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Cypriots Reject Deposit Tax, but That Will Likely Change

A Cypriot woman shouts slogans as she holds a placard during a protest against an EU bailout deal outside the parliament in Nicosia on March 19, 2013.
Patrick Baz | AFP | Getty Images
A Cypriot woman shouts slogans as she holds a placard during a protest against an EU bailout deal outside the parliament in Nicosia on March 19, 2013.

The Cypriot parliament has reportedly rejected the bill to levy taxes on depositors. This bill would have no tax on deposits below 20,000 euros, a 6.75 percent tax on deposits from 20,000 to 100,000 euros, and 9.9 percent above 100,000 euros.

No matter: They will likely revise the plan and vote for a sole tax on depositors above 100,000 euros.

Stocks had already dropped early on word the bill under consideration may not pass, and on unconfirmed reports that the Finance Minister has resigned.

Why are U.S. stocks reacting to this? Because it raises the stability question. Stability of whether Cyprus will stay in the euro zone, and that other countries may institute a similar tax.

Here's why some tax on deposits will likely pass: there is no other place to get money except bank deposits. The country is an offshore bank haven. There's olive groves, and banks. There are not a lot of bank bondholders. There are a lot of foreign depositors.

So the Cypriots have almost no choice but to vote for some kind of tax on deposits. Under 100,000 euros, over 100,000 euros, it doesn't matter. The International Monetary Fund/European Central Bank/euro zone one have made it clear: You will only get 10 billion euros. You need roughly 17 billion. You make up the difference.

The ECB has a gun to its head. If the Cypriots vote down the proposal, the ECB will likely stop providing emergency assistance to Cypriot banks. The central bank of Cyprus would then have to provide its own help, but they don't have the money and (theoretically) they can't print it either. So what else can they do?

Sure, they can go and get external funding. From whom? From Russia? What a coincidence! Mr. Sarris, the finance minister, is supposed to go to Moscow...tonight...to meet with Mr. Putin.

How'd you like to be a fly on the wall for that meeting?

Don't expect much to happen on that front. They already owe the Russians money.

Let's face it: unless the Cypriots want to become a client state of Russia, they need the ECB. The will need the ECB because—whether they pass a tax on deposits or not—there will be capital flight as soon as they open the banks.

Oh sure, I suppose they could impose capital controls, but this would be an additional blow to confidence. They wouldn't be that dumb—would they?

So there will be capital flight. Deposits are the main source of funding for the Cypriot banks, so somebody is going to have to replace all the money that is going to be pulled out or the banks will collapse.

That's where the ECB will step in to provide EVEN MORE MONEY under one of the many rescue programs, like the Emergency Liquidity Assistance program.

The alternative, of course, is to leave the euro zone.

By CNBC's Bob Pisani

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  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

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