Why Russia and Cyprus are getting cozy again

After Cyprus' financial system crashed so spectacularly in 2013, requiring an international bailout that hit Russian investors hard, you'd be forgiven for thinking that Moscow would be steering clear of the Mediterranean country.

But after a day trip by Cypriot President Nicos Anastasiades to meet Russian President Vladimir Putin in Moscow on Wednesday, the countries had signed a deal to give the Russian navy access the island's ports, a controversial move at a time when Russia is in Europe's bad books over Ukraine.

Russia's cozy relationship with Cyprus is nothing new, although it has been sorely tested when the country's banking system collapsed in 2013.

Cyprus secured a 10 billion euro ($11.8 billion) bailout overseen by the European Commission, European Central Bank and International Monetary Fund. In return for the aid, Cyprus had to find a further 11 billion euros of its own to maintain its banking system.

As well as imposing strict capital controls on account holders, the Cyprus government had to wind down the Cyprus Popular Bank and recapitalize another—the Bank of Cyprus—with measures including the seizing of depositors' uninsured savings above 100,000 euros ($120,000).

Russian President Vladimir Putin and Cyprus President Nicos Anastasiades
Sasha Mordovets | Getty Images News | Getty Images
Russian President Vladimir Putin and Cyprus President Nicos Anastasiades

Standard Bank emerging markets analyst Timothy Ash described the presidents' meeting as "significant" but warned that Cyprus' renewed cozy relationship with Russia could be a "dangerous" and "irritating" card to play with Europe and the U.S.

"(It's) another huge PR coup for Putin following his visit to Budapest last week, where energy deals were signed," Ash said in a note Wednesday.

"I think the message to Washington DC and Berlin from Putin is clear, we have allies in the heart of the EU, and that we can use these relationships at will to counter any actions you may like to take with respect to Ukraine," Ash added.

In particular, Ash believes that Russia was using its close ties with Cyrpus as a bargaining chip with the international community. "The message will be 'try more sanctions iterations at your peril, as you might see European unity torn apart as we will play the Hungarian, Cypriot and Greek cards at our pleasure,'" Ash warned.

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Putin is persona non grata in the West for his country's apparent assistance of pro-Russian rebels fighting the Ukrainian military in the eastern part of the country, a charge Russia denies. A cease-fire brokered by France and Germany almost two weeks ago appears to have tentatively taken hold.

Best friends forever?

In the overhaul and "bail-in" of Cyprus' banks in 2013, many of the accounts with larger deposits were foreign owned, and the island's financial system was particularly popular with Russian investors and businesses, prompting accusations that it was a place for money laundering. Moscow said it would not bail out the Russian depositors who lost out, particularly as it was keen to repatriate Russian money to its own coffers.

Two years on, and it looks like Russians could be prepared to dip their toes into Cyprus again, according to one Moscow-based business advisor.

"Obviously, Cyprus-Russia relations went through a very bad patch during the Cypriot banking crisis, but it's funny how everyone here in Russia seemed to take it in their stride," Ian Ivory, business advisor at Russian law firm Goltsblat BLP, told CNBC Wednesday. "I think Russians are used to less constancy in their banking system so they weren't perturbed by what happened in Cyprus."

"The reality is that Cyprus remains the best place for Russian business to locate their offshore financial structures although there is still a lot of pressure on Russian companies to repatriate assets," he added.

Dangerous card?

Like its neighbour, Greece, Cyprus has been critical of western sanctions imposed on Russia for its part in the conflict in Ukraine and Nicosia's latest move to allow the Russian navy access to its ports will no doubt raise eyebrows in Europe.

The rapprochement carries great risks for Cyprus and Russia, experts warned.

"For Cyprus, this might prove to be a dangerous card to play. This will irritate the U.S. no end, and might see a less supportive U.S. approach over the future of northern Cyprus (which is Turkish territory)," Ash warned.

"Cyprus also likely views Russian support as important in allowing development of offshore gas fields—therein the Russian-Egyptian-Cypriot angle is becoming interesting," he added.

Ivory said Russia was taking a risk, too.

"On the face of it, from the Cypriot perspective they need Russian money but I would argue that it's much more nuanced than that. It's unlikely that a Grexit will occur but if it did and there was another Cypriot banking crisis then it would be a disaster for Russia given that its economy is already suffering from the ruble's decline and economic sanctions."

"Russia's economy is still very much interconnected with the global and European economy so any shocks there such as a Lehman-type event elsewhere would have an extremely profound effect on the country."

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