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EU proposes rescue plan for Cyprus

Willl involve radical cull of country's financial sector.

The European Union (EU) has proposed a rescue plan for Cyprus that includes bailing in uninsured bank depositors and drastic shrinkage of the country’s financial sector.

The confidential radical plan, including a haircut of 50 per cent on sovereign bonds, is expected to shrink the country’s financial sector by about one-third by 2015.

Under the plan, which is not approved by eurozone members, three options will be put forward as alternatives to a full-scale bailout.

The proposal will reduce the country’s bailout from €16.7bn to only €5.5bn by involving more foreign depositors and bond holders. In addition, the proposal is expected to cut Cyprus’s outstanding debt to 77 per cent of economic output, compared with 140 per cent in the current full bailout plan.

EU officials, howver, said that bailing in depositors was never considered in previous eurozone bailouts and warn such drastic action could restart contagion in eurozone financial markets.

The bail-in option would seek to raise corporate income tax to 12.5 per cent (from 10 per cent), and increase withholding tax on capital income to 28 per cent. It would also seek to extend the maturities on the €2.5bn loan that Cyprus received from Russia in 2012.

Cyprus’s bailout is small compared to Ireland, Portugal and Greece. The eurozone ministers are trying to agree the plan by March 2013.