The largest external investor in Russia in 2011 was not the world’s biggest economy, the United States. Nor was it one of the emerging economic behemoths China or India, or even one of the country’s neighbors. 

The country from which the most money entered Russia was in fact the world’s 121st largest economy, an island of just 850,000 people. The tiny Mediterranean state of Cyprus was responsible for 22 percent of the $18.4 billion in foreign direct investment that went in to Russia in 2011.

Yet, as Mark Twain wrote, there are “lies, damn lies and statistics”, and that fact means little without knowledge of the Cypriot economy. In the past decade economic relations between Russia and Cyprus have increased exponentially, as political alliances have improved. The country’s President Demetris Christofias is a fluent Russian speaker and, as the European Union’s (EU) self-described only communist leader, appeals to a Moscow leadership that may have formerly shed the Soviet title but is still led by many schooled in its basic principles. 

As political relations have improved, tens of thousands of Russians have put their money in Cypriot banks, an estimated $26 billion in total, a sum greater than Cyprus’ gross domestic product of $17 billion. Much of this is eventually funneled back to Russia, thus explaining the investment figures.

Until recently the increasing ties, in a formal sense at least, had largely been one-way. While Cyprus opened up to Russians to move their capital into the collective market of the EU, Moscow was officially hostile to Nicosia, with Cyprus on its so-called ‘black list’ of tax havens. 

Yet all that has now changed. In 2010, the two countries agreed to a formal double-tax treaty to enable cooperation between their respective tax authorities, but with the inevitable delays it only came into force last month. This coincides with the removal of the black mark against Cyprus’ name. A similar tax agreement Cyprus struck with Ukraine in November 2012 also offers potential with another emerging economy.

“I would say the treaty we have with Russia, the recent one, possibly is one of the best that the government has managed to sign,” said Kyriakos Iordanou, general manager at the Institute of Certified Public Accountants (ICPA), on a trip to the island state organized for Executive by the Cyprus Trade Center in Beirut. “It allows Russian investors to come to Cyprus, set up businesses with deposits in the bank, and reinvest back to Russia through Cypriot companies.The benefit is tax — it is not tax evasion but they take advantage of the different tax structure.”

Different indeed. In Russia the flat rate of corporate tax is currently 20 percent, while in Cyprus it is just 10 percent. Across the EU the figure varies from 10 percent in Bulgaria to around 33 percent in France, with the smaller economies generally using lower taxes to lure business.

Cyprus has long prioritized its services sector, with its lowest tax rates in the 27-member EU (along with Bulgaria) as the cornerstone of that principle. For foreign investors seeking access to the EU without having to pay much for the privilege, Cyprus is a perfect location. 

Russians have a long history of investments in Cyprus, dating back to the fall of Soviet Union, when a lot of money was moved into the country. Nowadays Russians are estimated to be involved in more than 20 percent of new property purchases; there are Russian banks, schools, shops and even a Russian newspaper on the island. 

While property investment has been increasing there has been an even greater surge in tourism. In 2005, 97,000 Russians visited the country, but by 2011 that number had risen to 334,000. Initial estimates suggest the figure reached 400,000 by the end of 2012, while an estimated 50,000 have made the tiny island their permanent residence.

 These huge increases have offset the decline in tourists from Western Europe where the economic downturn has hit vacationers; in 2011, the 800,000 or so travelers that came from the United Kingdom — Cyprus’ largest source of tourists — was 200,000 fewer than those who came in 2008.

Christos Moustras, from the Cyprus Tourism Organization, sees even more potential in the market. “We estimate that in the next couple of years we may still have 15-20 percent growth [in the numbers of Russian tourists],” he said.

The bear gases up

Yet Russian interest is not just about getting a nice tan. Since the discovery of offshore gas in the Aphrodite field in late 2011, foreign energy companies have had a new reason to invest in Cyprus, but not all of it seems to have been above board.

In October, the Cypriot government announced the winners of four tenders for the country’s newfound offshore oil and gas. To help the Cyprus’ cabinet come to a decision, they had commissioned an independent committee to advise on the best potential bids. In three of the four cases, the top-ranked bid was selected.

But in the case of Block 9, the most potentially lucrative, a joint Russian-French bid headed by Total and Novatec — a subsidiary of Russian state-energy company Gazprom — was initially chosen, despite being ranked as the fourth-best by the panel. With regard to the financial criteria, effectively an assessment of value-for-money of the deal, the top-ranked bid vastly outperformed the Total and Novatek proposal.

The companies that lost despite being higher-ranked started legal proceedings to appeal, claiming political alliances were put before economic sense. Speaking to Executive in November, the government officially denied any political motivations, with Eleni Mavraki from the Cypriot Energy Ministry rejecting allegations of favoritism influenced the decision.

“The committee sees the technical and financial criteria but there are other criteria when the Council of Ministers decides who will start the negotiations,” she said, without elaborating on those criteria. “The deal was published in the European newspapers…[and] it is legal. The Council of Ministers is the licensed authority that gives licenses.”

However in late December the Cypriot government claimed that insufficient progress was being made and suspended the Novatec agreement. A rival consortium made up of ENI and Kogas won the bid in late January 2013.

For some, however, there is a wider Russian plan to influence gas supplies to Europe. Speaking to Executive in late 2012, Fouad Makhzoumi, head of Future Pipe Industries — one of the world’s largest companies supplying pipes for oil and gas projects — said Moscow was planning to invest billions in a Liquefied Natural Gas plant in Cyprus as part of a geopolitical game to ensure prices remain stable. 

