[LINK] "Cyprus and Russia Did Not Just Break Up"

[rfmcdonald]

Yuri M. Zhukov's Foreign Affairs article makes the argument that Russian chose not to bailout Cyprus because, among other reasons, the Russian government wanted to stop the offshoring of Russian business and other funds. Allowing the biggest Russian offshore financial sector to collapse while other countries are loath to take on the Cypriot role works.

Facing a stark choice between losing a lucrative tax haven and throwing more money into a bottomless pit, Russia picked the strategy that it hopes will minimize its potential losses. Russian assets in Cypriot banks total approximately ten billion euros and the most recent projections of Russian losses are four to six billion euros. That is troublesome, but minor compared to the other problems Russia is facing right now: the flight of capital cost the economy 44.5 billion euros in 2012 and 63 billion in 2011.

To be sure, Cyprus is part of the financial infrastructure routinely used by Russian companies and the bailout will change how they do business. Yet many see this adjustment as inevitable and overdue. The current reliance on Cyprus originated in the early 1990s, when Russia’s financial system was in disarray, payment in foreign currency was nearly impossible, and the ruble was inflated. Seeking financial security, many Russians opened offshore accounts. The country’s financial system has since stabilized, but the use of offshore accounts has stubbornly persisted.

In December 2012, President Vladimir Putin declared “deoffshorization” as a central policy priority. In keeping with this objective, Prime Minister Dmitry Medvedev has proposed “domestic offshore” zones in the far eastern regions of Russia. This is not a new idea: Russia already has over 20 special economic zones, which offer tax benefits on investment and business income. So far, however, most of these zones have had trouble attracting investment. Low taxes do not compensate for Russia’s lack of adequate property rights protections, independent judicial branch, or stable business climate -- the core reasons why so many Russians open offshore accounts in the first place.

But the EU’s growing opposition to Russian investment has created a new opportunity to lure capital back into Russia. The president of the Euro Group, Jeroen Dijsselbloem, has suggested that the Cyprus experience may serve as a model for future EU-led Eastern European bailouts. ECB officials have also reportedly warned Latvian banks not to accept outflows of Russian capital from Cyprus. Thus, Russian investors are finding it increasingly difficult and risky to park their money in the West.