ForexSpace.com - As we speculated on our site yesterday, Cyprus has reportedly just asked Russia for a €5bn loan. The as yet un-confirmed story in a leading Cypriot newspaper today, suggests Cyprus - whose economy is closely linked to debt-stricken Greece - has gone cap in hand to Moscow. As Cypriot FinMin Vassos Shiarly told journalists yesterday: "The issue is urgent. We know the recapitalisation of the [island's] banks must be completed by June 30, and there are a few days left."

Locked out of the capital markets for the past 12 months and running vast deficits, the tiny Island says it needs the equivalent of 10 percent of its GDP just to prop up Popular Bank, its second-largest lender, looking for an investor willing to fill a €1.8bn regulatory shortfall. The Cypriot government has been reticent about its parlous state, preferring to seek help from Russia rather than from its euro zone allies, not least because of the tough austerity measures that Greece, Ireland and Portugal have been obliged to swallow in exchange for cash.

It’s worth restating our contention from yesterday how Cyprus received a €2.5bn bilateral loan from Russia late last year, sidestepping its EU partners. The latest rumor, as Neal Kimberley, fx analyst with Thomson Reuters, told us, reinforces this view. Kimberley told me how he expected Russia to be the first port of call, “given that Moscow extended a loan to Nicosia before. Plus, taking in to account the situation in Syria,” opines Kimberley, “it might suit Mr Putin to keep friends in Cyprus, lest Russia loses access to its naval base at Tartus in Syria.”

The Republic of Cyprus boasts an annual GDP of about $24 billion, hugely bolstered by its position as an offshore financial center with a banking presence much larger than its size would suggest. Which, to a large extent, has been the island’s undoing. The Bank of Cyprus and Cyprus Popular Bank, its two largest lenders, now need billions of euros to recapitalize after having to mark down the value of their holdings of Greek government bonds and loans to Greek businesses and consumers.

While Cyprus’s problems are pressing, more worrisome for officials and investors is the fear that Italy — the third-largest economy in the euro zone after Germany and France — will itself end up needing help. Euro zone government bond yields were higher across the board on Tuesday, led by Spain, where 10-year government bonds traded to yield 6.60 percent, up 14 basis points, and Italy, where 10-years were at 6.11 percent, up 11 basis points.

Thus another Mediterranean sovereign joins the lengthening queue for a bailout after Spain. Indeed, we just heard that the Austrian FinMin says he can't rule out the possibility that Italy may also need external help. Whilst 4bn for Cyprus is not going to break the bank, Italy is the next most significant line in the sand. Either the euro zone chooses to formalise the bailouts via a more stable fiscal and political union or we keep walking down this road.

We highlighted this prospect yesterday when we suggested that a likely bailout for Cyprus will see the number of countries under the bailout                                                                                                               umbrella increase to five in the coming weeks. If Italy does become an issue, then the crisis response will once again be tested. Six could be the magic number that leads to a shift from muddle through to deeper fiscal and political union.

Drew Hillier. Editor