The Cypriot government could seize pension funds and land as it scrambles to avoid or lessen a controversial tax on bank deposits, with only days left before a forced eurozone exit.
The European Central Bank gave Cyprus until Monday to reach a bailout deal with international rescuers before withdrawing emergency lending that has kept its banks from collapsing.
U.S. stocks fell on the news despite a string of positive domestic economic data. Eurozone indicators looked bleaker, but Chinese manufacturing strengthened.
While Cyprus accounts for just 0.2% of eurozone GDP, the festering crisis has potential to spill over elsewhere, said Jeroen Dijsselbloem, who heads a group of European finance ministers.
"In the present situation I think there is definitely a systemic risk and I think the unrest of the last couple of days has proven this, unfortunately," he said.
Standard & Poor's cut Cyprus' credit rating one notch further into junk at CCC. But S&P doesn't expect the island nation to exit the eurozone.
Cyprus must come up with 5.8 billion euros to secure a 10 billion-euro bailout from other eurozone members and the International Monetary Fund.
On Tuesday, lawmakers rejected a tax on deposits meant to generate that amount. But with a population of just 800,000 relying on a financial sector more than 20 times GDP, there are few other sources of money.
The latest idea involves the creation of a "solidarity fund," possibly backed by nationalized pension funds, state and church property, natural gas revenue and foreign investment.
Cypriot officials said the fund wouldn't include deposit taxes, but others said they weren't being ruled out. A senior eurozone source told Reuters a tax on deposits of more than 100,000 euros and pension funds could be used, noting pensions were incorporated in bailouts for Portugal and Ireland.
Cyprus also is looking for ways to save its banks, which took steep losses when Greece forced "haircuts" on debtholders as part of its second bailout last year. The island could impose capital controls to prevent bank runs.
Bloomberg reported eurozone finance chiefs may demand losses of up to 40% on unsecured creditors and depositors at Cyprus' two largest banks. Insured deposits of up to 100,000 euros would be protected as part of a bank restructuring.
The IMF proposed a similar plan last week but it was dismissed as too extreme. Instead, Cyprus and international lenders agreed on a 6.75% tax on all deposits below 100,000 euros and a 9.9% tax on bigger ones. That was voted down Tuesday.
Reports said the banks would be revamped into a "good" bank made from the Bank of Cyprus and the good assets of the Cyprus Popular Bank and a "bad" bank comprised of the rest of Popular Bank's assets.
No More Help?
As time runs out, options are dwindling too. Eurozone leaders are seen rejecting any plan that would add more debt to Cyprus and reiterated Thursday that they won't increase their bailout beyond 10 billion euros.
Russia appeared unwilling to give the government or ailing banks more money. Turkey said it could challenge the use of offshore gas reserves, which could take several years to exploit.
Cypriot officials remained in Russia, whose citizens and firms have about 30% of the island's deposits, to discuss possible investment in the offshore gas fields or the solidarity fund.
Cyprus' deteriorating situation threatens to worsen business and consumer confidence in the rest of the eurozone as well as further slow down economic activity, warned Chris Williamson, chief economist at Markit.
The financial data firm's composite index of eurozone manufacturing and services fell to 46.5 in March from 47.9 in February, indicating faster contraction.
France saw the worst drop since March 2009. Germany's modest rebound seemed to fade as manufacturing began shrinking again.
"Instead of the eurozone economy stabilizing in the second quarter, as many — including the ECB — have been hoping to see, the downturn could therefore intensify in coming months," Williamson said in a statement.