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Inflation crisis: Does the government grasp the gravity of the situation?

Συνέντευξη στο ΚΥΠΕ – Υπουργός Οικονομικών Κωνσταντίνος Πετρίδης
Cyprus authorities don’t really understand the gravity of the situation or don’t really care

Given that consumer prices will continue to rise over the coming months with increases in incomes falling far behind, even lower middle-income households are likely to experience financial problems

 

With the rate of increase of consumer prices rising further to 8.8 per cent over the 12 months to May 2022 and costs for businesses at extremely high levels, an increasing number of households and employers, including the Cyprus government, are facing growing financial difficulties. In this respect there is concern as to whether the Cyprus authorities really understand the gravity of the inflation situation which threatens livelihoods, worsens inequalities and could undermine financial and social stability. Or don’t they really care and are just focused on policies to influence the outcome of the forthcoming presidential election?

 

Developments and prospects

As a result of their incomes rising at more modest rates of three to four per cent on average over the last year, households have suffered large losses in real purchasing power. And coping with inflation is much more difficult for poorer families, who have less flexibility to adjust their spending in response to rising prices. This is especially true right now in Cyprus when inflation is concentrated in essential categories like basic foods, electricity and fuel. Indeed, it is estimated that with poorer families spending higher proportions of their income on such items than the average consumer they are facing annual rates of inflation of at least 11 per cent.

Given the prospect that consumer prices will continue to rise over the coming months and with increases in employee incomes and payment of social benefits falling far behind, even lower middle-income households are likely to experience financial problems as they deplete their meagre savings.

Furthermore, a large number of businesses, particularly those in the construction, manufacturing and agricultural sectors, are experiencing higher costs of electricity, fuel and raw materials, which they cannot pass on and are likely to curtail their operations and lay-off employees, threatening livelihoods in the process.

 

Short-term measures

Government policies in dealing with the costs of living and business operations crisis have focused on short-term measures to reduce energy costs and some targeted assistance to vulnerable groups. Discounts and VAT reductions on electricity bills have been introduced for a limited duration, while the supplementary budget of May 27, 2022 allocated a pitifully low €103 million on measures including targeted assistance for households and pensioners as well as subsidies for farmers and the installation of energy saving devices and roof insulation. But these measures, costing around 1.3 per cent of GDP, are far from sufficient in helping vulnerable groups and businesses cope with the cost of living crisis.

Rather misleadingly Finance Minister Constantinos Petrides has argued that the government does not have the financial resources to provide substantial support to vulnerable groups and businesses. Yet the government, in part because of much higher VAT receipts, is recording budget surpluses and had at end-April 2022 over €5.5 billion (24 per cent of GDP) in deposits or reserves at the Central Bank and commercial banks. It appears that the government is just reserving these funds to use for political purposes. In addition, it has collected sizable revenue under the emissions trading system (ETS), which should be used mostly to protect vulnerable households and ensure that energy poverty is not aggravated. Unfortunately, the ETS revenues in Cyprus are being used to finance other budget expenditures.

Thus, the government should show more concern for the livelihoods of vulnerable households and businesses by using a greater amount of its funds in providing much more targeted financial support to protect these entities from the ravages of inflation.

However, government social benefits alone will hardly be sufficient to protect households, especially for those dependent on low private sector incomes, from being forced to depress their standard of living. Many private sector enterprises including large supermarkets, pharmacies, health clinics and oligopolistic petroleum companies have been able to protect and even boost their profits from inflation by passing on higher costs in price increases for their customers. Surely, these enterprises should help their employees to protect families against inflation by raising their wages!

But many employers argue that they cannot afford to raise the compensation of their employees because they cannot pass on their higher costs. In this situation businesses such as certain ones in the agricultural and animal husbandry sectors should have their costs including wage expenses partly subsidised so that they can maintain the supply of essential products such as cows milk at reasonable prices. And in other areas of the economy, such as in construction where there is oversupply and contractors cannot pass on their huge increases in costs, operations should be ceased temporarily and workers laid off and become eligible for social benefits.

 

More permanent measures

Most of the measures undertaken so far and recommended above including tax reductions on energy products and government subsidies aiming at dealing with the adverse effects of the worsening cost of living crisis, especially if prolonged, would place overwhelming pressure on the limited government resources. In addition, major deficiencies in the institutional structure and features of the Cyprus economy are aggravating the cost of living crisis and seriously limiting the ability of the Cyprus authorities to take appropriate remedial action.

Revenue resources: Because of its regressive tax system, lack of a decent property tax, and failure to collect taxes owing to large-scale tax evasion and avoidance and a grossly inefficient tax system, the Cyprus government does not have the tax revenue to finance sufficient social welfare assistance and real development expenditures compatible with that of an advanced European country. It was reported officially that tax arrears at end-2021 amounted to over €2 billion, which is the tip of the iceberg as many Cypriot residents, including wealthy individuals, do not file tax returns and, accordingly, their tax obligations are not assessed.

And, as repeatedly recommended, there is an urgent need for reform of the increasingly regressive tax system, the introduction of a progressive central tax on immovable property, and an overhaul of the grossly inefficient and corrupt tax administration so as to raise not only much greater tax revenues, but also to markedly reduce large wealth and income inequalities.

Incomes: Wages paid to employees in the sector private sector, excluding those working in banks, have remained depressingly low since the financial crisis of 2012/13 and by 2021 were half the average of those paid to well-compensated government employees. Institutional factors such as absence of a national minimum wage, the ineligibility for cost of living adjustments (Cola) for most non-bank employees, and the very large number of persons working in the informal sector that by definition don’t have access to social benefits, largely explain the low levels of incomes of most private sector employees. With such low incomes the households of these employees are vulnerable to being driven into poverty by the ongoing steep increases in the cost of living.

Given these grim prospects for many private sector employees and the government’s obligation under Article 9 of the Cyprus Constitution to prevent its citizens from descending into poverty there is a compelling need to legalise and nationalise a minimum, yet livable wage. This should comply with the recent deliberations of the European Council in setting rules for the payment of adequate minimum wages with the EU claiming that “a minimum wage of €1,000 will greatly help the groups at risk of poverty in Cyprus”. In Germany the government has proposed that its parliament enact the minimum wage as law and increase it from €9.82 per hour to €12 per hour by October 2022 as well as setting a floor for wages per hour for part-time and marginal employees affecting 6.2 million workers.

In addition, until institutional arrangements are made to extend Cola to most employees in the formal economy Cola should not be paid as this would just benefit the more highly-paid employees in the broad public sector and banks and worsen already wide income inequalities.

Furthermore, serious efforts are required to bring more people working exclusively in the very large informal economy into the formal sector so that they can obtain social benefits and secure at least minimum wages. Hence, forms and procedures for making applications for social benefits as well as for submitting tax returns and making social security payments should be simplified and be promptly processed by, hopefully, a reformed and more efficient public service.

 

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

 

 

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