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By Paul Taylor
PARIS, Feb 4 (Reuters) - For the first time since Cyprus joined the European Union nearly a decade ago, its partners have financial leverage to press for a settlement of the island's almost 40-year division.
Yet there is no sign that Brussels is preparing to use its advantage to achieve a reunification that narrowly eluded negotiators when the Mediterranean island joined the EU in 2004.
Indeed the most powerful member states, Germany and France, may be content to see the frozen Cyprus conflict fester rather than deal with the potential consequences of a resolution that would bring Turkey closer to EU membership.
The Republic of Cyprus, run by the 800,000 Greek Cypriots, is broke. Heavily exposed to Greece's debt crisis and its own banks' misadventures, the government says it may run out of money in April without a European bailout.
Nicosia desperately needs around 17 billion euros from its euro zone partners, equivalent to a whole year's economic output. That amounts to 19,722 euros ($26,800) for every man, woman and child in the Greek Cypriot part of the island.
This ought to give Brussels a crowbar to pry the Greek Cypriots into cooperating with the Turkish Cypriots in the north of the island on a loose bi-zonal federation of the kind proposed by then U.N. Secretary-General Kofi Annan in 2004.
At the time, the Turkish Cypriots voted in favour of the Annan plan, encouraged by Turkey, which has about 30,000 troops in northern Cyprus, most of whom would have gone home by 2018.
Turkey invaded northern Cyprus in 1974 in response to a brief Greek-backed coup in Nicosia by Greek Cypriot hardliners seeking union with Athens. The island has been divided ever since.
Safe in the knowledge that they would be admitted to the EU even if they spurned the reunification blueprint, the Greek Cypriots rejected the Annan plan in a referendum a week before they entered the Union.
EU officials and especially Guenter Verheugen, the bloc's enlargement commissioner at the time, felt betrayed.
"The understanding was quite clear when we gave Turkey candidate status in 1999 and even clearer when we concluded negotiations with Cyprus in 2002: the Greek Cypriots would not allow the peace plan to fail, and if it failed due to the Turkish Cypriots, then Cyprus could join," Verheugen told Reuters in an interview.
"We came very close. The problem was that in the end, we didn't have any leverage over the Greek Cypriots any more since they knew they would join anyway," said Verheugen, now honorary professor of European governance at the Europe University in Frankfurt-an-der-Oder in Germany.
The big losers were the Turkish Cypriots, who remain economically isolated and excluded from the EU. The Greek Cypriots went on to use their membership to obstruct Turkey's accession negotiations with the 27-nation bloc at every twist.
At the time, Brussels released some money pledged to the Turkish Cypriots for economic development and promised to allow them to export their produce directly to the EU. But the Greek Cypriots blocked direct trade, while Turkey refused access for Greek Cypriot traffic to its ports and airports.
At the very least, the EU could use a financial rescue for Nicosia to try to secure direct trade access for the Turkish Cypriots that might prompt the Turks to lift the blockade.
The favourite to win a Feb. 17 Cypriot presidential election, conservative Nicos Anastasiades, voted for the Annan plan. The United Nations is reviewing the state of play in the talks and U.N. special representative Alexander Downer is expected back on the island in March.
Yet some EU diplomats say it would be politically dangerous to apply diplomatic pressure by exploiting Cyprus's economic plight. Any linkage could backfire and benefit hardline nationalists on both sides, they warn.
Sceptics say it suits Berlin and Paris just fine to keep the Cyprus problem in long-term stalemate, because that prevents Turkey advancing towards the EU's door.
"Europe itself is divided on the Cyprus issue. There are several countries that have no interest whatsoever in solving the problem because Turkish accession would be moved forward," said a former mediator on the island, who spoke on condition of anonymity because he is still involved in diplomacy.
The United States used to be actively engaged in trying to settle the Cyprus dispute, which it saw as a potential flashpoint for instability in the eastern Mediterranean.
Former colonial power Britain retains sovereign bases on the island that are a vital listening post for the Middle East and were useful when the U.S. led invasions of Iraq and Afghanistan.
But U.S. interest in twisting arms seems to have waned since Cyprus found large amounts of natural gas beneath its waters and began working cooperatively with Israel, Washington's biggest regional ally, to tap the offshore wealth.
The seabed bonanza may eventually help Nicosia out of its bailout problems. One way of paying off rescue loans may be to borrow against future gas revenues due to start flowing in 2019.
At that point, any incentive to reach a settlement with the Turkish Cypriots may evaporate in a haze of gas. So if European countries want to wield some influence, it's now or never.
While Brussels may temporarily have more leverage over the Greek Cypriots, its sway over Turkey has shrunk, and the Turkish Cypriots elected hardliner Dervis Eroglu as president in 2010. He favours independence for the self-styled Turkish Republic of Northern Cyprus.
"Turkey is in no way as willing to compromise as it was in 2004," the former mediator said.
This is partly because few Turks believe the EU will ever admit their country, and hence two-thirds now oppose membership, but also because Ankara has been so economically successful in the last decade that it has much less need to join the bloc.
Deputy Prime Minister Ali Babacan says the EU accession process has helped Turkey to implement democratic and economic reforms and strengthen the rule of law, underpinning a decade-long economic boom in which GDP per capita has tripled.
"EU membership is a strategic target for us," Babacan told reporters in Davos, Switzerland. "We have been working for this target since 1959... It seems we are still going to take a long time to reach it, if it (ever) happens."
While the EU process had been very effective in drawing in investment, full membership "is less of a target for us now because some of things being done in the EU we don't agree with too much," Babacan said, citing what he called choking labour market regulation.
Cyprus, one of the smallest euro zone economies, applied for financial aid from the EU and the International Monetary Fund last June after its banks were badly hurt by an EU-sanctioned writedown of Greek debt held by private investors.
EU officials are demanding that Cyprus shrinks its banking sector, privatises state companies and makes economic reforms as conditions for assistance. German lawmakers have raised concerns over alleged money laundering, which the Cypriot government hotly denies.
But so far no one has linked a bailout to a diplomatic settlement. Possibly the last chance of a Cyprus settlement may go begging for lack of European interest. ($1 = 0.7367 euros) (Additional reporting by Michele Kambas in Nicosia; Writing by Paul Taylor; editing by David Stamp)