Not the End of the Road

  On March 31, Cyprus officially exited the Memorandum of Understanding (MoU) signed with the Troika. Over a three-year period, Cyprus received around €7.2 billion (of a total of €10 billion available) at a very low interest rate of about 1%. The Troika’s evaluations will continue every six months until 75% of the loan received is repaid. Government officials have argued strongly that our exit from the economic adjustment programme is proof that it was successful and met its objectives while the opposition argues that it failed and brought more pain and misery to the people of Cyprus. In my humble opinion, the truth lies somewhere in between, though closer to a successful programme, given the poor state of the economy in April 2013. The programme rested on three pillars: fiscal consolidation, banking and financial sector reforms, and structural reforms.

Fiscal Consolidation

This was achieved through cuts in wages, pensions, social and discretionary spending, as well as increases in tax rates – VAT, immovable property tax, corporate tax, etc. Growth has returned to positive territory after years of recession, while unemployment is on a slow but downward path. Furthermore, public debt has been kept on a sustainable trajectory, expected to decrease to 100% of GDP by the end of this year. Credit ratings have improved (although still junk status) and the government has regained access to the international financial markets (albeit with a yield of more than 4%, one of the highest in the EU area, reflecting significant risks that remain in the economy). Another issue (for the eurozone overall) is continuing deflation, which restricts consumption/investment and hinders growth.

Banking and Financial Sector Reforms

 Although a number of banking reforms have been completed, the banks have been recapitalized and liquidity levels have improved, this has not been transferred to the real economy. Why? (a) because companies and households are over-leveraged (Cyprus has one of the highest private debt levels in the EU); (b) because there are simply not enough viable business opportunities to lend to,; and (c) because regulatory requirements have become so strict that it is very difficult for households and companies to comply with lending criteria. The biggest problem is the huge level of non-performing loans (NPLs) – a staggering amount of around €27 billion, which translates into around 50% of the total banks’ loan portfolio, or more than 150% of the country’s GDP. Magical solutions do not exist, unfortunately, and it will be a slow and demanding process to resolve this problem.

Structural Reforms

This is where, unfortunately, we have not seen much progress. The only major privatisation has been that of the Limassol Ports Authority, while for Cyta and the EAC, it has been postponed until the end of 2017. Civil service reform has not yet been completed and bureaucracy still reigns in the public sector. The same applies to reform of the health sector (and the implementation of the NHS), labour (the trade unions have substantially increased their demands recently) and the legal system.

Furthermore, populism has been growing (especially ahead of last month’s parliamentary elections), corruption is still present everywhere, while competitiveness, transparency and corporate governance have not really improved.

The fact that we have exited from the MoU implies that substantial progress has been made and this is why we have regained the trust of foreign investors and markets. However, much more work is needed before we have finally restored/corrected all the major problems that the economy previously faced.  

Info: Dr. George Theocharides is an Associate Professor of Finance at the Cyprus International Institute of Management (CIIM) and Director of the MSc in Financial Services.