VZCZCXRO3388
PP RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHNC #0814/01 2841349
ZNR UUUUU ZZH
P 101349Z OCT 08
FM AMEMBASSY NICOSIA
TO RUEHC/SECSTATE WASHDC PRIORITY 9227
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE PRIORITY
RUEHAK/AMEMBASSY ANKARA PRIORITY 5287
RUEHMO/AMEMBASSY MOSCOW PRIORITY 2167
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY

UNCLAS SECTION 01 OF 03 NICOSIA 000814 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EEB 
TREASURY FOR INTERNATIONAL AFFAIRS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN PREL RU CY
SUBJECT: CYPRUS SHORES-UP CONFIDENCE IN BANKS, RUSSIAN 
INVESTMENT FLOWS HELP 
 
REF: A. NICOSIA 759 
     ¶B. NICOSIA 763 
 
¶1.  (SBU) Summary. Although the Cyprus Stock Exchange has 
experienced larger losses than most global exchanges, local 
banks remain solid and confidence in the country's economic 
future among consumers and businesspeople remains high. This 
is due to a lack of Cypriot exposure to stock and bonds, 
foreign and domestic, and the conservative manner in which 
the banking system has been managed. Also, Cyprus' position 
as a key intermediary for investment flows to Russia has 
provided an annuity type of income for the many accountants 
and lawyers on the island. While the tourism and property 
markets are expected to decline over the coming months, low 
leverage and the hope that customers from new markets will 
take up some of the slack has helped maintain a generally 
positive outlook. The biggest risk to the economy is if teEuropean counterparties of Cyprus' banks start failing and 
this causes dominoes to start falling here. End summary. 
 
¶2. (SBU) The Cyprus Stock Exchange has been one of the 
worst-performing in the world so far this year, down 63 
percent. While this is primarily because the exchange is 
dominated by the three big domestic banks, which investors 
have sold vigorously like most other banks in the world, 
there was little concern shown in Cyprus because most 
Cypriots have avoided investing in the stock market since the 
local exchange crashed in 1999 and bank customers do not 
conflate bank stock prices with the underlying safety of the 
institution. 
 
Deposit Insurance Increased 
--------------------------- 
 
¶3. (SBU) Two weeks ago, Cypriot finance and banking 
authorities believed the global financial crisis would 
largely pass Cyprus bye (reftels) due to the low exposure of 
their banking system to problematic securities and continued 
high liquidity. In the face of some data indicating a 
slowdown in the domestic economy (slowdown in auto and 
property sales, albeit from high levels) and fear of 
financial turmoil contagion from their European partners, the 
ROC is now taking measures to ensure continued confidence in 
their banking system. On October 7, in conjunction with the 
decision taken by EU finance ministers, Cypriot Finance 
Minister Charilaos Stavrakis announced that all bank deposits 
up to Euro 50,000 would be guaranteed by the government for 
one year. Following his meeting with local commercial banks 
on October 8, the minister upped the ante to insure deposits 
up to Euro100,000 "to consolidate full confidence in the 
banking system and the island's economy." In addition, the 
Minister has repeatedly told the press that the state has 
Euro1.9 billion immediately available to support the banking 
system although the system "enjoys ample liquidity and high 
capital adequacy." 
 
¶4. (SBU) The chief economist at the Central Bank, George 
Syrichas, told us on October 3 that Cypriot banks had 
increased their deposit base over the last few weeks and 
there was no sign of depositor concern. He attributed this 
positive situation to the extremely conservative approach 
taken by both the banks and the Central Bank. Most loans are 
simple 1-15 year adjustable-rate with at least 20 percent 
collateral, and banks lend only about 75 percent of their 
deposits as a result of Central Bank requirements and the 
large amount of deposits in the system made by the 
International Business Units operating on the island (see 
para. X) . Additional liquidity is due to a 70 percent 
reserve requirement for all foreign currency deposits. 
Cypriot banks are net lenders to the European interbank 
system. Total deposits through August totaled Euro56.35 
billion (more than Euro700,000 per capita), up 13.3 percent 
year-on-year and up 1.3 percent month-on-month. Loan volume 
is even more robust, up 35 percent so far in 2008 on the back 
of strong corporate demand. As of October 8, there has been 
indication of deposit net outflows. 
 
Real Estate Sales Down, But Prices Stay Firm 
-------------------------------------------- 
 
¶5. (SBU) The housing and property markets, key drivers of 
growth over the past decade, have declined sharply over the 
course of 2008 in terms of sales but not in terms of values. 
Foreign second home-buyers are traditionally from the UK and 
tend to buy in the Paphos area.  We spoke with a major Paphos 
 
NICOSIA 00000814  002 OF 003 
 
 
developer who confirmed that the British property buyer has 
disappeared from the market due to the downturn in the UK 
economy and the depreciation of Sterling against the Euro. 
Nevertheless, the developer is not dropping his prices. 
Rather, he is delaying future development plans (building 
permits issued are down 14.5 percent in 2008) and focusing 
sales efforts on Russia and Eastern Europe.; "even if it 
takes some time to sell our inventory, we remain very liquid 
and have always kept our leverage low." Taxes from property 
sales are down 18 percent this year and, according to the 
Director of the Land Registry, sales have dropped by an 
average of 40 percent.  Individual Cypriots tend to be 
reluctant sellers of property and rarely sell under 
distressed circumstances, with families as a whole providing 
financial support if needed. Our contacts inQe property 
sector anticipate low sales volume for several years but only 
marginal decrease in values. The foreclosure process here is 
difficult and time consuming, typically it takes at least six 
years to foreclose on a property, therefore banks tend to 
work closely with problem borrowers to restructure their 
loans. Bank contacts tell us that, so far, their 
non-performing loans remain below 2 percent. 
 
