BUSINESS
03/19/2013 02:30 pm ET | Updated Mar 19, 2013

Cyprus Parliament Rejects Deposit Tax For Bailout

The European debt crisis is back.

The Cypriot parliament on Tuesday soundly defeated a controversial bailout proposal that would have taxed bank deposits, marking a new and uncertain phase in a crisis that until very recently had seemed to be quelled.

The vote, taken with protesters chanting outside the parliament building in Nicosia, raised the chances that Cyprus could default on its debts and leave the euro zone, possibly throwing global financial markets into turmoil. Nevertheless, investors initially reacted with calm. Many believe that a solution will be found, while others suggest that Cyprus is so small -- with an economy of just $25 billion a year -- that its withdrawal from the euro might have little effect.

Markets also got a boost shortly after the vote, when the European Central Bank announced that it would supply Cyprus with short-term cash despite the rejection of the bailout plan. Late Tuesday, the euro was down only about 0.5 percent to a little less than $1.29. In the U.S., the Dow Jones Industrial Average actually ended the day up about 4 points.

Still, days of uncertainty and panicky meetings lie ahead, always a recipe for market unrest. Cyprus and its potential saviors in the euro zone seem far apart on a solution. Shortly after Cyprus rejected the bailout plan, an official from Angela Merkel's ruling party in Germany told Bloomberg News that Cyprus would not get any money without a tax on deposits. And Austria's finance minister declared that a Cypriot bankruptcy would be far more damaging than any tax on deposits.

The Cyprus bailout plan, proposed over the weekend by euro-zone finance ministers, the European Central Bank and the International Monetary Fund, would have kept Cyprus afloat with a 10-billion-euro (about $13 billion) loan, but only on the condition that it seize money from savings accounts to help cover the rest of Cyprus' cash needs, totaling 5.8 billion euros. The plan would have taxed deposits of more than 100,000 euros at a 9.9 percent rate, while smaller deposits would have been taxed at 6.75 percent.

Finance ministers from Germany and other euro-zone nations, facing political pressure after years of bailouts of peripheral nations, first pushed the idea of tapping deposits, according to various accounts of weekend talks. Foreigners hold about a third of Cypriot bank deposits, many of which are Russian oligarchs. The idea was to make those depositors help shoulder the cost of the bailout. Reportedly, however, Cypriot officials didn't want to risk abandonment by foreign investors, and they pushed to spread the pain to smaller depositors.

The result was a plan that outraged nearly everybody involved from the moment of its introduction. Depositors rushed to withdraw funds over the weekend, until ATMs ran out of cash, and there were fears of bank runs in other troubled nations, including Spain and Italy. Cypriot banks are closed through at least Thursday, and Dow Jones reported that they might not open for another week.

Ahead of Tuesday's vote, Cypriot officials altered the terms of the plan to ease the pain on Cypriots with small bank deposits, exempting deposits below 20,000 euros from the tax. But that was not enough to win passage. In fact, the bailout plan received no votes in the 56-member parliament, with the ruling party of resident Nicos Anastasiades abstaining from voting at all.

Anastasiades' government claims to have a Plan B and a Plan C, according to Market News International. Cypriot Finance Minister Michalis Sarris flew to Moscow on Tuesday to talk about getting cash from the Russian government, which had loudly condemned the bailout proposal. There were reports earlier on Tuesday that Sarris' resignation had been rejected, reports that he later denied. In an ominous sign, euro-zone leaders were "stunned" by Sarris' trip to Moscow, the Financial Times reports.

The Cyprus blowup comes after several months of relative calm in the euro zone, following years of crisis and bailouts of Greece, Ireland, Portugal and Spain. ECB chief Mario Draghi last summer declared the central bank would do "whatever it takes to preserve the euro," a decisive moment in the crisis -- and one that may still be offering comfort to investors now.

This story has been updated with details throughout. For an explainer on the situation in Cyprus, click here.

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