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Cyprus Rejects Tax On Bank Deposits Sought By Eurozone

Cypriot lawmakers rejected a proposed bank deposit tax Tuesday, hoping for easier bailout terms, but an eventual deal likely won't change much, analysts said.

A bill to tax bank deposits received no support in parliament, drawing 36 no votes and 19 abstentions. The tax is a requirement to get an international bailout of 10 billion euros. Parliament adjourned until Thursday.

The overwhelming rejection came despite a new exemption for deposits of less than 20,000 euros. Those of 20,000-100,000 euros would've faced a 6.75% tax and bigger ones a 9.9% hit.

Even if the tax was OK'd, the small-deposit exemption would mean the levy would generate less than the 5.8 billion euros demanded by Cyprus' rescuers.

U.S. stock indexes pared early losses for a second straight day, after the European Central Bank reaffirmed its commitment to provide Cyprus with liquidity as needed within existing rules.

Who Will Blink?

Eurozone officials must go back to the bargaining table.

"This is brinksmanship in the sense that it's the intent of the Cyprus government to increase pressure on its international partners," said Jacob Kirkegaard, a senior fellow at the Peterson Institute for International Economics.

He expects a deal sometime in the next week, noting that the government can't keep banks closed indefinitely. They are supposed to reopen Thursday, but speculation was growing that they will stay closed for longer.

Seeing the intense backlash the proposed deposit tax produced, eurozone leaders late Monday said the tax burden shouldn't fall on savings below 100,000 euros.

But bigger deposits would suffer a heavier blow, further angering Russian and other offshore investors who used the island as a tax haven. The Cypriot finance minister was set to meet with officials in Moscow.

Moody's has estimated that Russian lenders and companies had about $31 billion in Cypriot banks at the end of last year.

Cyprus has few options, making the eventual deal likely similar to the one just rejected.

"They don't have a way out," Kirkegaard said. "They're going to have to agree to it with a few tweaks.

A Price On Credibility

As long as a resolution comes soon, depositors in other eurozone nations like indebted Spain and Italy probably won't worry too much about their own accounts. But letting Cypriot lenders collapse might trigger bank runs, he said.

Cyprus looks like it will lift the tax exemption on deposits to 100,000 euros and toughen capital controls, said Virendra Singh, a director at Moody's Analytics, also predicting a deal in a week.

Eurozone leaders guaranteed deposits up to 100,000 euros during the 2008-2009 financial crisis. Violating that pledge over 5.8 billion euros doesn't seem worth the damage to Europe's credibility, Singh said.

"It brought into question a lot of other promises European politicians have made," he said.

Cyprus by itself may not cause a meltdown, but may set a bad precedent for the next crisis, said Bill Adams, senior international economist at PNC Financial.

While Europe's leaders say the deposit tax is a special case, he noted states such as Luxembourg and Malta have outsized financial sectors too, though he hasn't heard of brewing problems there.

"Cyprus is not the only offshore banking center in Europe. It's unusual but not unique."