Prime Minister Lawrence Gonzi had a brief meeting in Berlin with German Chancellor Angela Merkel that was widely reported in the press last Wednesday and hailed as an acclamation of the island’s economic progress. Indeed Merkel praised the islands’ “excellent” economic performance. It stands to reason that that gave Gonzi’s ego a boost, and really and truly his government deserves all the kudos showered on it in Berlin. Standing next to Prime Minister Gonzi, Merkel praised Malta for having a financially sound policy and gave it as an example of stability despite the eurozone crisis. With the Nationalists in election mode, it comes as a blessing for the party when reminiscing that no Med Club countries were ever showered with such praise from the Iron Lady, the controller of the EU purse.
An obvious contender for the title of a laggard is undoubtedly Cyprus. Its bonds recently plunged to a three-month low after the International Monetary Fund allegedly demanded a Greek-style debt restructuring as a pre-condition for a bailout alongside a ‘hair-cut ‘on loans. In this article I want to analyse in more detail the reason why this Mediterranean country, much praised in the past as the island of Aphrodite with beautiful beaches and a healthy economy suddenly fell into the abyss and is now a bailout contender.
The background history, which caused the sickness that engulfed Cyprus goes back a few years and of course is mainly tied to huge loans linked to failed Greek banks that are now under extreme pressure because of Greece’s stagnant economy. The huge loss suffered by non-performing loans in Cyprus was temporarily compensated by massive inflows of Russian monies that flowed into the island’s banks. Last year, Cyprus requested an EU bailout and it is estimated that close to €20 billion may be needed to solve its financial problem. It is a fact that banking losses in Cyprus were partially compensated due to its close connection with Russian friends who, for different reasons, have found the sun-blessed island a tax haven for their secret hoards of oil and tax monies.
In Berlin at the Gonzi/Merkel meeting, the press asked the two leaders about Cyprus and its current request for an urgent bailout. Ms Merkel lost her smile when she commented that there could be no special bailout conditions that did not include economic reforms like privatisation, which so far have been aggressively ruled out by the island’s outgoing President. In his comments, Dr Gonzi said that privatisation was one of the key elements that had helped Malta move forward and make its economy more competitive (pity some assets were sold at ‘fire hire terms’ but let bygones be bygones). Even though the rescue sum requested by Cyprus is comparatively small, there exist concerns that such funds may go to repay losses suffered by banks funded by Russian oligarchs who in the past allegedly used the island for money laundering. One member of the Merkel government admitted “this could be very politically incendiary”. Observers argue that Merkel is in danger of discrediting her entire euro policy by agreeing (without the usual stiff conditions) to bail out Cyprus. It goes without saying that Merkel is cautious not to upset her coalition partners who are against indirectly helping Russian oligarchs with German taxpayer monies .The share of the aid to be paid by German taxpayers is small but even at €2 billion it is a symbolic sum.
With hindsight, it is fair to recall how Malta and Cyprus, both island nations, joined the euro in 2008 although for obvious reasons the similarity ended there with Merkel saying that no comparison could be drawn between the two: “One island is not the same as the other… Malta and Cyprus are very different.” But how different are the two islands one may ask?
The answer is amply given in a report prepared by BND, a German intelligence service agency. The BND has analysed the situation in Cyprus and after debating it with experts from the “troika,” made up of the European Commission, International Monetary Fund and European Central Bank (ECB) it concluded that it didn’t bring good tidings. On paper it is officially known that its regulators are well placed to scrutinize all transactions and in theory the island nation sticks to all the rules on combating money laundering laid down by the EU and other international agreements. The country had promulgated the necessary laws and set up the required organisations as regulators. The fly in the ointment according to BND is that there were problems when it came to implementing those rules and some weren’t being scrupulously applied.
According to the agency, money laundering in Cyprus is facilitated by generous provisions for rich Russians eager to gain Cypriot citizenship, as it is well established that over 80 oligarchs have gained access to the entire EU in this way. Again, the flow of funds resulting from this conduit is quite substantial and according to the agency, in 2011 alone some $80 billion flowed out of Russia while $26 billion were deposited in Cypriot banks. In perspective, one must realise that such sums exceed the aggregate of the annual GDP of Aphrodite’s island. Cyprus started being a lucrative tax haven in the 1970s. At first, it kept taxes low to attract shipping companies that registered their ships in Limassol while the big boom didn’t come until after the collapse of the Soviet Union, which ushered in billions (unlike Malta, Cyprus has a unique Double Tax treaty with Russia). Russian oligarchs, businesspeople and clans men siphoned funds to Cypriot companies to keep tax costs down and to be able to re-invest at least part of it in Russia at a later date.
Cyprus joined the EU in 2004, followed by changing its currency to euro in 2008. Since joining the euro club, this step has opened the floodgates for a number of firms registered. On paper, the country had to tighten up its regulations on money laundering as part of its pre-accession obligations. Since then, the Cypriot economic model has been highly attractive and has been given a clean bill of health by the OECD because it supposedly does enough to stop money laundering. However, a paper by the World Bank on 150 international corruption cases cites several companies and accounts in Cyprus. However, Cyprus has, through its Attorney General, opened an investigation into a story that surfaced last year about stolen Russian tax money linked to the murder of Sergei Magnitsky allegedly laundered through its banks.
Some background on this infamous case: Magnitsky, a 37-year-old Russian accountant was killed in jail in 2009 after he exposed a huge tax embezzlement by a criminal gang − “the Klyuev group” − involving high ranking officials in the Russian interior ministry and its internal intelligence service, the FSB. It has been reported that lawyers for his former employer, the UK-based Hermitage Capital investment fund, submitted evidence to Cyprus’ attorney general last year. Such documents included copies of financial transfers amounting to $31 million of the tax money siphoned out of Russia using five Cypriot banks: Alpha Bank, Cyprus Popular Bank, FBME Bank, Privatbank International and Komercbanka. Unfortunately, more facts reveal that a certain Dmitry Klyuev, the alleged ringleader, owns a Cypriot-based firm called Fungamico, operating an account at the Bank of Cyprus.
Naturally, amid all this confusion, it is a known fact that the Cypriot government is banking on the Europeans being unable to refuse aid. When the euro finance ministers voiced criticism, their Cypriot counterpart reacted furiously, saying his country would solve its problems without the Europeans if necessary and threatening to leave the single currency. One can sympathize with the dilemma facing Angela Merkel. She said: “There can be no special conditions for Cyprus because we have common rules in Europe that are valid for everyone.” On the other hand, the reply from Cypriot President Dimitris Christofias (who is the only active Communist President in the EU) was not positive and, as expected, he resisted the conditions of the bailout, especially privatisation measures that are anathema for the style of administration practised under his regime. One hopes that a realistic solution is reached since it is in nobody’s interest that Cyprus leaves the eurozone. If it does exit it can either became a vassal of the Putin regime or if it stands alone its business model will no longer be as attractive. One hopes that the fair island of Aphrodite will regain its economic stability and be welcomed back into the safe hands of the EU club where it belongs.
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Mr Mangion is a partner in PKF, an audit and business advisory firm.