By John O'Donnell and Michele Kambas
NICOSIA (Reuters) - Doubts over Greece's future membership of the euro are straining its historic kinship with Cyprus, as Nicosia distances itself from Athens to try to secure its foothold in the currency bloc.
Cyprus wants to reverse a perception that the two countries are inextricably linked, worried that it could be dragged down with Greece, should Athens' finances collapse and force the Greeks to abandon the euro.
The fate of Cyprus, a divided island on Europe's frontier with the Middle East, could prove an important test of the durability of the euro zone and the wider European Union in the face of political uncertainty in Greece.
"(Sharing a) language is one thing but being the same economy is completely different," said Harris Georgiades, finance minister of a country largely populated by Greek Cypriots. Linguistic solidarity leads Cyprus and Greece to give each other's contestant the top score each year in the Eurovision song contest.
"There are cultural ties but that's it. We are following our own course," Georgiades told Reuters in an interview.
Unlike Greece, Cyprus has been largely diligent in implementing reforms required in return for an international bailout it received in 2013. There has been little public protest despite the deep recession that ensued.
Their paths have diverged more sharply since the radical leftist Syriza party won power in Greece in January, denouncing austerity and demanding a reduction of its official debt.
The centre-right Cypriot government blames former Communist President Dimitris Christofias for delaying a cleanup of Cypriot banks that made the eventual bailout more painful.
Cyprus hopes to return to borrowing on bond markets this year, Georgiades said, while Athens has little such prospect.
Trade ties are modest. Greece ranks second behind Britain in selling services to Cyprus, such as holidays, but it lags far behind Russia, Britain and Germany as a customer.
The former British colony has also severed its banks' links to Greece that resulted in heavy losses when Greek bonds were restructured or 'haircut'. It was those losses that fatally compromised the Cypriot financial system and prompted its bailout.
"We hope that there will be no problems in Greece," said Chrystalla Georghadji, the governor of the Central Bank of Cyprus. "But if there are any problems, the banks here are ring-fenced."
Yet the island, just 100 kilometers from war-torn Syria and far from central Europe, remains vulnerable.
Cyprus has been divided since a brief coup in Nicosia triggered by colonels then ruling Greece prompted a Turkish invasion 40 years ago to protect Turkish Cypriots in the north of the island. A diplomatic drive to reunite the country before it joined the EU in 2004 foundered when Greek Cypriots rejected a U.N.-brokered peace plan in a referendum.
After prospering for a few years in the EU, Cyprus ran into trouble because of its banks' exposure to the Greek debt crisis as well as a domestic property bubble.
The punitive bailout terms imposed losses on big depositors in Cypriot banks in return for loans from euro zone states such as hardline paymaster Germany. That triggered a deep recession in a country dependent on tourism and business services, often to Russian companies seeking to cut their tax bill.
"The terms of the bailout destroyed vast tracks of savings," said John Hourican, chief executive of Bank of Cyprus, the country's main bank.
"And while it was portrayed as an attack on Russian money, really it was an attack on Cyprus because the real Russian money destroyed was modest," he said. "The savings and investment funds destroyed were enormous."
The economy is on track to grow modestly this year but the improving outlook masks problems.
ROASTING THE PIG
Many Cypriot borrowers can't or won't repay their loans. Almost half of loans given by the Bank of Cyprus, which accounts for most lending on the island, are in arrears.
A new foreclosure law to accelerate the slow-motion pursuit of bad debtors, which has been held up in parliament, will make it easier to seize security, such as property.
Ending a political logjam over this reform would enable Cyprus to join the European Central Bank's asset purchase program. Cypriot authorities expect this to release roughly 500 million euros to buy government bonds, making it cheaper for the state and banks to borrow.
There are signs of frustration in Cyprus but, unlike in Greece, they are mostly understated. When Syriza won the Greek election, some left-wing opposition lawmakers in the Cypriot parliament removed their ties in a show of solidarity.
Greece's uncertain future worries many Cypriots, who regard Athens as their only pillar of support against Turkey, which has kept more than 25,000 troops in a breakaway self-styled Turkish Republic of Northern Cyprus since 1974.
"The euro zone pushing Greece out ... is, as the Chinese say, like burning the house to roast the pig," said Theo Panayotou of the Cyprus International Institute of Management.
"Greece is sort of the shield of Cyprus against the excesses of Turkish policies. If Greece defaults, Greece would be so poor ... for at least two or three years, Greece would be no credible threat to Turkey," said Panayotou.
That might prompt Turkey to move in on recently discovered major offshore gas reserves in Cypriot waters, which promise the island a prosperous future as an energy producer.
But being pigeon-holed with Greece by the wider world may be a bigger short-term problem for Cyprus.
"The worst risk is to reputation, people thinking if Greece fails, Cyprus is failing to," said Stavros Zenios, an academic and member of the Board of Directors of Cyprus's central bank.
Officials at EU headquarters in Brussels are also keen to avoid lumping the two together, to safeguard Cyprus in the euro zone. Losing Greece would be a blow to the currency bloc, but to lose two members could be fatal.
(Writing By John O'Donnell, editing by Mike Peacock and Paul Taylor)