Cyprus became on Monday the fifth euro zone country to seek financial assistance from the EU's rescue funds, announcing it was applying for a bailout for its banking sector hit by exposure to the crisis in Greece.
Tiny Cyprus needs to raise at least €1.8-billion ($2.24-billion U.S.) – equivalent to about 10 per cent of its domestic output – by June 30 to satisfy European regulators about the health of Cyprus Popular Bank, which saw its balance sheet hurt by bad Greek debt. It may seek more.
"The purpose of the required assistance is to contain the risks to the Cypriot economy, notably those arising from the negative spillover effects through its financial sector, due to its large exposure in the Greek economy," a government announcement said.
With its coffers emptying rapidly and hurtling towards an immovable deadline, the island suffered a further fiscal sovereign credit rating cut to non-investment, or junk, status by Fitch at BB+.
With a bailout widely viewed as all but inevitable, Cyprus has for weeks been trying to juggle its options between a bailout from Europe's rescue funds, the temporary EFSF and the permanent ESM, or a bilateral loan from either Russia or China.
Cypriot President Demetris Christofias was scheduled to brief political leaders on Tuesday afternoon, a statement from the presidency said.
If Cyprus signs up for the EU rescue program it will join the ranks of Greece, Ireland, Portugal and Spain.
Mr. Christofias, the EU's only Communist leader, has been reluctant to accept the fiscal and regulatory conditions that might be attached to a European rescue. Weekend trips by government officials to China suggested Cyprus was still holding out hope for a bilateral loan from a third country.
Commerce, Industry and Tourism Minister Neoklis Sylikiotis confirmed discussions in China were focused on a loan or a Chinese investment in the troubled Cyprus Popular Bank.
"We have had some contacts... We have requested an answer in coming days," Mr. Sylikiotis said in comments to the state broadcaster.
Cyprus is fiercely protective of a corporate tax rate that is one of the lowest in the EU and eight months before a general election shows no appetite for the stringent spending cuts that any EU funding would tie it to.
"I think they want to avoid [the EFSF] at least as the sole provider simply because they are afraid of the strings attached," said political analyst Hubert Faustman.
Officials say any aid via the EFSF would likely be restricted to the banking sector and not to broader budgetary requirements.
Cyprus, with just one million people, has a disproportionately large offshore financial sector that is heavily exposed to Greece, the larger neighbour with which it has close political links.
Cyprus Popular needs a capital infusion urgently to satisfy regulators after writing off the value of Greek government bonds in a sovereign debt swap earlier this year.
In its report, Fitch said the recapitalization bill for Cypriot banks could potentially reach €4-billion. That amount, equivalent to 23 per cent of GDP, would also take into account rising non-performing loans from the domestic market.
Fitch said it saw a heightened possibility of the Republic needing both an EFSF bailout to recapitalise its banks and a bilateral loan from Moscow to cover gross budgetary financing requirements until the end of 2013.
Moscow already provided Cyprus with €2.5-billion in a bilateral loan last year and has an interest in maintaining Cyprus as an offshore financial centre with low tax rates for Russian businessmen, who use it as a base to reinvest in Russia.
However, seeking such large sums from Moscow or Beijing is controversial in Cyprus, where EU membership is a matter of national pride. It could be embarrassing for Brussels as well, as Cyprus assumes the bloc's rotating presidency on July 1.