A former central bank advisor says Cyprus’ very own oligarchs are sowing the seeds of another crisis aided by a compliant government
By Leslie G Manison
The recent ‘parliamentary’ election campaign in the Turkish-occupied area of Cyprus featured major concerns about the cronyism and corruption of the political and economic system there. But these concerns did not influence significantly the actual preferences of voters.
Notwithstanding, voters in the forthcoming presidential election in the government-controlled area of the Cyprus should be just as concerned with the crony capitalism and the related institutional incompetence plaguing the Republic, which inevitably produces recurring crises.
Unfortunately, the Cyprus Republic is characterised by a mixture of oligarchic and debt-financed capitalism fostered and facilitated by lawlessness and irresponsible government and bank policies. And institutional incompetence and nepotism – reflected most notably by the appointment and deployment of less-than-competent staff by self-serving, politically motivated managers – allows crony capitalism to prevail and deprives Cyprus of the most salient virtue of capitalism, namely genuine competition.
The pursuit of quick financial gains through speculating in shares of public companies resulted in stock market booms and subsequent collapses, especially in 1999-2000. Banks wasted resources in greedily extending credits to purchase their own shares, while the regulatory authorities irresponsibly turned a blind eye to insider trading and devious distributions of private placements by the ruling oligarchs. An enduring legacy of the stock market collapses has been the progressive demise of the capital market, particularly for non-financial corporations seeking equity finance.
With abundant foreign capital inflow in the 2000s, especially in the form of non-resident bank deposits, and with capitalists relying almost entirely on debt to finance their activities, banks extended credit at a break-neck pace, particularly in fuelling speculation in the property market.
The eventual bursting of the property bubble together with large bank losses stemming from their considerable purchases of Greek bonds culminated in a severe financial crisis and recession from 2012 to 2014. Cyprus bankers played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. Furthermore, the Central Bank of Cyprus (CBC) failed miserably in adequately supervising the irresponsible behaviour of the banks, highlighted by the absence of proper risk assessments in the extending of a multitude of loans.
Lessons have not been learned and the current authorities or rulers continue to support crony capitalism and one-sided bank behaviour that is adding little real value to the economy, but is instead sowing the seeds of another crisis. And a considerable number of the same managers and staff in government ministries and the CBC and other official institutions that contributed to the crisis with their neglect and incompetent analysis are still in positions of importance, supporting the crony capitalistic policies of the current government, in the process helping to usher in the next crisis.
More specifically what has happened in Cyprus in the period following the crisis? Have the ruling business and financial elite including large developers and hoteliers ceded power so that urgently needed regulatory measures and reforms could be undertaken to improve significantly the functioning of a market-based capitalist system?
While government expenditures have been substantially cut and banking and legal measures introduced to enhance bank debt recovery, private sector entities namely non-financial corporations and households have not adjusted their behaviour to place the economy on more solid foundations. Indeed, the political and business elite in conjunction with compliant bankers have led the way in not pressuring major debtors to repay and/or productively restructure their large loans. And it is the rich and powerful who are the major debtors and have used their political influence to engage in the bulk of strategic debt defaulting.
Furthermore, the culture of tax evasion, in effect increasing indebtedness to the government, prominently featuring hoteliers and developers and the professional elite of doctors, lawyers, accountants and school teachers, has become more entrenched, spawning a flourishing underground economy, but severely narrowing the tax base. In fact, the ‘Cypriot oligarchs’, particularly the large property owners, were most influential in pressuring politicians to abolish the tax on immovable property, thus making Cyprus the only country in the EU without such a tax on wealth.
Moreover, the crony capitalism prevailing in Cyprus encourages political corruption and rent-seeking behaviour by the private sector which is severely diminishing efficiency in the allocation of resources at least as compared with a sound market-based capitalist system.
Many businesses in Cyprus thrive not because of their profitable investments in the real economy, but rather because of a return on money amassed through a nexus between a business class and the political class. The ruling oligarchs use state power to crush genuine competition in handing out licences, permits, government grants, special tax breaks and exemptions, and in awarding contracts for public works. And state intervention over the allocation of resources has been exhibited in the corruption entailed by the rich oligarchs of Cyprus in obtaining the use and favourable rental rates for Turkish Cypriot properties. These powerful oligarchs are often afforded preferential treatment so that they can extract rent or income without adding any real value with their own activities.
Given the emphasis on restoring financial stability, banks did not pursue the typical traits of financial capitalism in the immediate period following the crisis through engaging heavily in speculative activities. However, more recently banks have become involved in some of the more unsavoury aspects of financial capitalism. They have undertaken questionable financial and accounting transactions including manipulating provisioning policies and overestimating accrued income (especially from interest) to artificially raise profits and obscure and postpone the need for fresh capital injections. The latter of course would inflict considerable wealth losses on current bank shareholders. Moreover, bankers are focusing excessively on financial transactions including shedding assets to generate short-term gains, rather than devoting attention to financing investments in the real economy; indeed, bankers lazily and incompetently lament the lack of investment opportunities and the dearth of credit-worthy borrowers.
