Cyprus: dwarfs in a strategic geopolitical game

Is the abandonment of Cyprus part of strategy at play?

 Throughout history, economics drove politics. In Cyprus it seems the other way around. Are the world leaders going economically crazy? Or might it be grand strategy at play?

The CEO of PIMCO, El-Erian, argues that the harsh position of northern Europeans imposed through the Eurogroup and an intensification of the current crisis may push Cyprus to turn closer to Russia, just as Egypt turned to the Soviet Union when turned down by the West in the 1950s.  The greater the disappointment of the Cypriots with their European partners and the growing sense of desperation among Cypriots, the greater the pressure to turn to Russia for help. Such help would not be granted complementary, but would come with concessions on key strategic Cypriot assets, such as bank assets (Cyprus banks have successful operations in Russia and the Ukraine), gas reserves, strategic access to the Russian fleet etc. Naturally, Russia should be very willing and able to step in to fill the void and increase its strategic role in Cyprus and the Mediterranean region. Various links between the two nations make this attraction quite logical. Russia has a sizeable loan of €2.5 Billion to Cyprus that it hopes will be serviced; its own government agencies in addition to Russian oligarchs have sizeable bank deposits (estimated at about €24 Billion) -€2 Billion of which would be lost if the proposed haircut on bank deposits went through or Cyprus went bankrupt. There is significant real estate and tourism business, as well as interest in Cyprus’s undeveloped gas fields. Russia’s total economic interest in Cyprus is about €45 Billion.

So the European partners should be more careful, one would think, not to push things too extreme with Cyprus, as they might risk pushing Cyprus out of the euro zone and into the arms of Russia. That would not be in the interest of Europe, not least because Russia has monopoly control of the gas supply to Europe.

Many Cypriots’ hopes turned to Russian help following parliament’s rejection of the troika’s hard measures to ‘rescue’ Cyprus. But news of a helping Russian hand was nowhere to be found. After one week of pleading and desperate discussions, nothing came out! The Cypriot Finance Minister Michael Sarris said on March 20 that he would stay in Moscow for talks “as long as it takes.” But some days later: “I think we aren’t able to get the support that we wanted to get,” he said after checking out of hotel Lotte in Moscow. As Sarris was leaving, the "Russia and EU: potential for partnership" conference was starting in the same hotel, including meetings with EU’s Mr. Barozzo, Putin and Medvedev. Meanwhile, Cypriot Foreign Minister Kassoulides was still waiting to hear about his request to see his Russian counterpart. Ironically, they could all have met in the same hotel and easily sort out this trivial €5.8 Billion business. Except if they did not really want to help Cyprus, but to weaken it.

It’s not that Russia does not have the ability to help. One month ago, on February 22, in an official working meeting of a delegation led by Prime Minister Dmitry Medvedev to Cuba, it was announced that Russia would write off about $30 billion (€23 Billion) of Cuba’s debt. Russian Minister for Industry and Trade, Denis Manturov, told reporters after the Russian-Cuban talks: “More than $30 billion - this is the total amount of debt that will be partially written off and partially refinanced.”

Why Russia has not been willing to offer even a tenth of that, €2.3 Billion, or just the amount it would have lost from the proposed haircut on its Cypriot bank deposits, to help save Cyprus?

Why are European hardliners so intent on downsizing Cyprus’ economy even at the risk of destroying its financial system? And why the Russians seem to go along?  Besides giving a lesson to Russian oligarchs evading taxes at home,  is it perhaps that Russia decided it is in its long-term interest that Cyprus is scaled down to a point that it cannot effectively exploit its gas reserves growth option so it does not pose a serious threat to its current monopoly power over European gas supply? And that this strategic objective overshadows any other link and interest in Cyprus?

Coincidentally, “Israeli Apology Resets Alliance with Turkey” (Wall Street Journal, March 22). "When the triangle between the U.S., Israel and Turkey is working together, it is something that no one can ignore," said Alon Liel, a former Israeli envoy to Turkey."These are the main military and economic powers in the region and the only stable countries."

