Why Cyprus Freaks Out Russians

MOSCOW - As the Cypriot Parliament debated the "haircut" on bank deposits, the across the board tax on bank accounts to finance a bailout of the country's economy, Russian President Vladimir Putin came out blasting the move as "unfair, unprofessional and dangerous."

Putin and others in Russia are panicking in large part because Russians have parked a massive amount of money in Cyprus, including money some believe was obtained through less than legal means. Russians and Russian financial institutions that have deposited or invested money in Cyprus stand to lose a lot if depositors are asked to cover any bailout, or if the island's economy takes a nosedive.

According to Moody's ratings agency, Russians keep $19 billion in Cypriot banks, nearly as much as Cyprus' entire GDP. Russian banks have an additional $12 billion invested and have loaned another $40 billion to Cypriot companies of Russian origin.

The island is also a popular vacation destination for Russians. Aside from the financial benefits, the weather is decidedly more attractive than in Moscow. Some parts of the island even have signs written in Russian.

There so much Russian money in Cyprus because Russia has a low tax rate (flat 13 percent for personal income), but many Russians are eager to park their money in perceived safe havens abroad, away from corruption, and also far away from scrutinizing eyes. Cyprus' 10 percent corporate tax rate is low and the island was seen as politically stable. It also doesn't ask a lot of questions about where the money came from.

Capital flight is a major concern in Russia, a reflection of how little confidence there is in Russian financial institutions as well as the need to stash potentially ill-gotten gains elsewhere. Last year $56 billion fled the country. On Tuesday it was reported that $14-16 billion have left Russia for overseas havens so far this year, already exceeding what was perhaps an overly optimistic estimate by the central bank that only $10 billion would leave during all of 2013.

Russia has loaned Cyprus money before, but the fact that Russia is freaking out is also freaking out Cyprus. The fear is if Russian money leaves the country, Cyprus' economy will collapse. The Wall Street Journal reported that Cyprus is offering Russia favorable partnerships in energy projects and other ventures in exchange for a bailout. The Cypriot foreign minister held talks with Russian officials in Moscow today and will continue discussions on Thursday.

The Associated Press contributed to this report

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