“If they control [the gas plant], they will make sure that this gas will not be delivered to Europe at a lower price than they are delivering [through Eastern Europe],” he said.

The dragon follows

It appears that Moscow’s increased interest in Cyprus is being followed by an even bigger waking giant, China, though the main project that could have been a solid foundation for that growth has not materialized as yet. In the early part of 2012, the Cypriot government announced a $600 million deal for the Chinese Far Eastern Phoenix company to develop a disused airport in Larnaca into a commercial center for Chinese companies to use as a base for investing in the EU. 

Yet the deal fell through in August 2012, with Cypriot media reporting that investor Yang Ki blamed lengthy and complex procedures for his change of plans. The Cypriot government has not officially abandoned finding a new buyer, but as Executive went to press hopes of a deal were small.

While that deal may have fallen through, the trend for increased Chinese investment is clear. 

Speaking in November, Panayiotis Loizides, secretary general of the Cyprus Chamber of Commerce and Industry, said that the second half of 2012 saw huge investments in real estate from Chinese individuals, particularly in the coastal town of Paphos. “They are coming to Cyprus and investing in houses — in the last 2 or 3 months they have bought over 600 houses in Cyprus,” he said, estimating the investment at more than 200 million euros ($269 million). 

As with the Russians and the Ukrainians, the primary selling point for the Chinese is access to the huge market of the EU, taking advantage of favorable rules on immigration. Under Cypriot law, an investment of more than 300,000 euros (roughly $404,000) in real estate gives access to permanent residency.

“Having permanent residency in Cyprus, they can move freely throughout the European Union,” Loizides said. “And China is moving toward Europe, so they can do business freely and this is the main reason why they are coming and buying all these houses.”

The increase in investments is so new (having boomed in 2012 in particular) that it is difficult to tell whether it is a blip or a trend. But with regards to tourism, it appears that as yet there has been no crossover — fewer than 1,000 Chinese visited Cyprus for tourism in 2011.

The trouble with Troika

Cyprus’ move towards Russia and other investors has not gone unnoticed in Western Europe. And since the Cypriot banking sector crashed in late 2011 — following the decision by major credit ratings agencies to downgrade Cypriot debt due largely to their heavy exposure to Greek banks — Nicosia has found the EU less willing to provide support than it might have hoped.

In November, the leading German magazine Der Spiegel cited an intelligence report that claimed that an EU bailout for Cyprus would help Russian oligarchs. It argued that the island was a well-known base for tax evasion and was used to launder money both back into Russia and into the EU. 

By bailing out the banking sector, the leaked Bundesnachrichtendienst (Germany’s foreign intelligence agency) report argued that the EU member states would be guaranteeing Russian deposits in Cypriot banks, adding that the Cypriot government had willfully turned a blind eye to money laundering. 

The normally affable Cypriots became noticeably pricklier when such accusations were put to them. 

“Cyprus follows full regulations internationally, and International Monetary Fund regulations for anti-money laundering. We as a profession have issued our own anti-money laundering regulations,” said ICPA’s Iordanou. “We are following all European regulations as well. So I find it a bit difficult for someone to claim that Cyprus is like some other countries — a haven for evasion and other illegal activity. I find it very, very difficult.”

Irrespective of their accuracy, allegations of favoritism toward Russia — which has already bailed out Cyprus once with a 2.5 billion-euro ($3.3 billion) loan in December 2011 — are unlikely to ease negotiations with Troika, the committee led by the European Commission with the European Central Bank and the International Monetary Fund which is responsible for an EU bailout. 

As Executive went to press, media reports said that Eurozone finance ministers told the government in Nicosia that the 17 billion euro ($23 billion) package would be delayed until the spring, following concerns about the size of the offering. 

In reality, the upcoming presidential elections, due to take place on February 17, are likely to have had as much bearing on the decision as the size of the package. 

Critics have accused President Christofias of being reluctant to make a deal that cuts spending. Iordanou said his organization has made a series of proposals to Troika about potential areas of expenditure that could be cut, particularly in the public sector, but believes that the communist leader finds the thought too unpalatable to contemplate. 

“Until now we haven’t seen the strong political will to reform the government sector. The reason is obvious — every now and then we have got elections so if we touch this sensitive issue possibly we would lose percentage points,” he said. “This is something we stressed with the Ministry of Finance, that his ministry would need to take action, irrespective of political cost.”

The elections may well have a major influence on Cyprus’ relations with both the EU and Russia. 

Christofias has decided not to run, instead throwing his weight behind Minister of Health Stavros Malas. He will go up against Giorgos Lillikas and Nicos Anastasiades, both of whom are seen to be less favorable to Moscow than Christofias’ Progressive Party of Working People.

Either way, as Cyprus continues to be part of a global struggle for power and influence, those awaiting the government’s decision wish that it would come sooner rather than later. In late November, ratings agency Fitch downgraded Cyprus by two notches, from BB+ to BB-, saying the “delay in negotiating official support [for a bailout] has contributed to the deteriorating economic conditions and raised uncertainties about public sector reform and the correction of macroeconomic imbalances.”

While a deal on a bailout may well be reached after the elections, for many in the business community the wait is hurting trade. “We have a large increase in [interest] but it is not materializing [into investment] because, naturally, every serious investor wants to know tomorrow and the day after tomorrow,”  said Charis Papacharalambous, director general of the Cyprus Investment and Promotion Agency. “We need clarity, we need to get rid of the mist of the morning if we want to see development in the future.”

Note: The original version of this article claimed that Total and Novatec had won the bid for Block 9. This had been accurate at the time of Executive’s visit to Nicosia but by time of publication was no longer so.