Cyprus Mail

Economy at a crossroads: coming out of the crisis

By Andreas Theophanous

IN RESPONSE to the article by Mr Timothy Spyrou entitled ‘Clientelism, cronyism and also complacency’ which criticises the study entitled The Cyprus Economy at Crossroads – Coming Out of the Crisis please note the following:

Mr Spyrou takes issues circumstantially and misses the broader picture. Furthermore, he elaborates on issues that I did not even refer to in my study. For example, he confuses incomes and price controls (that I do not mention and do not support anyway) with the incomes policies that I recommend. For years I have been stressing that we could not have in the public sector salary increases, automatic increments and COLA without taking into consideration the fundamentals of the economy.

The key question is whether Cyprus can get out of the depression within the framework of the philosophy of the Memorandum and the current architecture of the eurozone. Unfortunately this is not possible because of three major factors – a huge fiscal cliff, a great negative wealth effect as a result of the decisions of the Eurogroup in March 2013 and the developments thereafter, serious internal and external restrictions to capital flows. and a crippled financial sector.

Decision makers and their advocates in the media fail to comprehend that the Cypriot economy does not have structural depth and therefore it may not withstand big and sudden economic shocks. In addition the Eurogroup decisions, with the consent of the Cypriot government, have led to the dismemberment of the economy. At the same time two important pillars that condition economic dynamics – spending and saving – have incurred a serious blow.

For Cyprus to address the depression in the eurozone there must be a fundamental change in the philosophy of the Troika so as to allow a generous Marshall Plan, unconditional liquidity, immediate removal of the internal restrictions to capital flows and discretionary fiscal policy.

The policy paper does make bold suggestions that at first glance appear unconventional. This is an outcome of the unprecedented circumstances that the Cypriot economy finds itself in. We should not forget that Cyprus is facing a depression with a crippled banking system and with poor liquidity and growing uncertainty.

Allowing companies to pay in euros if they wish, does not necessarily mean parallel currency. Cyprus will have its own national currency.

The idea of states giving parts of their sovereignty to the centre – Brussels/Frankfurt – within the framework of a broader European integration is that in time of need the centre will be more effective to address problems. In the case of Cyprus this has not been the case. Unfortunately, it is not only Cyprus which faces problems due to the ineffectiveness of the central institutions.

Undoubtedly Cyprus has been facing structural problems; but there was a willingness to address them substantively. Fiscal rationalization had started in December 2012. The new government which took over on 2 March 2013 did want to push further. Eventually, the political climate on the island was such that the people were prepared for a gradual paradigm shift. In this effort, Cyprus had expected the solidarity of the Eurogroup and above all Berlin. Instead there was an unprecedented attack bordering on robbery which raises serious questions about the existing value system in the EU. Inevitably there are serious disruptions on all aspects of life.

Feldstein (EMU AND INTERNATIONAL CONFLICT (Foreign Affairs, vol. 76, no. 6, Nov./Dec. 1997, pp. 60-73) had predicted strains in the EMU due to the different economic structures of the participating countries as well as of their objectives. He had also indicated that in times of crisis the EMU would be facing serious challenges. The eurozone debt crisis and the gap between the European North and the European South are indicative.

What is even worse is the lack of a vision and a comprehensive economic strategy to get out of the negative vicious circle. Currently, Feldstein suggests that it will be better to monetize the debt (for a period of time) in order to get out of the economic crisis.

It should also not escape our attention that over time serious misperceptions were created about Cyprus; that it was a money laundering centre, a casino economy, and above all that it was a state that caused the EU recurring headaches. It also seems that some circles in the EU had held a grudge that in 2004 the Greek Cypriots had rejected the UN plan for the solution of the Cyprus Problem. Be that as it may it is unfortunate that on several occasions Cyprus proved to be clumsy; not to ignore the fact that Cyprus itself has failed to produce a narrative to project internationally.

The Eurogroup’s vindictiveness against Cyprus is beginning to backfire as it undermines the entire concept of the Euro and worse still of all modern banking systems which are based on fractional reserves for banks, backed by one or another form of governmental guarantee. Already it has been reported that this year European banking system would lose about €15 billion deposits. It remains to be seen how this will end.

Mr Spyrou has failed to understand that the withering out of the Cypriot banks from Greece is an additional proof of our de facto exit from the eurozone. This decision has left the Cypriot government with no systemic leverage whatsoever.

It is clear that the philosophy of draconian fiscal restraint has failed. And if the same philosophy is maintained, the eurozone will be facing worse problems. Cyprus is de facto outside the eurozone and many analysts predict that it will be a matter of time before this leads to the formal exit. If this is the case, exiting at a later stage with a higher public and private debt will lead to worse conditions and outcomes.

Mr Spyrou indicates that he is not a policy expert. Yet with an assertiveness that borders on arrogance he argues in favour of sustaining a path full of tears and pain. In conclusion, given that the philosophy of the Troika and the architecture of the eurozone are leading Cyprus to collapse, the study gives a bold and comprehensive road map for exiting the crisis and establishing a new economic paradigm.

Andreas Theophanous is Professor of Political Economy and President of the Center for European and International Affairs of the University of Nicosia

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