By Les Manison
The government and most of the media in Cyprus have been trumpeting the statistics on real GDP growth and the promotion of public debt to an investment grade rating followed by a “successful” Eurobond issue as evidence that the Cyprus economy is performing very well and has recovered remarkably from the financial crisis of 2012/13.
On the other hand, some opposition politicians and a very few economists contend that thousands of people and many businesses are still suffering from the adverse effects of the crisis, including the inability to secure decent jobs and continue to be anxious about the economy and its financial institutions.
But what do official statistics reveal? Do they show that economic growth is benefitting most Cyprus households? And are the main sources of growth sustainable and compatible with financial stability?
In Cyprus as in other economies, it is not enough to know how rapidly the economy as measured by real GDP is growing. Real GDP is just a measure of the quantity of total economic activity of a country. It does not provide specific information on how the economic welfare of households is being affected by the economic and financial developments in a country. Cypriots need to know how the economy is performing for people like them.
Evidence shows that a broad-based economy providing benefits to most of the population is key to building a strong economy with sustained growth. And this starts with the timely collection and analysis of data that enable policymakers to understand how the economy is performing for all Cypriots.
What is of real concern is that government policymakers and most of the media in Cyprus focus just on very few official statistics such as real GDP growth and the rate of unemployment as well as credit ratings on public debt in assessing the performance of the economy. They do not seem to care to analyse how the benefits of economic growth are being distributed to the different segments of the population. Some critics even go so far as to claim that the ruling oligarchs only seriously care about whether their wealthy supporters are being enriched.
But what do official statistics reveal about who is participating in and benefitting from the growth of real GDP? The return to positive economic growth since 2014 has been associated with a considerable fall in the rate of unemployment from its peak of over 16 per cent to just under 9 per cent by mid-2018 as labour has been increasingly employed in the faster-growing areas of construction, retail and wholesale trade, and accommodation and food service activities. However, many jobs in these areas are low-paying and often part-time and seasonal. The sad truth is that the private sector is not generating well-paid jobs utilising the skills acquired by the younger generation of educated graduates many of whom are forced to take up employment abroad and/or become under-employed in Cyprus at humiliatingly low wages.
More generally, the real wages of employees have lagged considerably behind the growth of productivity and are still below pre-crisis levels. Indeed, what is striking since the crisis years of 2012/13 is that the total compensation of employees in 2017 remained in money terms 9 per cent below their level in 2012 whereas the gross operating surpluses of corporations and public companies increased by nearly 17 per cent over the same period. These developments indicate clearly that there has been a distribution of the GDP pie or income away from labour in favour of profits and rents derived from capital and property.
However, what is important also for measuring developments in the economic welfare of Cyprus families is whether household incomes including social transfers are sufficient to satisfy their consumption and financing needs: that is to make ends meet. The latest household survey of 2017 by Cystat indicates that the mean disposable incomes of Cyprus households in 2016 had fallen by 14.8 per cent since their peak in 2011; yet in the three years to 2014 the ratio of household debt to income climbed by over 24 percentage points to 199 per cent (Euro area average was 95 per cent) and had fallen back to 179 per cent by 2016. Thus, households were confronted with increasing and heavy debt servicing obligations at a time when at least up to 2014 their incomes were declining steeply. It is estimated that by 2014 indebted households in Cyprus required on average nearly 36 per cent of their income to meet monthly debt payments and that the bottom 20 per cent of least-wealthy households needed an overwhelming 64 per cent.
But despite lower incomes and heavy debt obligations, households in recent years have largely sought to defend their pre-crisis consumption levels. And in this respect household consumption by 2017 was 2.5 per cent above its level in 2012. This behaviour has been facilitated by many households running down their savings and failing to repay their debts. In the years 2014 to 2016 the household saving ratio was negative averaging minus 4.5 per cent which compares with the EU average of plus 12.4 per cent. And during the same years NPLs of households at banks remained at uncomfortably high levels averaging around 53 per cent of gross loans. Furthermore, with many non-financial corporations over-burdened by their very large debt that reached a peak of 150 per cent of GDP in 2015, many of these business entities were unable or opted not to service their debts. In consequence NPLs of banks reached a peak of over 45 per cent of gross loans in late 2015 and declined thereafter, but still are at an unsatisfactorily high level of over 20 billion euros.
