European policy makers weighed how far to push Cyprus afterlawmakers in the Mediterranean nation rejected an unprecedentedlevy on bank deposits, throwing into limbo a rescue packagedesigned to keep it in the euro.

Stocks and the euro gained as investors speculated that theEuropean Central Bank, whose Governing Council meets today inFrankfurt, will continue to support the country's banks until nextweek. Chancellor Angela Merkel, saying she “regrets” the Cypriotparliament's decision, signaled a willingness to engage with Cyprusas long as its banks contribute to a bailout.

“It's important that Cyprus has a sustainable banking sector,”Merkel told reporters in Berlin. “Cyprus is our partner in the euroarea and therefore we are obliged to find a solution together.”

Cyprus's rejection of the levy followed days of recriminationsparked by European plans to force depositors in the country toshoulder part of the bailout with their savings. Cypriot PresidentNicos Anastasiades returned from marathon talks in Brussels onMarch 16 saying the alternative would be the “indescribable misery”of the ECB cutting off funding to one of its banks.

The euro, which fell to almost a four-month low yesterday,strengthened for the first time in three days, rising 0.4 percentto $1.2939 at 1:54 p.m. in Frankfurt, after the ECB pledged toprovide liquidity to Cyprus. European stocks advanced, with theStoxx Europe 600 Index gaining 0.4 percent.

Officials from the troika of international creditors — the ECB,the International Monetary Fund and the European Commission — arein Cyprus discussing further capital controls and possiblyextending a bank holiday to the end of the week, a Europeanofficial familiar with the talks said on condition of anonymitybecause the discussions are confidential. March 25 is GreekIndependence Day, and a national holiday also in Cyprus.

ECB Executive Board member Joerg Asmussen said the central bankcan “only provide emergency liquidity to solvent banks,” accordingto an interview in German newspaper Die Zeit. Cyprus bank solvency“can't be considered a given unless an aid package, which ensures afast recapitalization of the banking sector, is agreed soon,”Asmussen was cited as saying.

After the vote, focus also shifted to Russia, whose companiesand individuals have an estimated $31 billion of wealth in Cyprus,according to Moody's. Cypriot Finance Minister Michael Sarrismissed yesterday's ballot as he flew to Moscow to hold talks aboutfinancial assistance.

Russia Talks

Russia and Cyprus are in the midst of loan discussions, Sarrissaid after meeting his counterpart, Finance Minister AntonSiluanov. The talks included “things beyond that,” Sarris said,when asked about extending the term of an existing 2.5 billion-euroloan from Russia or a new credit.

Negotiations will take “as long as it takes,” Sarris toldreporters after meeting Siluanov. Discussions with First DeputyPrime Minister Igor Shuvalov yielded no results, Russian state- runnews service Prime reported.

Russian President Vladimir Putin this week called the called theCyprus levy “unfair, unprofessional and dangerous.”

The 17 euro finance ministers, who pulled together thedeposit-levy deal after 10 hours of negotiations March 15-16,should reconvene as soon as possible, Luxembourg Finance MinisterLuc Frieden said yesterday in an interview.

“This is not a good result — neither for Cyprus, nor for theeuro zone, and we have to look together for alternatives to thenegotiated package,” Frieden said by phone from Frankfurt.

Dutch Finance Minister Jeroen Dijsselbloem, who chairs themeetings of finance ministers, said the euro group “stands ready toassist Cyprus.” The European Commission called on Cyprus to come upwith an alternative method of financing.

“The ball lies squarely in Nicosia,” German Finance Ministryspokesman Martin Kotthaus told a regular government pressconference in Berlin.

The deposit levy drew worldwide criticism that it broke a tabooover the safety of bank-deposit savings and risked launching a bankrun in other European countries. Cypriots awoke March 16 to findbank transfers blocked, prompting images of long lines at ATMs.

While the island country accounts for less than half a percentof the euro-region economy, the fight over the bank tax riskstriggering new turmoil in the financial crisis that began in 2009in Greece.

“It has some symbolism impact on Europe, but it's not a reallymajor economic issue,” Laurence D. Fink, the chief executiveofficer of BlackRock Inc., the world's largest asset manager, saidin a Bloomberg Television interview in Hong Kong today. “It doesremind us of the frailty of Europe. It does remind us that theEuropean fix will be multiple years.”

'Plan B'

Anastasiades met with political party leaders in Nicosia todayas Cyprus's banks and stock exchange remained closed. The partieshave put together technical teams who will meet at the Central Bankof Cyprus to discuss a “plan B” with central bank officials on howto raise the 5.8 billion euros needed, Christos Stylianides, agovernment spokesman, said.

Protesters in the capital cheered outside the parliament aslawmakers rejected the proposal with 36 votes against and 19abstentions. No legislators voted in favor. The bill softened theoriginal levy of 6.75 percent on all accounts below 100,000 eurosby exempting those with less than 20,000 euros. Deposits exceeding100,000 would be taxed at a 9.9 percent rate.

The ECB's support for Cyprus's banks could now come into focus.Cypriot government bonds became ineligible as collateral inrefinancing operations in June last year, after all three majorratings agencies had downgraded Cyprus to junk status.

That forced Cypriot banks to turn to so-called EmergencyLiquidity Assistance from the Central Bank of Cyprus. Under ELA,the national central bank may continue to lend to commercial banksat a higher interest rate and only with the permission of the ECB'sGoverning Council.

Should the ECB consider the situation untenable, it could refuseto sanction the provision of further liquidity. The central banksaid in a statement after yesterday's vote that it would continueto provide funding as needed “within the existing rules.”

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