The regional geopolitics has instantly changed. This is a strategic check- mat, further cornering Cyprus. Cyprus politicians had hopes for a new-found strategic alliance with Israel (effectively betraying the historical sympathy and support for Palestinian refugee cause, in the interest of economics). If the amount of Cypriot gas reserves were not high enough to justify their economic exploitation by building a liquefaction (LNG) plant at Vassilico, a viable alternative might have been to share the cost of a larger plant by joining gas supplies with Israel. That would bring the cost down to be economically viable.

With the Israeli apology and rapprochement between Israel and Turkey, that option is stricken out in a moment. Cooperation with Israel for joint liquefaction and exports would have been a vehicle for Cyprus to reach an expansion option beyond Europe to target the global market. Unlike the oil market which is global with a single oil price, the natural gas market is regionalized with three main diverse and distinct markets: the USA market with very low prices ($3.5), the European market with medium prices ($9), and the Asian market with premium prices ($14). To reach the global market, liquefaction is necessary. Now that option is cut off (unless we get too lucky with unexpectedly very high reserves). Cyprus is henceforth limited to serve only the European (rather than reach the global) market, and therefore restricted to building a gas pipeline to Europe. The cost of going the route of underground-sea cables might be excessive. We will thus be forced by basic economic necessity (and probably political pressure by our European partners) to go through the more economically viable option, sharing through the pipeline route that Israeli gas would be channeled. That might be a gas pipeline to Turkey and through it to Europe. Economic strength and national defense position go hand in hand. The Cypriots are pushed against the wall, like a mule walking along the edge of the precipice.

The strategic geopolitical chess moves by Europeans, Russians, Israel and Turkey are all colliding this past week to corner and downscale Cyprus. Greece continues its traditional solidarity with Cyprus, accepting to take over the branches of the Cypriot banks (after a handy payment to Piraeus Bank) –after having turned a deaf ear, like Russia, to the new Cypriot government’s plea for help. Cyprus was forced to take a fatal €4.5 Billion hit in the Greek debt haircut, and now is paying nearly another € Billion for Greece to take over the Cypriot bank branches, and saying thank you. A tiny population is proud to boast s so many brilliant strategists among its politicians.

Against this geopolitical structural change going on at this very moment, all at the expense of Cyprus’s national interests, what do the Cypriot politicians do? What is their strategic response?

In Cyprus Parliament Friday night, harsh measures were passed to satisfy the European lenders in the hope of ending the crisis. But at this very crucial moment, when the nation walks at the edge of the precipice, and despite reassurances by all Cypriot politicians that  the nation’s interest would be put above all, political egos rose again above national interest. The leaders of the two main opposing parties (right-wing and communist parties) disagreed over the phrasing of words (even though the arguments were repeated four times in front of a national TV audience) concerning an amendment that the communist party wanted to attach about the benefits fund affected by the restructuring of Laiki Bank. And even though all agreed that the parliament would handle this issue in the near future, the amendment was taken off and then put back on, risking the future of the nation (by a few votes if the communist party had chosen to oppose rather than abstain) as a result of a peacock-type fight of words among the two political leaders while the nation was hanging in the balance.

Are the geopolitical developments and the near bankruptcy of the national economy proving Cypriot politicians to be strategic dwarfs?  If this analysis is correct, we have not yet seen the worst. Starting with the Eurogroup now and beyond.

 Lenos Trigeorgis holds a PhD (DBA) from Harvard University and is the Bank of Cyprus Chair Professor of Finance at the University of Cyprus and President of the Real Options Group. He has been a Visiting Professor of Finance at the London Business School. He is the author of Real Options (MIT Press, 1996), Strategic Investment (Princeton University Press, 2004) and Competitive Strategy (MIT Press, 2011).