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Mitigating the damage from troika MoU: a strategy for economic recovery, part 2

Christoforos Pissarides the Nobel Laureate economist

By Costas Apostolides

In my first article of three on what a recovery plan for our economy should entail, I described the two steps that should be initially taken, namely ending the war between the government and central bank which has been going on for more than five years, and to implement the troika memorandum.

Since publication two weeks ago the climate has worsened. The official investigation by three judges into the causes of the economic and financial crisis is deepening political divisions, and making cooperation between the parties more difficult, while the emergency meeting of the House of Representatives on the powers of the central bank governor may send everyone into the trenches. Yet without total cooperation between government, political parties, trades unions and business, economic recovery is not possible. The situation is serious and we must all pull together.

The six dimensions of a recovery plan are set out below. Parts 1 and 2, I covered in my previous article. This week, I will focus on parts 3 and 4:

  1. Achieving agreement on a plan of action for economic growth between the president, the governor of the Central Bank, political parties, the trade unions and business interests.
  2. Implement the Memorandum of Understanding with the troika and Eurogroup.
  3. Mitigating the damage to the economy that has been and will be done by implementing the memorandum.
  4. Develop a fall-back position in case the memorandum cannot be implemented (i.e. in case the effects of the memorandum are such that it cannot be implemented).
  5. Reform social policy to create a safety net for those in need and exclude present beneficiaries that can do without (announced for implementation in 2014).
  6. Develop a plan and appropriate policies for achieving growth, without which the whole strategy will fail, because the international crisis may not go away and the memorandum owing to its inconsistencies could cause further misery and fail.

Mitigate the Damage

Great risks come with the Eurogroup decisions and the memorandum and the worse effects must be avoided at all costs:

The decision by the Eurogroup to take the money needed for the restructuring of the merged Bank of Cyprus and Laiki Bank from unguaranteed depositors, has caused an outflow of funds on a massive scale from the banking system already, but the fear is that when the exchange controls are eventually removed the outflows that will inevitably result will endanger the whole financial system.

The policy on non-performing loans has to be more flexible than the stated three months. A policy of banks gradually calling in mortgage guarantees for non-performing loans and delaying sales of such assets has to be put in place, otherwise property prices will collapse and the whole banking system will be in dire straits. This would arise because the property prices will fall for all banks, and the resulting reduced value of guarantees on loans of all types, will require further capitalisation of all banks.

High bank interest rate charges on loans and the lack of bank liquidity is preventing recovery, consequently reductions in both loan and deposit interest rates are necessary. But a reduction in deposit rates contradicts the objective of minimising outflow of funds, since higher deposit rates act as a disincentive for an outflow of funds.

The rate of decline of GDP in 2013 and 2014 should be minimised by encouraging growth, otherwise it may be impossible to meet the requirements of the memorandum, and that would cause further austerity and further decline. The troika stated they expect a total GDP decline of 13 per cent covering the period 2013 and 2014. Already state revenues are declining as a result and this could make the targets of the memorandum unattainable.

The Cyprus economic model was a target for the Eurogroup with the German finance minister announcing that this model has been destroyed. This should be avoided because changes of the model take time, often five to 15 years, so one builds on what one has by developing new sectors and adding them, not by destroying the old.

Christoforos Pissarides the Nobel Laureate economist who leads the president’s economic advisers stated recently that the restrictions in the banking sector should be phased out over time, and reconsidered every six months with a view to allowing free flow of capital movements over a two year period. This is a logical sequence which would avoid a nightmare scenario, but the government spokesman immediately contradicted this statement by announcing that the government wants a return to normal as soon as possible. Unfortunately this demonstrates that the government has no understanding of the risks.

To avoid the destruction of the model, and keep international services in Cyprus, it is essential to invest in modernising and upgrading the Registrar of Companies in Cyprus, and adjusting tax measures to ensure that Cyprus remains an attractive business location. Immediately one or both the large Laiki Bank buildings on Makarios avenue, Nicosia should be taken over by the Registrar and fully computerised operations established.

Develop Plan “B”

The minister of finance has repeatedly stated that there is no Plan “B”, because Cyprus will implement in full the troika memorandum. That is a brave statement, but a wiser approach is to plan ahead and prepare for the case where the memorandum cannot be implemented because for example the economic performance is worse than anticipated, or any or all of the risks mentioned above occur. Cyprus cannot again suffer because the government was unprepared and uninformed. All the trends in Cyprus, in the EU and the international situation have to be followed.

At a minimum Plan B has to relate to what happens if falling revenues mean that the government budget deficit does not meet the troika target levels. At a maximum a Plan C needs to be prepared for exit from the euro if any more unacceptable conditions are imposed on Cyprus. Preparation for a euro exit would improve Cyprus’ bargaining position in a worst case scenario. Between these two extremes any number of scenarios can be developed. Failing to prepare would be reckless.


Costas Apostolides is chairman of EMS Economic Management Ltd ([email protected])


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