NICOSIA (Reuters) - Cyprus's parliament votes on Monday on a plan to seize money from bank deposits as part of an EU bailout, a move that has sent a shiver across the bloc, caused the euro to tumble and stock markets to dive.
The announcement at the weekend that tiny Cyprus would impose a tax on bank accounts as part of a 10 billion euro (S$16 billion) bailout broke with previous practice that depositors'savings were sacrosanct.
Ahead of the vote in parliament, the government was working on a plan to soften the blow to smaller savers, by tilting more of the tax towards those with deposits greater than 100,000 euros. The government says Cyprus has no choice but to accept the bailout with the levy on deposits, or go bankrupt.
Residents on the island emptied its cash machines to get their funds over the weekend. The move not only infuriated Cypriots, it unnerved depositors in the euro zone's weaker economies and investors fearing a precedent that could reignite market turmoil.
The euro tumbled early on Monday in Asian trade.
London's FTSE 100 and Paris's CAC 40 fell between 1.5 and 2 per cent on opening.
Brussels has emphasised that the measure is a one-off for a country that accounts for just 0.2 per cent of European output.
The worst fear is that savers in other, larger European countries could become nervous and start withdrawing funds, although there was no immediate sign of that early on Monday.
"Despite reassurances from Brussels that Cyprus is a special case and that indiscriminate levies won't be a common policy tool, depositors across Europe are doubting their sincerity and are fearing that a new precedent has been set for other debt-laden euro zone countries," Mr Jonathan Sudaria, dealer at Capital Spreads, said in a note.
Monday is a bank holiday in Cyprus, giving the government until Tuesday to approve the measures before banks open. The bailout is needed mainly to recapitalise banks.
Approval in the fractious 56-member parliament is far from a given: no party has an absolute majority and three parties say outright they will not back the tax. A vote initially planned for Sunday was rescheduled to give more time to build a consensus.
Faced with a growing public backlash, Cypriot finance ministry officials began discussions with lenders on Sunday to lessen the blow for smaller savers.
A source close to the consultations told Reuters authorities were hoping to cut the tax to 3.0 per cent from 6.7 per cent for deposits under 100,000 euros. The rate for deposits above that would then be jacked up to 12.5 per cent from 9.9 per cent.
In Brussels, a spokesman for Mr Olli Rehn, the European commissioner in charge of economic affairs, said changes to the amounts paid by different depositors could be acceptable given that the financial impact would be the same.
Cypriot President Nicos Anastasiades, a conservative elected just three weeks ago, said the tax on deposits was an alternative to a disorderly bankruptcy.
In a televised address, he said it was painful but "will eventually stabilise the economy and lead it to recovery."
Savers who lost money would be compensated by shares in commercial banks, with equity returns guaranteed by future revenues expected from natural gas discoveries, Mr Anastasiades said. But many legislators remain unconvinced.
"Essentially parliament is called to legalise a decision to rob depositors blind, against every written and unwritten law," said Mr Yiannakis Omirou, speaker of parliament and head of EDEK, the small Socialist party.
"We refuse to subscribe to this."
Cyprus's banking sector is large for a country that makes up a tiny portion of the euro zone economy, and its banks have been severely hurt by exposure to much larger neighbour Greece.
Its open economy has meant that its banks also attract large deposits from Russians. Moscow is also considering extending an existing 2.5 billion euro loan to help bail the island out.
A Russian government source said there was no decision yet on whether to extend the loan or whether to involve Russian investors in the recapitalisation.
Russia's Deputy Economy Minister Andrei Klepach was quoted as saying he did not believe the Cyprus action would affect Russia's domestic capital flows.
Many foreigners live in Cyprus, including large communities of expatriates from Britain, which maintains a military base there. The government in London has said it will guarantee the deposits of its military service members stationed there.