $80 billion flowed out of Russia and much of that money had been channelled though Cyprus, according to the BND. Russians have deposited $26 billion in Cypriot banks, says the BND. That is well above the annual GDP of Cyprus.
If Cyprus leaves the eurozone, its business model will no longer be as attractive, the BND says. But the BND's conclusions also mean that if Cyprus gets an EU bailout so that it can keep the euro, the money of German and other European taxpayers will be protecting illegal Russian money.