Cyprus faces the choice of asking for a bailout from its European partners in the euro or from Russia, and will decide where to turn after this weekend's crucial elections in Greece, officials said Friday.
Government spokesman Stefanos Stefanou wouldn't name the country where a possible loan could come from. But an official, speaking on condition of anonymity because of the sensitivity of the matter, identified it as Russia.
Stefanou said Cyprus is looking at both options in order to have "flexibility to deal with the issue."
"We have these options in front of us, we're looking in the direction of a bilateral loan as well as toward the European Union support mechanism," he told the Associated Press.
Cyprus Popular Bank, the island's second-largest lender and the most exposed to Greek debt, needs (EURO)1.8 billion ($2.27 billion) in order to boost its capital levels to an EU target by the end of the month. The government has vowed to put up the money if the bank, as expected, can't raise it on its own.
But its money that the small country of less than a million people doesn't have. Unable to borrow from international markets with its credit rating reduced to junk status, Cyprus is depending on a (EURO)2.5 billion ($3.15 billion) low-interest loan from Russia to see it through to the end of the year.
Moreover, prospects look bleak for the island's economy, which is projected to shrink by one percent of GDP this year before rebounding slightly in 2013.
Complicating matters are Sunday's parliamentary elections in Greece, which are expected to determine whether the debt-wracked country leaves the eurozone. A Greek euro exit, which could be possible if an anti-bailout party wins, would be particularly bad news for the Cypriot banks given their large branch network and loan portfolios in Greece. Cyprus can't afford further damage to a banking system that's eight times the size of the national economy.
Finance Minister Vassos Shiarly said a decision will be made once the results of Sunday's Greek elections become clear.
"We won't necessarily ask for a loan from the (EU bailout) mechanism. There are other choices or a combination of choices. These matters, however, will be decided when we know what the results of the Greek elections will be," Cypriot financial Website Stockwatch quoted Shiarly as saying.
The Cypriot government is wary of turning to the EU bailout fund due to fears that it might, like Greece, be forced to make painful austerity measures as a condition for the money. Cyprus is particularly afraid it might be asked to raise its 10 percent corporate tax rate, which attracts much foreign business.
Cyprus' left-wing President Dimitris Christofias has repeatedly lamented what he described as Europe's erroneously single-minded focus on austerity at the expense of policies that promote economic growth.
Because of these concerns, the government is again reaching out for a helping hand from Russia, a trusted ally with vested interests in the island's economy.
Russians have billions stashed in Cypriot banks and Russian companies are looking to invest in natural gas exploration off the island's south coast, where a large mineral deposit has already been discovered.
If the country does apply for aid from the European bailout fund, having backing from Russia in the form a loan could strengthen Cyprus' hand in negotiating better terms for the rescue money from its EU partners, the anonymous official said.
Alternatively, Cyprus could use the EU bailout money to recapitalize the banks and the Russian cash to finance the country's public debt and foster growth, he added.
Still, some analysts see a Russian loan as a risky proposition. Nicosia-based economist Michalis Florentiades said that while it would buy Cyprus time to reorder its finances, the country could soon find itself in the same position if it doesn't push through the kind of reforms urged by the EU to restore investor confidence. At some point, Cyprus will have to regain the bond markets' trust in order to tap them for capital.
"This government's record in taking decisive action on reforming the economy has been patchy," said Florentiades. "Will we keep turning to the Russians every six months or every year for more loans?"
University of Cyprus economics professor Sofronis Clerides said a Russian loan may generate a sense of complacency in the government, delaying pension reforms and public sector cuts and wage deals.
Moreover, he said any short-term benefits would be offset by offset by possibly dubious clauses hidden in the deal.
"Europe has made mistakes and it's justified to be concerned about its focus on austerity," said Clerides. "But the benefits of the EU forcing us to look at problems are greater."