Between the government’s main focus being more and better paid public employees and banks’ passiveness and single-mindedness the economy only works for the few
President Nicos Anastasiades, Minister of Finance Constantinos Petrides and Disy party leader Averof Neophytou brag that the Cyprus economy is doing very well and is in safe hands. In addition, the Cyprus authorities backed by credit-rating agencies contend that banks are financially stable and performing better. As evidence, it is claimed that the relatively fast growth of real GDP demonstrates good economic performance and that the banks by getting large amounts of NPLs off their balance sheets are contributing positively to financial stability.
However, it is argued below that the poor use of resources including taxpayers’ money and bank deposits by the government and banks, respectively, mean that the so-called good performances of these institutions tend to just benefit the few and make economic growth less sustainable.
Government policies
Inefficiency in the use of resources and unfavourable labour market conditions exists in areas of activity strongly promoted by the government, such as property development, tourism and consumerism.
In the property development/construction sector government policies through tax incentives and unevenly applying laws and regulations, including generously granting building permits and licences, as well as in the corruption-tainted implementation of the ‘golden’ passport scheme, have led to a squandering of resources in the excessive construction of luxury apartments and commercial offices, damaging the natural environment in the process. Simultaneously, spending on social housing and accommodation for lower-income earners has been inadequate leading to widening inequalities between older property owners and the younger generation of renters.
Only large developers and collaborating lawyers, accountants, bankers and real estate agents have gained substantially from this inefficient allocation of resources within the property sector. And in the retail and wholesale trade and hospitality sectors catering for consumers and tourists it is mainly relatively unskilled workers receiving low wages that constitute the bulk of employees.
Furthermore, as a result of the government spending relatively small amounts on research and development and employing many persons on the basis of who you know rather than on what you know, an environment is created that is adverse to fostering well-paying, good jobs utilising the highly-skilled and educated labour force of Cyprus.
An analysis of expenditure allocations relating to Cyprus government budgets confirms that government policies are not efficiently using taxpayers’ money. For decades Cyprus budgets and their questionable implementation have been biased toward current expenditures directed at gaining short-term political support rather than effectively investing resources in development projects and programmes that give the potential for most of the population to contribute to and benefit from sustained economic growth. Even expenditure on social protection, which remains inadequate in Cyprus, is an investment that benefits society at large and helps foster sustained development.
Most notably, in contrast to its lack of concern for private sector employees, the government in its budgetary policies continues to feather the nest of its own employees by increasingly using taxpayers’ money obtained mainly from the incomes and spending of private sector employees for paying high wages and attractive benefits to its surging army of public sector employees. Expenditure on personnel is expected to reach €3.2 billion or 12.2 per cent of GDP in 2022 partly as a result of an increase of I,165 or 6.3 per cent in the number of casual workers over the 12 months to November 2022, surely primarily for political purposes.
Reflecting great inefficiency every year, the implementation rate for development projects is usually below 65 per cent, and in the first nine months of 2022 this rate was a pitiful 32 per cent. And during the budget year unspent funds originally earmarked for development projects are regularly shifted to boosting current expenditure on items such as remunerating newly hired employees and advisors.
Bank activities
Much of the savings of Cyprus households and businesses is deposited in banks giving these institutions substantial amounts of funds to lend out to earn income through the financing of productive projects. However, in recent years Cyprus banks have not used their accumulating deposit base well in extending new loans and have piled-up huge amounts of cash and cash balances at central banks “earning” negative interest. At the same time Cyprus banks have become increasingly pre-occupied with calling-in NPLs and removing them and related property collateral from their balance sheets by selling such impaired loans to third parties.
Given this preoccupation banks have focused inadequately on expanding their portfolio of interest-bearing new loans. In fact, after deducting NPLs held by banks, such loans outstanding on their balance sheets declined by over €12 billion or 34 per cent between end-2015 and June 2022. And over the same period the cash and cash balances at central banks held by Cyprus banks, “earning” negative interest in recent years, rose spectacularly by €12.8 billion or over 100 per cent.
ECB statistics reveal that the systematically important banks of Cyprus had a ratio of interest-bearing loans to deposits of around 47 per cent banks at end-June 2022, whereas the corresponding ratio for counterpart banks in 17 other EU countries was around 100 per cent. This factor indicating the inability of banks to use a sizable portion of their deposits in extending income-yielding loans accounts importantly for the lower profitability of Cyprus banks relative to the majority of EU banks. In fact, in the first half of 2022 the returns on equity and assets for Cyprus banks averaged 2.18 per cent and 0.17 per cent, respectively, while such returns on equity and assets for banks in 17 other EU countries were much higher and averaged 6.83 per cent and 0.42 per cent, respectively.
Given the relatively weak performances of Cyprus banks, the financial authorities and bankers have been somewhat misleading in referring favourably to the satisfactory performances of large banks and in their contributions to financial stability and growth. For example, bankers backed strongly by credit-rating agencies refer to the removal of NPLs from their balance sheets as being a very positive development for the Cyprus economy. But with the sale of NPLs and related property collateral by banks to third parties, the private sector including households and non-financial corporations remains heavily burdened with debt. Indeed, private sector debt according to the latest data of the Central Bank of Cyprus amounted to €6O.3 billion or over 240 per cent of GDP at end-June 2022, only €2.5 billion below its peak level in 2016.
Proposed remedies
To rectify the situation of the Cyprus government and banks using taxpayers’ and depositors’ money rather poorly, these institutions need to be made accountable for their inefficient and sometimes corrupt use of funds.
For the Cyprus government, performance-based budgeting is required making the government more accountable for what they have achieved with taxpayers’ money. In this connection there is a need to move the focus of decision-making in budgeting away from inputs or allocations (how much money can I get?) towards measurable results (what is being achieved with taxpayers’ money?).
Laws and regulations should be strictly enforced so that abusive and corrupt practices and investments (for example, illegal construction of apartments damaging sea coast) can be significantly curtailed.
And for both the Cyprus government and banks institutional changes should be undertaken to enable the very large amount of idle cash in banks and limited tax payers’ money to be put to more productive use. An independent Development Finance Agency needs to be established with competent staff tasked with identifying and arranging the financing of large scale economically viable projects, including those involving Public Private Partnerships.
Lastly, banks and related financial companies need to be made more accountable for their actions and practices by being better regulated and properly supervised. The sale of loan collateral by banks needs regulation giving original borrowers the first right to accept an offer made by a bank to a third party to sell collateral at a discounted price so as to prevent profiteering at the expense of the borrower.
Les 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
