By Stelios Hadjiyiannis
ALBERT Einstein famously remarked that a sure sign of insanity is “repeating the same experiment over and over again and expecting different results.” In the case of Cyprus, the mad scientists are the Cypriot policymakers and the experimental subject is the Cypriot economy. By implementing the same sort of fiscal austerity measures imposed by the troika on other countries in the European economic periphery, the Cypriot policymakers are hoping to save the economy. However, they need only look at how very poorly those countries have fared over the past few years under the troika’s tutelage in order to understand the insanity of their actions.
Countries like Greece, Portugal, Ireland and Spain are all experienced veterans in the field of severe fiscal consolidation in a euro straitjacket that precludes devaluation of the currency as a means to boost export growth. They can also all attest to the highly disappointing effects such a policy mix has had on their respective economies. Increasing unemployment, markedly negative GDP growth, and an increase in the proportion of non-performing loans to total gross loans are just some of the recessionary effects that the fiscal consolidation measures have had on each of these economies.
Greece, in particular, has experienced negative GDP growth and rising unemployment rates in every quarter since its fiscal consolidation treatment began some five years ago. As a result, Greece’s GDP is now more than 20 percent below its 2008 peak and it is officially expected that Greece’s economy will shrink by a further 4 ½ percent in 2013. Can Cypriot policymakers really be expecting a better outcome than that experienced in Greece for Cyprus when the Cypriot economy is being subjected to negative shocks that go well beyond austerity?
While Greece has had to deal with the painful consequences of budget austerity, the Cypriot economy now has to deal with a similar degree of budget austerity but in the context of the effective dismantling of the offshore banking sector model on which its economy was largely based. In addition, Cyprus will be doing so at the time that a major loss in household wealth and the maintenance of capital controls will be sapping household and business confidence.
The effect of fiscal austerity in such a context will almost surely result in a sharper decline in the Cypriot economy than that experienced in Greece. Indeed, the troika has recently revised downwards its forecasts for the Cypriot economy for 2013 and 2014, with the expectation that the economy will decline by almost 9 percent in 2013 and by a further 4 ½ percent in 2014. By way of comparison, Greece’s GDP declined by only 5 percent in 2010 (the first year of its fiscal consolidation program). This only helps to underline the catastrophic consequences of implementing the terms of the bail-out agreement.
Sadly there is every reason to believe that the Cypriot economy will contract by even more than the troika is currently forecasting. It is all too likely that the troika is underestimating the downward pressure on domestic demand from the severe writing down of bank deposits. It is also all too likely that the troika is underestimating the negative impact on demand from the imposition of capital controls and from the restructuring of the domestic financial system.
The strong likelihood that the Cypriot economy will experience an even sharper decline than in Greece raises several questions. Are Cypriot policymakers really expecting better results than experienced in the rest of the European economic periphery with the same sort of policy mix as applied there? Why have other policy paths not been seriously explored when the bail-out terms imposed on Cyprus are markedly harsher than those in other countries? And is there any basis for the troika’s expectation of positive GDP growth for the Cypriot economy in two years’ time when it is all too likely that the country will find itself in a vicious economic cycle?
Given Cyprus’ very bleak economic outlook under current policies, a solution that the Cypriot government needs to seriously explore is exiting the euro. This is especially the case since by imposing capital controls and by intervening in its banks Cyprus is already paying the cost of exiting without securing any of the benefits. The Cypriot economy needs growth in multiple economic sectors in order to pick up the slack left by its rapidly shrinking banking sector. One of those sectors is tourism. The only way that tourism can be boosted is through a currency devaluation that would make visiting Cyprus much cheaper.
Cypriot officials can emphasise the uniqueness of Cyprus’s situation in an effort to convince the troika to allow a Euro exit without setting a precedent for other countries to follow.
By exiting the euro, the Cypriot government can at least offer a glimmer of hope for the economy’s future. This is not to say that a euro exit will be without its complications. However, looking at the future prospects under the current conditions, it would be worth a shot because judging by the dismal experience of other countries in the European periphery consciously subscribing to the fiscal consolidation prescription of the troika would be insane.