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Cyprus Economy:  Responding to the Covid-19 Virus

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By Les Manison

The Covid-19 virus pandemic presents a new and unprecedented challenge to Cyprus and all nations. First and foremost it is a public health crisis that makes it impossible for our society and economy to function normally due to the necessary social distancing and shutdown of businesses required for the health of all of us. Indeed, Cyprus is now experiencing a health crisis and an economic recession simultaneously.

In responding to the current and prospective devastating loss of economic activity, jobs and incomes Cyprus policy-makers need to address two interrelated needs.

Firstly, there is an urgent need to protect the livelihood of its citizens, especially the most vulnerable. In Cyprus the latter include workers in the private sector who suffer most from a loss of jobs. And many of these workers comprise persons who subsist on daily earnings from the large, fragile informal economy of Cyprus.

Secondly, there is the related need to protect businesses so that they can resume operating when the shutdown of business entities is lifted. The economy’s productive capacity including employed workers needs to be preserved so that real business activity can recover quickly once the damaging effects of the Covid-19 virus are substantially reduced.

It should be stressed that providing financial support to households and businesses will considerably help in reducing the secondary negative effects of the shutdown on economic activity and incomes as these assisted entities will have more funds to spend. In fact, it is the lower-paid employees who are hit hardest in recessions that have the highest marginal propensity to consume. And domestic demand needs to be kept elevated as high as possible in order to partly offset the huge fall in external demand for Cyprus tourist product, so as to make the recession less severe.

Assistance to Households

How is the Cyprus Government responding in meeting the needs of households? Is the Government providing sufficient funding to members of households, especially the more vulnerable, to enable them to eke out a decent livelihood?

In March 2020 a supplementary budget of 370 million euro was approved by the House of Representatives aimed at paying part of the income of employees and the self-employed of businesses that had been forced to suspend their operations, fully or partially, as a result of Government decrees directed at preventing the spread of the Covid-19 virus. More specifically, to assist an estimated 220,000 private sector workers and self-employed persons who were expected to become unemployed, an amount of 182 million euro was earmarked initially to cover the period from March 15 to May 15, that is, an average of 827 euro per person over two months . However, there have been many complaints that the amounts received by individuals are much too low for them to support their monthly living expenses. For instance, a self-employed person with a café just received a monthly payment of 465 euro in assistance, which is insufficient to even cover his monthly rent of 600 euro. In response the Ministry of Labor has responded by increasing the amount of unemployment benefits and special allowances based on 60% of January 2020 pensionable earnings instead of those of 2018. Notwithstanding, it appears that the emergency financial assistance paid to many households is far from adequate in enabling them to cover their basic living expenses.

In addition, the coverage of this emergency assistance to households is inadequate as well, in so far as many persons working full or part-time in the informal economy and not contributing to the social insurance fund are ineligible for benefits provided for under the supplementary budget. This means that a significant proportion of the labor force (latest estimate indicates informal economy production amounting to over 25% of official GDP) are not being compensated for lost income with the aforementioned benefits. And this in turn reduces markedly the spending power of households in an already contracting economy.

Assistance to Businesses

For the business sector the main proposed measure is for banks to extend Government guaranteed loans to small and medium-sized enterprises of up to two billion euro at subsidized interest rates so as to provide liquidity support. It has been agreed also that financial organizations suspend installments on all serviced loans for businesses, households and self-employed workers for nine months. Furthermore, VAT payments for companies have been suspended and the submission of tax returns postponed. However, these liquidity support measures do not compensate businesses for their income losses. These two measures just intensify the heavy debt burdens of most enterprises and will force many to close down. Indeed, the suspension of loan and tax repayments is likely to perpetuate the unfortunate and prolific culture of debt defaulting and tax evasion by Cypriots.  Conversely, it would make sense to compensate struggling businesses for their losses with cash grants so that each business can re-emerge almost intact after the hibernation due to social distancing ends.

Deficiencies in Policy Design and Implementation

What the coronavirus and the related economic crisis have exposed is that Cyprus does not have the appropriate policies to deal effectively with reducing the severity of the current recession and, furthermore, the institutional capacity to bring about the sound and sustained recovery of the economy from recession.

The inadequate amounts and limited coverage of direct financial assistance to households and businesses will keep domestic spending depressed and along with the collapse in demand for the Cyprus tourism product deepen and prolong the recession.

Governments have shown both before the 2012/13 financial crisis and the current economic crisis that they do not have the values and institutional capacity to efficiently and equitably allocate funds to build-up the economy’s infrastructure. The political bias on keeping the size of Government small through having a narrowly-based tax system and privatizing Government institutions and agencies has led to the underfunding and equipping of Ministries.  The Ministries of Health, Finance and of Labor and Social Security, for example, are starved of resources including competent and apolitical managers to provide high quality public services. Indeed, reflecting under-funding and poor management, public and private hospitals and clinics as a whole have not been able to cope with caring for coronavirus patients and other patients requiring operations and medical treatment at the same time, while the Ministries of Finance and of Labor and Social Security have been found wanting in the selection, amount and prompt implementation of socio/economic measures to combat the economic crisis. In general, the Government is providing excessive protection to banks, while not giving sufficient direct support to households and small businesses with grants.

Ever since the Cyprus stock exchange crash of 2000 the capital market has remained dormant. This has meant that business enterprises have relied almost entirely on bank loans rather than equity to finance their investments. But banks have proved both before the 2012/13 financial crisis and the current economic crisis that they do not have the competence to productively lend the abundant funds at their disposal. Much of their lending was squandered in wasteful projects that contributed most importantly to the financial crisis of 2012/13 and, currently, banks are depositing most of their ample liquidity in the ECB at negative interest rates. And given their incompetence in utilizing available funds productively why should banks be trusted with the allocation of two billion euro of Government guaranteed loans?

Revamping Institutional Capacity

Thus, the recovery of and rebuilding the foundations of the Cyprus economy should focus on creating and strengthening competent institutional capacity. The tax system needs to become broad-based, fairer and more progressive through the greater taxing of wealth (immovable property and inheritances) and by undertaking serious efforts to combat prolific tax evasion. The resultant increase in tax revenue together with available finance from the EU’s structural and investment funds should provide sufficient funds to enhance infrastructure such as the healthcare system and the digitization of Government services so that, for example, social protection benefits can be more efficiently distributed and targeted.

Regarding revamping the financial infrastructure there is a compelling need to set up a well-functioning capital market. And given the extreme lack of equity financing of large-scale projects in Cyprus and the incompetence of banks in allocating funds for the financing of productive investments there a need as well to create a Development and Reconstruction Bank similar to the German Development Bank (KfW). This new institution would have prime responsibility for arranging the financing including equity of large-scale investment projects.

Leslie G Manison is an economist and financial analyst. 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

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