CYPRUS has the highest probability of a sovereign debt default, according to a Euro Exit Probability Index known as CEPIX and formulated by CAPCO, a global business and technology consultancy. The index – which describes itself as ‘an early warning system for European sovereign default’ – measurement for Cyprus is currently at 21.65 per cent, up from 17 per cent before the Eurogroup decisions. The index for Greece, with the second highest probability of bankruptcy in the eurozone, is significantly lower at 4.60 per cent.
It would be easy to dismiss the index as unreliable, find weaknesses or omissions in the way it is calculated and to even claim it is another foreign attempt to harm Cyprus, but this would be a mistake. We should remember that many of the problems we are suffering today were caused by our government and our political leadership ignoring advice, warnings and alarm signals from abroad. Ratings agencies such as Moody’s were dismissed as biased and unreliable when they downgraded our sovereign rating. Cyprus’ exclusion from the markets was viewed as a minor inconvenience while the repeated pleas for spending cuts by EU officials were treated with disdain.
Our tendency to ignore bad news, clear warnings and negative signals, in the belief that they would go away, has proved disastrous and we cannot afford to carry on deluding ourselves that everything will turn out fine. The Euro Exit index might not be the most reliable indicator but it is a pointer of how foreign analysts, after studying the numbers and forecasts, evaluate Cyprus’ ability to cope with the austerity measures and meet its obligations under the memorandum. The high default probability, which has been mooted by other analysts as well, is not idle speculation but supported by mathematical models that show the troika’s numbers might not add up.
In effect, many analysts believe that while the government’s objective, agreed with the troika, to cut state spending by one billion over the next three years may be achieved – the finance ministry has imposed expenditure ceilings on all ministries and departments – this does not mean the deficit targets will be met, because tax revenues could be much less than forecasted. If the contraction of the economy is bigger than forecasted this year and the next, it is very possible that tax revenue will be much lower and the government will be faced with bigger deficits it has no funds to cover.
What would happen in such a case? The troika has made it very clear that it would lend no more than the €10bn it has agreed to, because the public debt will be unsustainable. The government cannot go to the markets nor will it be able to borrow from illiquid local banks the deposits of which are steadily falling, despite the capital controls. There is also the issue of the €1.5bn, allocated by the troika for the re-capitalisation of Hellenic Bank and the co-op banks. What will happen if the amount does not cover their capital needs? Will there be a bail-in of uninsured deposits to cover the shortfall?
We may be fortunate and by some accident none of this happen, but it would be criminally irresponsible for the government to leave everything to chance, in the hope of a miracle. The only responsible course of action would be additional spending cuts as income generation options, apart from the sale of semi-governmental organisations, are non-existent. The public sector payroll should be cut by another 10 to 15 per cent, state pensions to public employees should be halved and brought in line with the rest of the population and more public sector jobs should be scrapped. The streamlining of the SGOs and their privatisation should be done as soon as possible, even if the government secured a year’s delay from the troika.
Instead of cutting spending by one billion euro over the next three years, the government should set a higher target – perhaps €1.5bn – so it can cover the almost certain shortfall in forecasted revenue. Such a move would spark unrest but it would be a small price to pay for avoiding bankruptcy, from which our EU partners will not save us, as they have ensured there is no risk of contagion.
We cannot afford to ignore the warning signs again and allow disaster to strike a second time, because the next time we will not be able to salvage anything. The government, for once, must take unpopular, pre-emptive, remedial action, even if it proves unnecessary, because it is better to be safe than sorry.