THE Russian business newspaper Vedomosti greeted news of a revised Cyprus bail-out plan with the headline “EU has saved Cyprus at the expense of others.” There were no prizes for guessing who the “others” were. They were, in the first instance, Russian companies and individuals with accounts in excess of €100,000 (£84,000) in some Cypriot banks. It now looks like a substantial proportion of these account holders stand to lose 20 to 30 per cent. Cyprus is unlikely to survive as an offshore financial centre.
But how important is Cyprus to the Russian business community and to Russia more generally? How, if at all, will the Russian economy be affected? And significantly, what, if anything, will Moscow do about the Cyprus problem?
Estimates of the scale of Russian deposits in Cypriot banks range from €20bn to €30bn. Some of those who stand to lose have been laundering the proceeds of dubious activities in Russia, but many are operating entirely legally – “optimising taxes” through Russia’s favourite offshore financial haven and endeavouring to keep their assets out of the reach of a predatory Russian state.
Most of Russia’s largest private-sector firms are closely held by one person or a small group of associates, with a modest fringe of minority shareholders. These strategic stakeholders typically channel profits to a holding company in a tax haven. The British Virgin Islands is widely used, but Cyprus is the most popular. For example, Evraz, Severstal, Magnitogorsk and Novolipetsk – most of the Russian steel industry, in other words – are all controlled through holding companies registered in Cyprus. One outcome will be more business for other tax havens.
The use of Cyprus also shows up in flows of dividend payments and “round-tripping” capital flows. In 2011, outward foreign direct investment from Russia totalled $67.2bn (£44.2bn), of which a third ($22.4bn) went to Cyprus. Inward foreign direct investment into Russia was $55.6bn, of which almost a quarter ($13.5bn) came from Cyprus.
But while the direct and immediate impact of a Russian haircut on the two-trillion-dollar Russian economy will be in aggregate terms quite modest, the longer-term impact will be more serious in two ways.
First, a large part of the Russian business world will be under pressure to re-organise its affairs. Payment flows will be impeded for some time, and most observers think Cyprus will cease to function as an offshore financial centre.
Second, this disturbance comes at a time when the Russian economy has been losing confidence and slowing down. Last year, GDP grew by 3.4 per cent, or about a percentage point less than in 2010-11. Retail sales, freight car loadings and business confidence surveys suggest a further slowdown into early 2013. Alfa-Bank, the leading Russian private bank, projects GDP growth at only 2.8 per cent this year. Russia’s Ministry of Economic Development puts growth in January-February at only 0.9 per cent year-on-year. Such figures might be welcomed in Britain, but they are way below both Russia’s recent past performance and its political ambitions.
Russia sells more than half its merchandise exports to Europe, so the state of the Eurozone was already one source of uncertainty for Moscow. Add to that manifest disagreements within the political elite over privatisation, pensions policy and who controls the energy sector, and what John Maynard Keynes called the “animal spirits” of Russian entrepreneurs were not at their brightest to begin with. This upheaval in a major financial centre for Russian business could hardly have come at a worse time.
Moscow’s options, however, look to be restricted. Last week President Vladimir Putin was harshly critical of the first, badly-bungled bailout proposals. When the Cypriot finance minister went to Moscow to look for an alternative source of support, however, nothing was forthcoming beyond some softening of the terms of an existing €2.5bn loan. Moscow might have been adventurous and offered a generous loan, balanced perhaps by stakes for Russian companies in Cypriot gas fields. It did not. Now first deputy prime minister Igor Shuvalov is saying that Moscow will wait and see before offering ideas or assistance of its own. The stability of the Eurozone, he says, is Moscow’s main concern.
Russia’s caution, so far, must be very welcome in Brussels.
Professor Philip Hanson is an associate fellow of Chatham House.