On Friday evening, as European stock markets closed, the 17 finance ministers of the euro zone, together with IMF managing director Christine Largarde, EU commissioner Olli Rehn and ECB executive board member Jorg Asmussen, convened in Brussels for an emergency meeting on Cyprus.

Despite signs that an agreement was imminent – euro zone officials had repeatedly said that a deal for Cyprus would be agreed after the election of the new government in March – late on Friday afternoon officials were still suggesting that a second meeting would be called this week.

The Eurogroup statement issued early Saturday morning after 10 hours of negotiations dispelled any sense of nonchalance. An unprecedented move to levy depositors, and a 45 per cent cut in the size of the bailout, broke new ground in the euro zone response to the economic crisis.

Leaked document

The suggestion of a “bail-in” of depositors had been mooted last month in a leaked document. With deposits representing the vast chunk of Cypriot banks’ liabilities, hitting depositors was always an option, particularly as burning of senior bondholders would have yielded a negligible amount. The fact that Cyprus’s banks are major holders of Cypriot sovereign debt also discouraged a Greek-style sovereign write-down, a move that itself had impacted Cypriot banks.

In the end a German-led group of states pushed for a tax on depositors during the final talks, a view cemented by the perception of Cyprus as a haven for Russian deposits.

Significantly, however, the decision to hit depositors was made to reduce the size of the bailout, with the IMF in particular insisting that a €17 billion bailout would push the cost of the bailout to an unsustainable level of 145 per cent of GDP. The IMF, which pushed for a higher tax on depositors, is still considering whether to contribute.

Vacuum

Ironically, the decision to schedule the meeting on Friday evening achieved precisely the opposite effect than had been intended. The timing allowed a vacuum to build up, with media coverage of panicked depositors dominating the narrative of the Cypriot bailout – the fact that Cyprus’s banks faced insolvency which could potentially wipe out all deposits if a deal was not agreed was overlooked in much analysis.

That the ECB were pushing the Cypriot government to agree the deal on Sunday also added to a sense of chaos.

On contagion, the relative size of Cyprus, which represents 0.2 per cent of total European GDP, the stabilisation in markets since the previous euro zone bailouts, and the ECB’s commitment last summer to “do whatever it takes” to save the euro zone, have supported the view that the risk will be contained.

The troika appears to have overlooked to some extent the Russian dimension to the Cypriot case, with Russia now threatening to withdraw its commitment to a €2.5 billion loan to the government.

Securing political agreement from the new Cypriot government is now the immediate hurdle facing the troika. The government’s decision to postpone the debate on the issue has underlined the sense that the national government has seized back control of events, albeit temporarily, over the last few days.

The political and public reaction in Cyprus has also served to highlight the increasing mismatch between official euro zone policy and the views of ordinary citizens that continues to persist in Europe as the economic crisis shows no sign of abating.