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European finance ministers on Monday pushed cash-strapped Cyprus into accepting an independent audit probing whether the country's financial institutions comply with international rules aimed at combatting money-laundering, officials said.
Cyprus, the euro region's third-smallest economy, urgently needs money from its European partners to prop up its ailing banks and keep its government afloat after getting caught up in Greece's debt crisis.
But on Monday night, the 17-nation eurozone's finance ministers failed to clarify how to fund the long-delayed rescue loan package for Cyprus without burdening the country with an unsustainably high debt.
Eurogroup chairman Jeroen Dijsselbloem declined to answer questions on whether Cypriot bank bondholders — and possibly even depositors — should be forced to pay a share of the cost of the bailout, saying the negotiations with Cyprus' new government were only starting. Dijsselbloem reiterated that the eurozone seeks to finalize the bailout by the end of the month.
The southern European island nation is seeking a bailout of up to €17 billion ($22 billion) — equivalent to the country's annual economic output. Analysts say the bailout would balloon Cyprus' debt to about 145 percent of its economic output, a level most economists consider unsustainable for such a small economy.
Cyprus can no longer refinance its debt, which forced the country to request a bailout from its eurozone partners last June. Talks on the bailout have dragged on ever since, but no agreement was reached with the last, Communist-led government. A new, conservative administration took office last month, and negotiations are now expected to pick up speed.
The idea of making bondholders and owners of large bank deposits take a hit is controversial, because many economists and leaders fear it might set a precedent that could spook markets, undermining recently regained confidence in the eurozone as whole. Cyprus has vehemently rejected the proposals, adding the discussion already has led some depositors to withdraw their money.
The leaders, however, managed to clear one hurdle for Cyprus, with the new government agreeing to an independent evaluation of the policies aimed at combatting money-laundering in financial institutions by a private auditor, Dijsselbloem said.
Germany, France and other nations had raised concerns that Cyprus' banks facilitate money laundering and tax evasion, especially for its many Russian clients. German lawmakers, who have to approve each European bailout agreement, threatened to veto helping Cyprus unless it comes with tough oversight of Cyprus' financial institutions.
Much remains to be sorted out, not least because the IMF apparently still has serious doubts about the viability of the bailout program.
"Cyprus is difficult," acknowledged Irish Finance Minister Michael Noonan ahead of the meeting. "The conditions are not yet in place for the board of the IMF to make a decision to participate" in the bailout, added Noonan, whose country holds the rotating EU presidency.
In a sign of the persistent unresolved issues, IMF chief Christine Lagarde and a group of nations including heavyweights Germany and France met with new Cypriot Finance Minister Michalis Sarris after the official meeting's end, an EU diplomat said. He spoke on condition of anonymity because he was not allowed to discuss the unofficial meeting.
The meeting also failed to reach a conclusion on the thorny issue of the conditions under which Europe's new permanent €500 billion bailout fund will be allowed to prop up ailing banks.
A deal struck last year allowing the European Stability Mechanism (ESM) to directly recapitalize banks was one of the eurozone's most important steps in seeking to break the link between banks and governments. Over the past few years, the cost of rescuing ailing banks has dragged down several governments' finances, some of whom had to seek a bailout from their European partners.
Ireland, Spain and other countries that have pumped billions of euros into recapitalizing their ailing banks now want the ESM to foot the bill for past bank bailouts, or at least partly, which would lower the governments' debt burdens. But Germany, the bloc's biggest economy, and others remain opposed to the idea of using taxpayers' money to retroactively fund bank bailouts in other nations. They say the instrument can only be used in future banking crises, once the bloc has centralized bank oversight, from 2014 onward.
The ministers "made progress" on the issue "but nothing is agreed until everything is agreed," said Dijsselbloem, adding that the matter will again be discussed at the group's next meetings.
The ministers, who are responsible for shaping the policies governing the currency used by some 330 million Europeans, also discussed granting relief to Ireland and Portugal, which have already received bailouts, by giving them more time to pay back their debt. Dijsselbloem hinted that there was wide backing for the measure, but before an announcement it will be discussed with the finance ministers from the 10 European Union countries that do not use the euro at a regular meeting Tuesday.
Juergen Baetz can be reached on Twitter at http://www.twitter.com/jbaetz