BRUSSELS Financial problems of Cyprus could still derail fragile confidence in the euro zone that the bloc fought hard to regain in 2012, European Central Bank board member Joerg Asmussen said on Tuesday.
His comments follow doubts whether the small island state, with gross domestic product of barely 0.2 percent of the euro zone's output, was large enough for a potential default there to unsettle the 17-nation euro zone, such a risk being a precondition for a bailout.
"Disorderly developments in Cyprus could undermine progress made in 2012 in stabilising the euro area. Cyprus could well be systemic for the rest of the euro area despite its size," he said on the sidelines of a meeting of EU finance ministers.
"Under normal circumstances one would expect the direct impact of a default to be limited, and it's obvious that without assistance the country will default," he told Reuters, but added the situation was not normal.
"At the same time we should recognise that the situation is not normal. Even though the promise of the OMT (ECB bond-buying)and other important decisions have calmed the markets, this situation is still fragile."
Among those to question the potential impact of difficulties in Cyprus is German Finance Minister Wolfgang Schaeuble, who has said repeatedly it was not yet clear "the problems in Cyprus could be a danger to the euro zone as a whole".
"We have to (establish) that very clearly as that's what the (ESM) treaty says and we do need to stick to the rules we agreed in the treaty," Schaeuble told reporters late on Monday.
But Asmussen said Cypriot problems could affect twice-bailed-out Greece through banking channels and send a negative signal to the rest of the euro zone, especially harming the outlook for states trying to regain full access to the markets.
Cyprus applied for financial aid last June after its banks suffered huge losses following an EU-approved writedown of Greek debt, but some states, including Germany, are also uneasy about bailing out a country they say lacks financial transparency.
The concerns have centred on allegations from some states that Cypriot banks may be misused for money laundering and tax evasion, a view Cyprus rejects. Asmussen said monitoring and addressing such issues needed to be included in a bailout.
Finnish Prime Minister Jyrki Katainen said last week Cyprus must open its books and quell speculation its banks may have been used for laundering money, before it can receive aid. Cyprus rejects the accusations.
"Cyprus is under attack from various quarters over its supposed money laundering. I say supposed, because there have been assessments both by the Council of Europe and international bodies and such a thing has not been established," government spokesman Stefanos Stefanou said on Tuesday.
"The European Union should display solidarity towards a member state, which is essentially a victim of a European decision. Let us not forget the (losses on Greek bonds) was a European decision, and Cyprus is today paying the price."
Cypriot banks were badly burnt by an EU-sanctioned writedown of privately-held Greek sovereign debt. Investment manager PIMCO is carrying out a review of its bank capital needs, with the findings being assessed by a committee of lenders and Cypriots.
Preliminary estimates of a draft bailout deal put the bill at 10 billion euros for bank support. On that basis, its total bailout, including fiscal needs, could reach 17-17.5 billion euros, equivalent to the island's annual economic output.
Asmussen, who was previously Germany's deputy finance minister, said he expected a bailout agreement was possible at the end of March, after Cypriot elections on February 17.
The current Cyprus government reiterated on Tuesday it would not give in demands for greater privatisation, something euro zone lenders have said they want to see in return for aid.
"As a government, we will fight to ensure semi-government organisations are not privatised, even if some in Europe consider it part of economic reform," Stefanou said.
But Finance Minister Vassos Shiarly was more conciliatory.
"We have to be sensitive to the issues which may arise in other member states. We are the applicants, they're the lenders, we have to be sensitive to their own issues," he told reporters in Brussels. "Therefore, if they say 'January', January; if they say 'February', February; if they say 'March', March. We have the ability to manage our fiscal requirements. We are strong and we can manage it."
(Writing by Annika Breidthardt, additional reporting by Michele Kambas in Nicosia and Charlie Dunmore in Brussels; editing by Stephen Nisbet)