The Cypriot parliament has thrown out a controversial plan to skim €5.8bn (£5bn) from savers' bank accounts, in a move that risks plunging the eurozone into a fresh crisis and heightens expectations that the cash-strapped country will seek a funding lifeline from Russia.
Cyprus has just 24 hours to find a solution to its funding gap before its banks are due to reopen following the dramatic no vote on Tuesday night, which failed to support a hastily renegotiated change to the original deal.
Late on Tuesday night the eurozone governments said that despite the vote Cyprus would still need to raise the €5.8 bn – a third of the €17bn bailout.
With the crisis escalating, an RAF flight carrying €1m in low-denomination notes landed in Cyprus to provide cash for 3,000 British service personnel based on the Mediterranean island. The banks have been shut since Friday and electronic transactions halted, although cash machines are still working and the Ministry of Defence said the euros were being flown in as "contingency measure".
About 2,000 of the military staff, typically posted to the island for 18 or 24 months, have their salaries paid into local accounts. The MoD said it was "approaching personnel to ask if they want their March, and future months' salaries paid into UK bank accounts, rather than Cypriot accounts".
Even before the no vote was announced, the euro had slumped to its lowest level in four months after speculation that the Cypriot finance minister, Michalis Sarris, had resigned. Sarris, who was in Moscow ahead of his meeting with his Russian counterpart on Wednesday, was forced to text-message Reuters to deny rumours that he had quit.
There were also reports that the banking arm of the Russian energy company Gazprom might pump cash into Laiki, Cyprus's second largest bank, which is in urgent need of a capital injection. Gazprom officials insisted this was not being planned.
Russia has already lent €2.5bn to Cyprus and has close ties to the country after its nationals flooded the island's banks with cash to take advantage of high interest rates and a lax approach to account vetting.
The 56-member Cypriot parliament rejected the bank tax by 36 votes with 19 abstentions (one MP was absent) even after the proposal had been tweaked during the day to remove any levy on savings below €20,000.
Accounts holding €20,000 to €100,000 still faced a 6.75% levy, and any account with more than €100,000 a tax of 9.9%, despite calls by Cyprus's eurozone partners not to tax accounts below €100,000 – the level at which a European Union-wide guarantee kicks in if an EU bank goes bust.
In return for the levy, savers would be given shares in Cyprus's banks and possibly a share in the nation's gas reserves – once the country is back on its feet.
Cypriot MPs had called the levy blackmail and a disaster for Cyprus, and the president, Nicos Anastasiades, had been promising to discuss a possible plan B even before the no vote, which had appeared inevitable ever since the bailout terms were revealed on Saturday.
Marios Mavrides, a government MP and former finance minister, raised the prospect of the country becoming the first to leave the euro. He told BBC2's Newsnight: "If we cannot come up with the €5.8bn in a few days then I think we will go to the Cyprus pound. That will be the end of Cyprus in the eurozone. We're going to exhaust all other possibilities but what can we do? If we have no other solution we cannot leave the people without money."
Despite what is now seen as a botched decision to try to confiscate the funds of savers with less than €100,000, Jeroen Dijsselbloem, the Dutch finance minister and chair of the eurogroup, issued a terse statement demanding that the Cypriot pledge at the weekend be honoured.
Germany sought to contain any damage from the Cypriot debacle. "We've taken adequate precautions to ensure that today's decision in Cyprus will have no negative effect on the rest of the eurozone," said Wolfgang Schäuble, the German finance minister.
There were calls for another emergency meeting of eurozone finance ministers as the dangerous brinkmanship between Nicosia and the rest of Europe escalated.Before the vote, hundreds of demonstrators gathered outside the Nicosia parliament chanting "No" and holding banners such as "Cyprus today, who's next tomorrow?" in reference to eurozone partners such as Spain and Italy.
Officials in Brussels insist the Cyprus savings tax will be a one-off and the guarantee stands across the rest of the EU.
The conservative ruling party aligned to Anastasiades had attempted to postpone the bill to another day but opposition MPs insisted on a vote. The 19 members of the president's party abstained even though the government had signed up to Saturday's bailout to release €10bn of eurozone funds and raise €7bn through a combination of the bank levy and new austerity measures.
Russia has expressed its anger about the levy, which would hit its nationals, 30 of whom are reported to have been granted Cypriot citizenship after either depositing at least €17m into local banks, making investments of €30m or registering businesses on the island.
Vladimir Chizov, Russia's envoy to the EU, likened the levy to a "forceful expropriation" that could wreck Cyprus's financial system. "When the banks open, people will rush to withdraw their deposits – that's another threat – and then the whole banking system can collapse," he said.
Russian officials also moved to avert concerns that its own banks could face difficulty if the taps remained turned off in Cyprus.
The ratings agency Moody's estimated that Russian banks had extended up to $40bn in loans to companies in Cyprus.
The markets will now be looking to the European Central Bank (ECB) to provide crucial liquidity lifelines to the Cypriot banking sector, which has expanded to eight times the size of the nation's €17bn economy as a result of the Russian cash deposits.
An ECB spokesperson said: "The ECB takes note of the decision of the Cypriot parliament and is in contact with its troika partners [the EU and the IMF]." Alex White, analyst at JP Morgan Chase, said: "If it is not ultimately reversed, we think the treatment of Cyprus will come to look like a watershed for the region. The objective in this case is to remove the implied support for the Cypriot banking system, so it can no longer function as a large offshore financial centre while receiving a European backstop."
Yields – a measure of the cost of borrowing – on Italian government bonds edged above 5% on Tuesday, a sign of potential tensions in the eurozone while yields on British government bonds, gilts, fell to their lowest levels in 2013 of 1.82% as the UK appeared a relative safehaven. Brent crude dropped by $2 to €107.45.
Mavrides said that the government was trying to renegotiate the deal with the Eurogroup, which had left open the option of Cyprus itself coming up with the money it needs to keep its banking system afloat.
"We have some ideas. We are thinking of nationalising the pension funds and provident funds of the state employees. That is about €2bn to €3bn, and we do have some other ideas which will come up in the next few days."
