Countries can learn lessons from Cyprus’ economic crash and subsequent bailout package in terms of preventing future financial crises, according to a newly-released report.
Researchers from Imperial College Business School and the University of Cyprus carried out an in-depth analysis of why Cyprus needed to be bailed out to explore what lessons could be learnt from the crisis. According to the researchers, Cyprus suffered from overconfidence arising from around 35 years of almost continuous and robust growth. This resulted in the Cypriot government making poor choices in regards to public finances, such as rapidly increasing public spending in welfare, and ultimately delays in reaching a bailout agreement, which affected the economy.
The researchers state in the study that the Cypriot government’s delay in taking action to avert the crisis was a mistake, which was compounded by the fact that it was too slow to ask the EU for help. The team says that the Government should have negotiated assistance in the summer of 2011 or summer of 2012, instead of completing the negotiations in March 2013. This delay meant that the European Central Bank had to increase the amount of money – called Emergency Liquidity Assistance (ELA) – it lent to Cyprus to keep the banking sector afloat. The impact of the delay meant that unemployment grew from around eight per cent in July 2011 to exceeding 15 per cent by March 2013.
In the lead up to the crash, the Government had also introduced financially unsustainable policies that contributed to the crisis.
The researchers also found that the Central Bank of Cyprus (CBC) did not recognise the rapid increase by other banks in house lending.
The researchers say that the housing boom and bust cycle experienced by Cyprus should be a cause for concern in countries such as the UK, where house prices are currently increasing, due to demand from foreign investors. According to the estate agent Savills, £7 billion of international money was spent on premium London homes in 2013, with just 20 per cent of that spent by UK citizens. Two thirds of the properties bought by international buyers were as investments.
Professor Alexander Michaelides, co-author of the report, said: “Cyprus enjoyed around 35 years of almost continuous and robust growth with a booming housing market, foreign investment and tourism. However, our research shows that from 2010, Cyprus’ debt problems were growing and the government was slow to respond to the crisis. The result is that Cyprus faced the real prospect of bankruptcy and being forced out of the single European Currency. In order to prevent crises of this magnitude standard macroeconomic policy advice applies: keep government deficits under control; ensure strong corporate governance in large banking sectors; beware of volatile capital flows such as large deposits being paid into bank accounts and then being quickly removed, and of rapid increases in house prices. Our findings can be used by governments of countries in and out of the Eurozone to learn lessons about how to prevent and manage crises effectively.”
The researchers used data from the Central Bank of Cyprus, European Central Bank and Eurostat, which provides statistical information to the institutions of the European Union, to form their conclusions.
The report is published in the journal Economic Policy.