State needs fiscal room to support green, digital and social programmes

Central Bank of Cyprus (CBC) governor Constantinos Herodotou on Friday stressed the need to maintain fiscal space in the midst of increased risks due to the war in Ukraine, something which would allow the state to support both the digital and green transitions, as well as funding social programmes.

Speaking at an event yesterday entitled ‘The Global Debt Trap: Implications for Growth and Ways to Address It’, Herodotou also called for increased vigilance at all levels to prevent risks of asset deterioration, which would lead to even higher levels of private debt.

Referring to the Republic of Cyprus’ debt, Herodotou said that after the economic crisis of 2012-2013, public debt has followed a downward trend, with the exception of 2018 and the impact of the measures related to the former Cyprus Cooperative Bank, as well as in 2020 due to the Covid-19 pandemic.

Furthermore, Herodotou said that the debt-to-GDP ratio fell below 90 per cent in 2022 due to the restart of economic activity and the economic recovery that followed.

He pointed out, however, that risks remain elevated due to Russia’s invasion of Ukraine and the worsening global economic environment.

“At the current juncture, maintaining fiscal space is critical, as government intervention is important to support the digital and green transition, improve competitiveness and promote social cohesion,” Herodotou said.

“The Recovery and Resilience Plan funds can support these goals and will have a positive impact on real growth,” he added, explaining that the successful adoption of structural reforms and the green and digital agenda will be key to transforming the economy into a more sustainable and resilient one.

Regarding private debt, Herodotou said that the granting of loans after 2013 is being governed by stricter guidelines, with data showing that the default rate of new loans is quite low.

However, he explained that domestic private debt levels are still being burdened by older loans, which are difficult to address and need special attention.

As he mentioned, private debt in Cyprus, which is the total of all household and business loans, fell to 236 per cent of GDP in the second quarter of 2022, from its peak of 353 per cent of GDP in the first quarter of 2015.

“Despite this significant reduction, domestic private debt still remains relatively high compared to the eurozone average of 140 per cent,” he said.

What is more, he noted that both households and non-financial corporations are exhibiting passive deleveraging behaviour, given that the decrease is mainly driven by the increase in nominal GDP.

He also stated that in an environment of high inflation, high interest rates and weakening growth prospects, the risks of a deterioration in asset quality, leading to even higher levels of private debt, are seen as upside.

“In fact, the high private debt of Cyprus, which amounts to 236 per cent of GDP compared to the Eurozone average of 140 per cent, and the European Commission’s limit of 115 per cent, combined with the high rate of loans in Cyprus with a floating interest rate, makes these loans particularly sensitive in the era of high interest rates that we are now entering,” Herodotou said.

Herodotou also commented on the central bank’s watchdog debt-to-income ratio measure, which is defined as a household’s monthly debt repayments divided by monthly disposable income.

The measure, he explained, is expected to somewhat moderate the impact of higher lending rates.

Herodotou concluded by saying that there is a need for extra vigilance and concerted action at all levels to address debt risks.