Cyprus Considers Money Lockdown, Russia Aid

Vladimir Putin Wags Finger

The Cypriot government is considering capital restrictions if banks reopen on Thursday, a senior government official told Reuters as negotiations between the country and Russia over financial assistance continue in Moscow.

"At the moment the issue is if and how banks will reopen tomorrow. Capital restrictions being considered," the official, who declined to be named, told Reuters in a text message.

Cypriot finance minister Michael Sarris is in Moscow for talks with Russian officials after the country rejected a bank-deposit tax proposal on Tuesday in return for receiving a 10 billion euro bailout from its euro zone partners.

The talks sparked a rumor that Cyprus had struck a deal to sell its Popular Bank to Russian investors, but a government spokesman denied such a deal.

"The government denies reports that the Cyprus Popular Bank has been sold to foreign investors," Christos Stylianides told Reuters in a statement, giving no further comment.

The reports of the deal surfaced in Greek media and briefly caused a spike in the euro and European stocks . Both quickly fell back following the denial.

Ivan Tchakarov, chief economist at Renaissance Capital, told CNBC that the situation could allow Russia to become the "savior of Europe" as the relationship between Cyprus and its European Union peers grew increasingly acrimonious. The European Commission squarely placed the blame with Cyprus in a statement on Wednesday, saying an alternative solution, preferably without a levy on deposits below 100.000 euros would be acceptable. "The Cypriot authorities did not accept such an alternative scenario," the Commission said.

"This situation presents a fantastic opportunity for Russia and even President Putin to take moral high ground and to extend another loan to Cyprus and to become a savior of Europe," Tchakarov told CNBC in Moscow on Wednesday.

"From now on, Russia will play a pivotal part in negotiations, the mistake [to leave Russia out] before has been corrected for the moment," he said, adding that Russia had a vested interest in helping Cyprus too.

(Read More: How Russia Could Take Revenge Over Cyprus Deal )

Russia has already extended a $3.2 billion loan to Cyprus which the country has asked to extend and thirty to forty percent of Cypriot bank deposits are estimated to belong to Russian businesses and individuals.

"At the end of the day we're only talking about an additional seven to eight billion dollars of additional money that is needed to have a complete package for Cyprus, this is small change for Russia,"he added.

Russia's leaders President Vladmir Putin and Prime Minister Dimitry Medvedev condemned the European proposal to levy a 15.6 percent tax on deposits over 100,000 euros. Putin called the move "unfair, unprofessional and dangerous" and Medvedev said it was tantamount to the "confiscation" of people's money.

(Read More: 'Unfair, Dangerous' Cyprus Deal Whacks Rich Russians )

"You can understand why the Russians are very upset about that. Yesterday we had the Russian finance minister saying that we had been left in the dark [during negotiations] and we were not happy about it. Giving all the financial links between Russia and Cyprus, it seems strange that Russia was not brought in on the talks," he said.

Tchakarov said that 70 billion dollars of Russian money would be exposed to the risk of capital controls in Cyprus should a bailout solution not be found. Helping the country was therefore a logical step for Russia.

Analysts and economists have told CNBC that Europe's proposed levy on Cypriot deposits was an indirect way of tackling what is seen as money laundering practices by Russians in Cyprus.

(Read More: Gartman on Cyprus: 'Don't Mess with Russian Mafia' )

In a report on illicit financial outflows from Russia from 2004 to 2011, the Global Financial Integrity (GIF) center questioned how Cyprus, an island with a gross domestic product (GDP) of $23 billion, could be the largest source of foreign direct investment (FDI) in Russia from 2009 to 2011.

According to the IMF, Cyprus sent $128.8 billion in FDI into Russia in 2011, further cementing the view that Russian businesses and individuals were using the island for money laundering purposes

Tchakarov said that as Russian deposits totaled only 30 to 40 percent of Cypriot deposits, domestic depositors stood to lose much more than the Russians. He refused to speculate on Europe's motives for targeting a bank levy on the largest deposits.

Edmund Shing, European Index Strategist at S&P/Dow Jones Indices told CNBC that Europe had made a "major mistake" in targeting every Cypriot depositor, despite the charge of money laundering.

"They haven't proved any money laundering - get the proof first rather than saying all depositors are going to be treated as if they're guilty. It's as if they've been proven guilty before being given the chance to show themselves as being innocent," he told CNBC Europe's "Squawk Box,"

Shing said that Russia could be the solution to Cyprus's crisis if its companies invested in Cypriot banks.

"It would make sense for the Russian banking system perhaps to to go in and sort out the Cypriot banks, why not if such a large amount of the deposits are Russian anyway? It provides a nice way out for Cyprus while relieving Europe of the obligation to rescue Cyprus."

He said that European markets were waking up to the fact that the euro zone crisis had not gone away and that the European Central Bank, by itself, could not "provide a solution."

-By CNBC's Holly Ellyatt, follow her on Twitter @HollyEllyatt

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