By George Christou
IT IS THREE years to the day, since Demetris Christofias, the president at the time, was sent a stern letter (reproduced in full on the right) by then president of the European Central Bank, Jean-Claude Trichet, urging him to rein in public spending and bring the budget deficit under control.
The letter, co-signed by then Governor of the Central Bank of Cyprus, Athanasios Orphanides, said that “Cyprus is one of the countries where the need for policy actions is particularly urgent” and noted that “the implementation of fiscal consolidation has to be a key priority for the 2011 Budget and beyond.”
The ECB had been concerned about the spreads of Cyprus government bonds which had been rising, an indication that the markets considered the risk bigger. This was because the Christofias government had refused to take adequate measures to cut state spending and reduce the budget deficit.
According to the ECB, the deficit should have been at 4.5 per cent of GDP in 2011 and 3 per cent in 2012, but according to its own calculations with which the European Commission agreed, it would be in the region of 5.7 per cent for both years. Apart from additional measures, it also urged the government to have concrete contingency plans “which can be quickly implemented in case the consolidation targets are at risk.”
Christofias not only ignored the warnings of the letter, which was copied to finance minister Charilaos Stavrakis, but he did not even reply or acknowledge its receipt. Five months later, in May 2011, Cyprus was excluded from the markets, its government bonds attaining junk status. This was the start of the economy’s collapse.
Christofias’ oft-repeated excuse for his inaction was that nobody had warned him about the expansion of the banks and the dangers this entailed. In an interview, published in Kathimerini three weeks ago, he said the following:
“Why was I at odds with Orphanides? Because we talked 100 times, he sent me as many letters, but never in any discussion or any document was there mention of the banks. He never told me that the banks were engaging in the expansionary policy… He (Orphanides) spoke to the infamous (investigative) committee. Did he say he warned the president about the situation of the banks? Never.”
Yet the Trichet letter did inform Christofias about the large size of the banking sector and the negative effect unhealthy public finances could have on it. It was expressed in technical terms but there were plenty of economists in his government, who could have explained the jargon to him.
Trichet said in letter said: “Although Cyprus’ sovereign debt market has a limited size, significant concerns exist. These concerns are particularly relevant in view of the large size of the Cypriot banking system, which may produce negative feedback loops between financial sector and public debt. Safeguarding market confidence in public finances and in the stability of the financial system has to be a key objective for Cyprus at the current juncture.”
The dangers posed to the banking system by the inability to put public finances on a sound basis could not have been made clearer. Yet Christofias ignored this clear warning and did nothing. The spreads on government bonds continued to rise and by April Cyprus was unable to borrow money from abroad.
The yields and spreads of Italian and Spanish bonds also surged in 2011, but because the governments of both countries had heeded the warnings to take measures to reduce their respective deficits, they were helped out by the ECB and overcame the problem. Neither was excluded from the markets.
Earlier this year, the ECB disclosed the purchases of government bonds it made to help governments in the euro area. The list included Italy (€99bn) and Spain (€43.7bn) whose governments behaved responsibly when warned by the ECB. A striking absence from the list, which also included Greece, Ireland and Portugal, was Cyprus.
Unfortunately, in 2011 Cyprus had a president who still claims that he was not warned by anyone and a finance minister who thought it best to look the other away.