Crony capitalism is allowed to flourish mainly because of the failure of the authorities to resolutely implement laws and regulations. The power and wealth of the oligarchs is largely sustained and protected by their connections and collusion with the government and banks. It seems that the leading capitalists are implicitly permitted to default on loan repayments and not adhere to other contractual obligations, and there is benign neglect toward the prolific tax evasion of the business and professional elite.
As a result of the special privileges and preferential treatment afforded to the oligarchs, resources are not allocated according to competitive market forces resulting in sub-optimal economic growth. Furthermore, with the unlevel playing field benefitting the powerful and the rich, wealth inequalities are exacerbated. Moreover, with government policies favouring the existing businesses of oligarchs in sectors such as property development, mass tourism and financial and legal services, a pattern of growth prevails that adds limited real value and is particularly deficient in employing the educated and talented younger persons, robbing Cyprus of considerable growth potential.
The present situation of the government in implicitly supporting strategic debt defaulting by the ruling oligarchs and providing other special privileges is jeopardising financial stability and should not be continued. Indeed, the prospect of banks with poor quality asset portfolios raising sufficient capital to meet existing and forthcoming provisioning requirements against impaired loans at non-extortionary prices is very remote. And in view of their overwhelming debts the possibility of large corporations securing equity finance is very low.
Furthermore, with the culture of tax evasion led by the ruling oligarchs and professional elite entrenched in Cyprus, the government does not generate sufficient revenue to undertake productive investments including infrastructure and facilities in the health and education sectors as well as for boosting outlays for research and development. Furthermore, its inadequate financial resources does not allow it to help capitalise new banking institutions (such as a restructuring and development bank or a development finance agency) or to potentially recapitalise any of the existing banks that may still be deemed viable.
It should be the primary task of the new government following the presidential elections to aim at steadily eradicating the crony capitalism that plagues Cyprus and to rebuild institutional competence. The strict and even-handed implementation of laws with respect to financial and economic transactions must be a major goal of a new government administration. This should start with fundamental reform of the judicial system and the legal procedures and financial arrangements for inducing and/or forcing the oligarchs to promptly repay their debts and to meet their other financial obligations.
Debt restructurings should utilise and target the financial and property assets of strategic defaulters to effect repayments, but should not be such as to cause the productive operations of the counterpart assets of oligarchic and often defaulting capitalists to completely cease and/or prevent such business persons as hoteliers from undertaking new economically viable investments. And given the recurring problems arising from the excessive reliance of the capitalists on debt financing, institutional arrangements need to be made whereby saving or funds from foreign and domestic sources can be channelled into the equity financing of capital projects. In this respect, the setting up of a development finance agency, capitalised by international institutions such as the European Investment Bank and International Finance Corporation and foreign development banks together with the government in helping to arrange project financing solutions should be given due consideration.
In order to undertake tax reform, including restructuring and reducing tax rates in favour of lower and middle-income households, the tax base must be substantially broadened involving the greater collection of revenue from the professional and business elite as well as from wealthy property owners such as hoteliers and large developers. In this respect the government has to embark on serious efforts to combat tax evasion and aggressive tax avoidance. But on the contrary the current government with its attempts to attract popular support have recently substantially reduced penalties for late income tax payments thereby incentivising tax-liable Cyprus residents to delay tax payments. In addition the government should re-introduce a progressive tax on immovable property, considered by international institutions as the least growth-unfriendly of taxes.
Leslie G Manison is an economist and financial analyst, specialising in macroeconomic policy analysis, bank viability assessments, and international financial relations. He is a former senior economist at the International Monetary Fund, an ex-advisor in the Cyprus finance ministry and a former senior advisor at the Central Bank of Cyprus.
- Overcoming Private Debt (Unblocking the Loan Burdened Real Economy in Cyprus), The Journal of Private Equity, Fall 2016, Vol. 19, No. 4: pp. 51-59, Savvakis C. Savvides
- Towards Sustainable Growth (Rebuilding the Foundations of the Cyprus Economy) John Deutsch International Development Discussion Paper, Queen’s University, DDP 2016-07, Leslie Graeme Manison and Savvakis C. Savvides
- Neglect Private Debt at the Economy’s Peril World Economics Journal, Vol. 18, No. 1, January–March 2017, Leslie Graeme Manison and Savvakis C. Savvides
- Lack of Adjustment of the Cyprus Household Sector: Results from the Eurosystem’s Household Finance and Consumption Surveys, Leslie Graeme Manison, May 2017. Available at SSRN: https:ssrn.com/abstract=2975802