By Stelios Orphanides
CYPRUS must go ahead with structural reforms such as overhauling the public sector, health sector and social welfare system, the privatisation of state owned corporations and make its economy attractive for foreign investors or else it risks seeing government debt increase to less sustainable levels, the finance ministry has said.
The reforms, which are included in Cyprus’ bailout agreement with international creditors and are unpopular with opposition parties, are key in helping the economy recover at a sufficient growth rate that will allow debt to return quickly to more sustainable levels, the finance ministry said in its budgetary risks report released on Thursday.
If all goes well – which is the base scenario – public debt which was 115.5 per cent of gross domestic product last year, is expected to peak at 119.4 per cent this year before a declining trend sets in. This will gradually reduce it from 117.3 per cent in 2015 to 93.4 per cent by 2020, the ministry said in the report.
In 2015, Cyprus is expected to see its economy grow again for the very first time since 2011. The growth forecast for 2015 is seen at 0.4 per cent, and at 1.6 per cent and 2 per cent for 2016 and 2017 respectively. Public debt stood at 18.4 billion euros by the end of September.
The return of government debt to more sustainable levels depends on a number of macroeconomic variables which could potentially either delay the debt reduction process or, in the worst case scenario, even reverse it, driving it to even higher levels compared to today, according to the report.
“According to a sensitivity analysis carried out by the finance ministry, public debt is deemed sustainable in all case scenarios, with one exception, in which the variable is economic growth,” the ministry said and added that in case that growth rate remains 0.5 below what is projected in the medium term, public debt is expected to rise to above 126 per cent of GDP by 2020.
In another scenario examined by the finance ministry, which assumes that real interest rates will be 50 basis points above those in the basic scenario during the reference period, public debt is expected to drop at a slower pace to 98.8 per cent by 2020.
Also, if the government fails during the period examined to meet its yearly primary balance target by half a percentage point of the GDP, then debt reduction will go ahead at a much slower rate. By 2020, it will be 105.8 per cent of economic output, the finance ministry said.
The primary balance is the difference between the total revenue and total expenditure excluding interest payments.
A fourth scenario that assumes a combination of the above negative scenarios in a more tempered manner (i.e. growth rate remaining 0.25 per cent below medium term forecast, interest rates remaining 25 basis points above those of the base scenario and the primary balance falling short by 0.25 per cent of GDP of the goal), shows that public debt may fall to 109.4 per cent in six years’ time.
“In case of deviations from macroeconomic forecasts, automatic counter-cyclic economic stabilisers are activated which safeguard the normalisation of the economy’s cycle,” the ministry said with respect to possible risk mitigating action.
“In addition to the above, additional measures to boost potential growth, including structural reforms to make the Cypriot economy more competitive, are in the making. They include measures to reform the public sector, to privatise, to reform the social welfare system and the health scheme. Attracting foreign investment is considered very important for the Cypriot economy and as a result, efforts in this direction are intensified.”
In the case that the macroeconomic variables remain within the margins of the baseline scenario, Cyprus is still not completely out of the woods. Further contingencies related to mainly government guarantees and loans extended by the government, may affect the levels of public debt, according to the finance ministry.
The guarantees extended by the government by March 21, were worth 3.1 billion euros, according to the report. In the context of the restructuring of Cyprus’ banking sector, 1 billion euros in guarantees was given to Cyprus Popular Bank while further guarantees worth 289 million euros were given to the European Financial Stability Fund to finance bailouts of other troubled euro area members.
Some 70 per cent of the remaining 1.8 billion euros in bank guarantees is related to loans granted to sewage boards or state owned companies such as the Electricity Authority, while individuals and local administration entities make up the rest. Government guaranteed non-performing loans are estimated at 150 million euros, the finance ministry said.
In addition, the total amount of loans extended by the government, mainly to public entities, such as the Central Agency for Equal Distribution of Burdens, a body that restores pre-war solvency of displaced property owners, and to Greece, was 807.8 million euros in 2013. In most cases these loans are deemed “recoverable” while their risk is assessed as low, the finance ministry said.
The ministry’s fiscal risks report dated September 2014 does not take into account July fiscal data, in which the finance ministry revised downward its 2014 debt projection to 117.8 per cent, bringing it closer to the forecast for 2015.
Further, Cyprus’ international lenders, whose forecasts are traditionally more pessimistic, expect in their base scenario that Cyprus’s debt will gradually drop to 103 per cent of gross domestic product by 2020, from 117.8 this year after peaking at 126.1 per cent of GDP in 2015.
The sensitivity analysis carried out by the lenders shows that in the worst case scenario, in which Cyprus’ economic grow rate fails the target by an annual 0.5 per cent, by 2020 government debt may soar to 137 per cent of the economy.