“I was thinking until an hour before it actually happened: it’s all a bluff,” a senior eurozone official who had been part of the negotiationssays of the posturing by Mr Anastasiades. “He’ll turn around and instruct his party to vote for it after all. He wouldn’t be going to vote if hehadn’t made sure the desired outcome was there.”More importantly, officials assumed Mr Anastasiades, having just three days earlier signed up to the deal – which controversially includedseizing the €5.8bn from Cypriot bank accounts – would use his recent victory at the polls as political capital to ram the package through.“Right up to the morning or midday, we thought: ‘It’s a presidential system’,” says another senior eurozone official who had negotiateddirectly with Mr Anastasiades. “He only puts a bill [before parliament] if it’s going to pass. We thought he’d take some time to negotiate with other parties. The moment we knew he was going to a vote, we knew it was over.”This error of judgment could have vital consequences for the eurozone. Cyprus’s rejection of the deal has resurrected fears that the three- year-old eurozone crisis, dormant for more than seven months, is on the verge of spinning back out of control. Although Cyprus only burst into world consciousness this week, its financial crisis has festered since the island was first cut off frominternational financial markets two years ago. Confidants of Angela Merkel said late last year that when she was asked about her biggestconcerns in the eurozone, the German chancellor – despite upheaval in Italy and Spain – had given a one-word answer: Cyprus.“Conceptually and policy-wise, this is more challenging than the Greek package,” says one senior EU official. “The size of the country doesnot correspond with the size of the problem.”
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Senior US officials have quietly urged the IMF to backtrack from its hardline stance over “bailing-in” – or forcing losses on – Cypriotaccount holders. Eurozone officials acknowledge they have been planning for a possible Cypriot exit from the single currency. Leadersopenly admit they have no idea where the solution lies.“There are a lot of people in Europe who are just scared [and] would happily throw some money at the problem to make it go away for afew weeks,” says one official directly involved in the talks. “But the other possibility is they leave [the euro].”In many ways, Cyprus presented the worst parts of other eurozone bailouts combined. Its banking collapse was on the scale of Ireland’s,and it entered the crisis with debt levels as high as Portugal’s. Like Greece, its economy was dysfunctional, reliant almost exclusively on itsoutsized financial sector for economic activity. As if that toxic mixture were not enough, leaders had to deal with another very large wild card: the Kremlin. As far back as November 2011,Olli Rehn, the EU’s top economic official, had first privately suggested the option of a bailout to the finance minister of the previousCypriot leader, Demetris Christofias. The president late that year won a €2.5bn loan from Moscow to put off the day of reckoning withBrussels.This time, EU and IMF leaders wanted to be sure things were different. On the sidelines of the Group of 20 finance ministers’ meeting lastmonth in Moscow, a high-ranking group met secretly with Anton Siluanov, the Russian finance minister, to sound him out on Cyprus.They wanted the Kremlin to help Nicosia by restructuring their €2.5bn loan – extending its repayments and lowering its interest rate – butthey also wanted to know whether the Russians wanted to take over either Laiki or Bank of Cyprus. An additional loan was of no help, the delegation told Mr Siluanov, since it would simply add to Cyprus’s debt level, and getting Nicosia’ssovereign debt down to 100 per cent of gross domestic product by 2020 had become a core reason for keeping the size of the bailout to€10bn. But a Russian takeover of Laiki, which had long been rumoured, was a different matter, since it would give Russian investors anownership stake without adding to Cyprus’s debt levels.However, according to one person in the room, Mr Siluanov was clear: he was willing to renegotiate the €2.5bn loan, but there was nointerest in giving Nicosia more aid or in urging Russian banks to take over Laiki.Just to be doubly sure, days before Jeroen Dijsselbloem, the Dutchman who chairs the committee of all 17 eurozone finance ministers,convened his counterparts in Brussels to bang out a deal on Friday night, he asked Mr Rehn to call Mr Siluanov once more. “Our Russiancolleagues were very explicit: ‘We don’t want one of those banks’,” says one official.The back channels to the Kremlin would prove useful when, after the bailout package was rejected on Tuesday, Michael Sarris, the Cypriotfinance minister, flew to Moscow in an attempt to secure an alternative to the EU-IMF programme. One eurozone official says even as MrSarris was locked in back-to-back meetings and prime minister Dmitry Medvedev was publicly railing against EU leaders, accusing themof acting like “an elephant in a china shop”, he had received word from Russian officials that no help would be in the offing.In fact, the biggest dispute was within the troika itself. The IMF, convinced it would not repeat the mistakes of the Greek bailout, wasdetermined to have a programme that kept Cyprus’s debt manageable and cut its bloated banking system down to size.Backed by Berlin, it proposed what came to be known as the “bail-in” or “Icelandic Solution” – to merge Laiki and Bank of Cyprus; create anew bank with all insured deposits under €100,000 and capitalised with Cypriot government and bailout funding; and put everything elsein a “bad bank”. That meant large depositors, including many Russians, would have their holdings put into the bad bank and cut by anywhere from 20 to 40 per cent. But it also meant cutting the bailout’s €17bn price tag in half.
Page 2 of 3Cyprus: A poor diagnosis, a bitter pill -FT.com23/03/2013http://www.ft.com/cms/s/0/a8c52cc6-92e6-11e2-b3be-00144feabdc0.html