Protests in Cyprus
Protests in Cyprus against the plan to tax all depositors

Cyprus has finally negotiated a deal in the 11th hour, and only several hours before the European markets open. The deal will allow Cyprus’ banks to continue to receive liquidity support from the ECB and thus allow the country to remain solvent and in the Euro, provided it is ratified by the parliament of Cyprus.

The deal appears to involve the wind-up on the second largest bank, Laiki, but its insured depositors (sub-EUR 100K) will get their funds (transferred to another bank), but deposits above 100K will suffer large losses as the bank is wound up. The second largest bank, the Bank of Cyprus, will be allowed to keep operating, but its deposits over 100K will suffer a haircut probably over 20%, possibly as much as 40%.

The bank workers union is considering a strike on Tuesday when banks are supposed to re-open (in protest over lost jobs, pensions, etc). Capital controls are expected to be implemented to limit withdrawals and transfers to avoid a potential bank run.

President Vladimir Putin and Prime Minister Dmitry Medvedev yesterday held talks with EU officials in Moscow. Ahead of the meeting, both Putin and Medvedev criticized the initial package on tax deposits advanced at the end of last week. Also, Russian officials issued several statements that were likely intended to render a strong bargaining position ahead of the talks with the EU.

In particular, Medvedev noted that Russia could contemplate a reduction in the share of its reserves held in euros. However, towards the end of the day after talks with the EU, Russia’s Ministry of Economy said that the share of the euro was unlikely to change significantly as a result of the Cyprus developments.

Russia has not issued a formal response yet to the plan. However, Russia appears to be a big loser in the deal reached. According to some calculations, 33-50% of all desposits in Cyprus came from Russia (rich friends of Putin) and these are the deposits which will be heavily taxed. This is in contrast to the original plan to tax all accounts, including those of small local depositors.

Market attention has shifted from Italian politics, but that also still remains unresolved and it is possible that a new election will be called soon. The President Napolitano has asked Bersani, leader of the Democratic Party that holds a majority in the lower house, to attempt to form a government with the support of Berlusconi’s party – People of Liberty, that holds the second largest block of votes in the upper house. However, it is far from clear that Berlusconi would prefer this over fresh elections.