The Cyprus authorities with their obsession with GDP growth, even if only for the short-term, have largely neglected policies to productively deal with the festering private debt problem. Instead, they have supported private consumption as the main source of real GDP growth as against encouraging and forcing households and non-financial corporations to save so as to finance debt repayments and productive investments.
Furthermore, the policies and behaviour of banks have hardly helped the real economy. They have over-lent to many clients, making loan repayments of numerous households and businesses unaffordable. And subsequently, they have failed to provide adequate debt relief to most of their debt-distressed customers. Productive debt restructurings for many potentially viable businesses have not been devised. For low income and less wealthy households that cannot even eke out a decent standard of living with their current incomes, let alone meet their debt obligations, banks should have been giving serious consideration to partly or fully writing off their loans on a case-by-case basis, rather than delivering generous write-offs and property for debt exchanges to politically exposed persons and the business elite. Unfortunately, the current policy initiative to sell bank loans to third parties albeit often at large discounts hardly helps the economy as the private sector is still lumbered with the same amount of debt.
The Cyprus economy is in a no-win situation. Failure to reduce substantially the huge private debt overhang that impoverishes many businesses and households is resulting in large losses to banks because of the related accumulation of impaired loans, wiping out much of their capital in the process as the demise of the Co-operative Bank has clearly demonstrated. Other banks with their poor profitability are having difficulty in raising fresh capital from external sources to make the provisions required for potential losses. And with their limited capital banks are forced to sell assets, often at considerable losses, ushering in a chain of events that diminishes further their profitability and jeopardises their survival.
Alternatively, sensible economic adjustment through inducing/forcing households and non-financial corporations, including the strategic debt defaulters, to repay their loans in accordance with their means would derail growth and most likely plunge the economy into recession. This is because the consumption of these entities would have to be cut back substantially so as to generate the increased savings required to finance higher debt repayments. Of course, the severity of an economic downturn would depend on the extent to which higher external demand albeit mainly from foreign tourists would offset the decline in domestic demand
The credit rating agency Standard & Poor’s recently upgraded Cyprus public debt to an investment grade rating. And in the wake of this upgrading, the Cyprus government sold €1.5 billion of Eurobonds at an interest rate of 2.4 per cent. Cypriot politicians including President Anastasiades claim misleadingly that this upgrading of public debt proves that investors have confidence in the Cyprus economy. However, all this upgrading means is that investors buying Cyprus government securities are more confident (with less risk than before) that the debt will be repaid. In consequence, this upgrading enables the government to borrow in international capital markets at more reasonable costs. It does not mean that foreign and domestic entities have the confidence to invest in the real economy of Cyprus and its financial institutions. Cyprus banks continue to be unable to raise capital at reasonable costs from external sources, and in this respect, the Bank of Cyprus recently had to issue €250 million in private placements in order to secure capital at the exorbitant cost of 12.5 per cent per annum.
Moreover, as the recent global financial crisis and that in Cyprus aptly demonstrate, economic development or good performance comes not from the issue of debt, whether public or private, but from the productive use of that debt. If the government is mainly issuing debt to repay existing debt it is not helping the real economy apart from some lowering of refinancing costs and is just passing on the servicing of debt to the law-abiding taxpayers of the future.
In sum an analysis of a broad range of statistics on the Cyprus economy, especially on those pertaining to the household sector, indicates that its performance and recovery from the financial crisis of 2012/2013 has not been as good as portrayed by politicians who rely heavily on GDP growth statistics and ratings of credit-rating agencies to form and air their views.
Household incomes have recovered much more slowly than real GDP, and living standards have been propped up by the substantial running down of saving balances and in many cases by the failure to service debts. A major lesson for policy-makers is that their obsession with GDP growth statistics has led to complacency and even neglect in adjusting policies to deal with the economy’s real problems such as the extremely large private debt overhang that is severely inhibiting productive investments, and is contributing to financing “excess” consumption, while depleting domestic savings.
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