

June 2013
On April 23, the Supreme Court of Cyprus began hearing appeals filed by local and foreign depositors who demanded that the decision to write off some part of the deposits at local banks and their restructuring be revoked. The Supreme Court decision will be final, with no ability to appeal.
So far, the Court has received 53 applications, but until June 12 - the deadline for filing appeals against decisions by the Cypriot authorities?the number of applicants may increase considerably, said Aliki Stylianou, the spokesperson for the Central Bank of Cyprus.
All complaints concern the decisions adopted by the Central Bank of Cyprus and the Cypriot government on March 29, 2013, to divide Laiki Bank and cut funds off deposits in excess of € 100,000 at the Bank of Cyprus. Deposits not exceeding € 100,000 at EU banks are considered to be insured and will not be affected by the crisis-related trimming.
Let us remind that Cyprus is restructuring its two largest banks at the expense of their depositors, security holders, and shareholders. This decision was made by the Eurogroup in March, after Cyprus had rejected the idea of forced cancellation of all deposits at the island’s banks. As part of the restructuring, Laiki Bank will be divided into two?“good" and “bad"?parts, with “good" assets and deposits to be transferred to the Bank of Cyprus. It was intended to write off up to 60% of funds (in exchange for bank shares) from deposits exceeding € 100,000. Then the authorities reported that the depreciation of deposits would not exceed 40–45%. The two banks may lose up to € 14 billion.
Besides the trimming of bank deposits, at the request of the EU authorities, the IMF, and the World Bank, company taxes will be increased from 10% to 12.5%, interest on deposits – from 15% to 30%, and a special tax on financial institutions – from 0.11% to 0.15%. Only after an increase in taxes and a reduction in public employee costs can Cyprus qualify for the EU’ assistance of € 10 billion.
Russian companies may bear the brunt of the Cypriot crisis. According to estimates by Standard & Poor’s (S&P), the share of Russian depositors accounts for about 100% of Cyprus’s total large deposits. They are not just the funds owned by Russia’s richest individuals, but quite definite profits made by Russia’s largest oil companies from their energy sales to Europe. They are serviced by subsidiaries of Russian banks, which will obviously suffer great losses. This business most heavily relies on operations related to transfer pricing: Russian parent companies concentrate all their foreign sales profits in Cyprus, where taxation rates are lower than in Russia.
As of January 31, 2013, non-residents deposited about € 21 billion, or 130% of Cyprus’s GDP, with Cypriot banks. According to S&P, most of these funds come from Russia, Ukraine, and other CIS countries.
Out of 131 financial companies licensed by the Cyprus Securities and Exchange Commission, about 20 entities are part of Russian financial groups. According to S&P analysts, most of these companies are based in Cyprus to optimize their taxation. These entities conduct business almost exclusively with Russian and international customers.
According to MDM Bank CEO Oleg Vyugin, Cyprus was a place where it was possible to effect asset transactions under common law, providing for a good protection for proprietary rights, and optimize taxation. “For example, security sales profit is not taxed there, while dividends are taxed at 5% compared to 9% in Russia," he explained.
“At present, Cyprus is irreplaceable as a low-tax jurisdiction," agreed Yulia Tseplyayeva, Chief Economist at BNP Paribas. “Their infrastructure was all set to provide financial services." There, it was possible to establish trusts and profit centers for holding companies, owing to lower taxes and judicial protection of higher quality. All this made Cyprus attractive to companies, owing to a comfortable business environment, rather than for some criminal reasons, she explained. The Netherlands, for instance, cannot compete with Cyprus in terms of office maintenance costs for non-resident companies.
The Cypriot crisis has adversely affected Russia’s macroeconomic indicators. “The Cypriot problem may lower foreign investment growth by 1.5%; while taking into consideration a 20% share of Cypriot investment in Russia’s GDP, the latter may go down by 0.3% as directly affected by a decrease in Cypriot investment," said Valery Mironov, Deputy Director of the CENTER OF DEVELOPMENT Institute of the HIGHER SCHOOL OF ECONOMICS National Research University.
However, Russia’s economic losses might be higher, taking into account a tax on bank deposits exceeding € 100,000. “These funds are left out of consideration while calculating Russia's GDP, although this money, which potentially could return to Russia, belongs to Russian residents; so, one way or another, it is a loss to the Russian national wealth," reasons Mr. Mironov.
Cyprus is reported to be one of the reasons for accelerating capital outflow from Russia. This year, according to the Ministry of Economic Development of the Russian Federation, net capital outflow is forecasted to reach USD 30–35 billion. However, only in 1Q 2013, according to estimates by the Bank of Russia, net capital outflow in the private sector (banks and companies) reached USD 25.8 billion.
“Macroeconomic consequences will be minimal for the Russian Federation," objected Alexander Morozov, Chief Economist for Russia and the CIS at HSBC. “Yet, non-resident foreigners are becoming increasingly cautious about Russian assets, specifically, about buying Russian shares and bonds. This means that Cyprus produced a negative effect on flows of non-resident’s funds. Some of them liquidate their positions, while others hesitate to invest. This situation will prevail for some time."
Besides, Russian companies’ operating activities may be affected, because large settlements in Cyprus are frozen?funds used for Russian companies’ settlements, rather than bank deposits.
“Cyprus is a small country, so, essentially, the Cypriot problem is a gnat sting for the Russian economy," objected Aleksey Devyatov, Chief Economist at URALSIB Capital (an investment company). The Russian–Cypriot foreign trade turnover accounts for as low as 0.3% of Russia's total exports, while exports of Russian goods to the EU exceed 50%. That is why developments in Italy, Spain, France and Germany are more important for Russia.
According to Yulia Tseplyayeva, some part of Russian business people who suffered from capital expropriation in Cyprus will return their funds to Russia for a short period. “There will be a short-term inflow of capital," she thinks. In this connection, according to Yulia Tseplyayeva, the main lesson learned by the Russians from their Cypriot experience is the loss of a feeling that “money can be safely kept abroad." “Russians will be more careful about choosing places for keeping their capital," said Alexander Morozov. According to him, the money that Russian business people can export from Cyprus after all will be invested in Russia.
Russian companies and banks’ funds - € 22–30 billion?will most likely be transferred to Latvia or the Netherlands, objects Valery Mironov. “However, some part of Russian money may return from Cypriot banks to Russia, if the Government makes some significant move aimed at improving the investment environment," he reasons. “For example, if the authorities release Mikhail Khodorkovsky from prison or establish an offshore zone in Russia, which should provide not only for reduced taxes, as was the case in Kalmykia, for instance, but also for special courts of justice for businesses, tax holidays for new businesses, or measures to support export activities."
There are fears that the Cypriot crisis may provoke a new recessional round in the euro area and a bank panic in Italy and Spain, said Mr. Devyatov.
Eventually, the Russian money concentrated in Cyprus will be transferred to some other jurisdictions, specifically, to Latvia, the Netherlands, and Switzerland.
In spite of all the problems, Cyprus will hardly exit the euro area. “For the time being, they will try and keep Cyprus as part of the euro zone not to create a bad precedent and provoke a banking crisis with a far greater probability than the write-off of the Cyprian money," said Mr. Devyatov. “The United Europe is a political project and it will keep Cyprus as part of itself."
Maria Selivanova, an editor at www.opec.ru
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