The Russian Connection 
---------------------- 
 
¶6. (SBU) Many Cypriots believe that they are somewhat 
insulated economically because Russia is taking the place of 
the UK as the country's main economic driver.  Finance 
Minister Stavrakis has said many times that "Russia is 
Cyprus' most important financial partner." Part of this view 
is perception rather than reality. As a trade partner, Russia 
is barely on Cyprus' radar, with 2007 exports to Russia 
amounting to US$26.7 million (1.8% of total), and imports of 
US$56.2 million (0.6 percent of total).  Total services trade 
with Russia accounts for only 5.4 percent of Cyprus' global 
total trade in services of about Euro10 billion. And while 
tourist arrivals from Russia are increasing at a better than 
17 percent annual rate, and Russian tourists are the 
highest-spending of any nationality, they still comprise only 
6 percent of Cyprus 2 million annual visitors.  Russians are 
increasingly important for the city of Limassol, which has 
about 30,000 Russians as permanent residents and who have 
supported the luxury end 
of the Limassol property market for several years.  In 
Limassol, Russian supermarkets, bars and restaurants are 
commonplace and high end businesses depend on the 
free-spending Russians for their profitabQity; one marine 
shop owner said Russians make up about 15 percent of his 
total customers but more than 50 percent of his profits. 
Cities like Paphos are making an effort to lure Russians away 
from their current enclave, but outside of Limassol, 
expatriate the Russian presence on society and the general 
economy is negligible. 
 
¶7. (SBU) The biggest source of business with Russia comes 
from the many Cypriot-registered companies that are created 
to channel investment to and from that country. Under the 
Cyprus-Russia tax treaty (signed in the 1980s) Russia 
withholds only 5 percent on dividends paid to shareholders in 
Cyprus and nothing on royalties and interest. Cyprus itself, 
meanwhile, has a flat 10 percent corporate tax rate and a 
range of double tax treaties with third countries in addition 
to being an EU member. The  result, major accounting firms 
tell us, is that 70 percent of all their business is 
foreign-related and, of that, 50 percent is related to 
Russia.  Much of that business comes from Western companies 
using Cypriot vehicles to invest into Russia, with a minority 
of transactions coming from Russians reinvesting into Russia 
via Cyprus. 
 
The Russian "Black List" 
---------Q------------- 
 
¶8. (SBU) Because of Russian concerns that its citizens are 
avoiding tax through Cypriot companies (although Cypriots 
tell us Russian government concern is actually to keep a 
close eye on who has money) Russia has put Cyprus on a "black 
list," requiring Russian companies in Cyprus that repatriate 
dividends to Russia to pay additional tax on those funds 
(although this is contrary to the provisions of the tax 
treaty with Cyprus).  In June, the Cyprus Parliament removed 
some levels of bank secrecy which prevented quick response to 
Russian requests for information on accounts.  As a result, 
Cyprus expects to be off the Russian "black list" soon, 
 
NICOSIA 00000814  003 OF 003 
 
 
probably during President Christofias' visit to Moscow in 
November. While the practical effect of the Russian action 
was limited - few companies are sending dividends back to 
Russia - the action demonstrated what Russia could do if 
Cyprus refused to cooperate. 
 
¶9. (SBU) The Finance Minister estimates that 25 percent of 
deposits in Cypriot banks are related to transactions with 
Russia. This would include actual operating companies that 
Russians have created here to manage their EU operations, as 
well as funds parked here pending investments and simply 
paying company expenses from Cyprus as "proof" the holding 
company is a bona fide Cypriot entity and therefore able to 
claim the benefits of the dual tax treaty. As the head of the 
Cyprus-Russian Chamber of Commerce explained, each bill paid, 
each board meeting attended by a local lawyer as a member of 
a board of directors, and each transaction undertaken by a 
local bank earns fees which go right into Cypriot pockets. 
While Austria and the Netherlands have similar (though not 
quite as advantageous) tax treaties with Russia, Cypriot 
officials and business leaders believe that  so long as 
relations between Cyprus and Russia remain good and Cyprus 
maintains its low-tax domestic regime, this sort of income 
will continue even if the pace of transactions varies 
according to economic conditions in Russia. In the wake of 
the Georgia crisis, bankers tell us that deposits from Russia 
to Cyprus increased slightly. 
 
¶10. (SBU) Comment.  The Cypriot tourism and property sectors 
are likely to see a decline over the next few months as the 
British and other traditional European visitors/investors in 
Cyprus struggle to respond to the financial crisis. It is 
unclear whether the turmoil hitting the Russian financial 
system will serve to reduce funds available to send to Cyprus 
or increase capital flight. In any case, we expect a slowdown 
in western investment in Russia via Cyprus.  But Cypriots 
learned their lessons about exposure to the stock market 
after the crash of the local bourse in 1999 and have largely 
kept their money in property and bank deposits; one reason it 
was prudent to increase the government guarantee on deposits 
from Euro20,000 to Euro100,000. Although consumer debt is up, 
there is no sign people are having difficulty meeting their 
payments, and business in shops and restaurants remains 
brisk. The storms elsewhere are of merely passing interest to 
most Cypriots who continue to feel financially secure. The 
recent statements by the Finance Minister were largely 
preemptive, highlighting that local authorities are taking 
all measures necessary to keep things protected. The Finance 
Minister's major concern is to diversify the financial sector 
away from the UK and Russia to Eastern Europe and Asia. The 
Central Bank governor is more immediately worried about the 
risk of contagion from failing European banks. 
 
Urbancic