Staff seem to have sacrificed quality for quantity in their obsession with the cult of GDP growth
The concluding statement of the IMF outlining its preliminary findings at the end of a visit to Cyprus is disappointing in many respects.
In their assessment of the performance of the Cyprus economy the IMF focused simply on numbers of real GDP and employment growth and the fiscal balances per se rather than on the quality of economic growth and government finances. Furthermore, visiting IMF staff did not address certain key problems afflicting the Cyprus economy, namely the lack of decent jobs, prolific tax evasion, the very low public investment rate, the failure of banks to adequately finance productive investments, and pressures on the external accounts. These shortcomings in findings means that the IMF gave unwarranted praise to the Cyprus authorities for their management of the economy and downplayed the policy actions and reforms required to rectify certain of the economy’s key problems.
Need for quality economic growth
IMF staff seem to have sacrificed quality for quantity in their obsession with the cult of GDP growth. Any economy needs economic growth that benefits the wellbeing of the bulk of its population. And GDP growth in Cyprus in recent years has not been associated with the creation of decent jobs and incomes in the private sector and in providing adequate social protection. It is mainly the more highly paid public sector and bank managers and employees as well as the profits of large retailers, hoteliers and property developers that have benefitted from GDP growth in most years since the 2013 financial crisis.
The IMF referred to the erosion of household disposable incomes by the upsurge in inflation, but in their policy recommendations they neglect any measures to protect the purchasing power of most employees and only state that the “Minimum Guaranteed Income be adjusted to improve its effectiveness and protect the purchasing power of vulnerable households” and that “in case downside risks materialise, automatic stabilisers should be allowed to operate and targeted support provided to vulnerable groups”. The IMF essentially argued against protecting the living standards of most households that depend mainly on incomes of private sector employees by “recommending against any upward revision to the Cost of Living (CoLA) mechanism” on the dubious grounds that it “would weaken economic resilience and competitiveness and deepen duality in the labour market since it is mostly public sector employees and around a third of private sector employees which are covered by collective agreements”. It is noted actually that all IMF staff receive full cost of living adjustments to their tax-free salaries each year.
Fiscal policies
While the role of fiscal policy in providing support to households affected by cost-of-living pressures is acknowledged, the IMF staff assessed the performance of the Cyprus government in managing its finances mainly by whether it achieved progress in improving its fiscal balances and put the government debt to GDP ratio on a downward path. And by being obsessed with improving fiscal balances rather than the quality of the government finances and their impact on the economy and society, the IMF implicitly supported the ongoing inadequate fiscal policies of the Cyprus authorities. In referring to the United States, leading economists Larry Summers and Jason Furman state “that policymakers should reconsider the traditional fiscal approach (calling for constraints on budget deficits and debt) that has often wrong-headedly limited worthwhile investments in such areas as education, healthcare and infrastructure… That is a mistake. Politicians and policymakers should focus on urgent social problems, not deficits”.
In Cyprus, fiscal policies have been distinguished by the harsh cutting-back of public investment expenditures and containing social protection expenditures in order to enable payment of the bloated wage bill for public sector employees and the achievement of fiscal surpluses. As 2022 unfolded Finance Minister Constantinos Petrides claimed that the government did not have enough money to support the payment of increased social benefits to households, despite the government having reserves or bank deposits of over €5 billion.
Apart from recommending the reinstatement of the immovable property tax, IMF staff did not comment on the glaring regressive and inefficiently administered tax system of Cyprus typified by widespread tax evasion. Surely the need to raise tax revenue through a more progressively structured and broader based tax system as well as by combatting tax evasion to enable Cyprus to finance productive public investments and social protection compatible with advanced European countries should be addressed in the forthcoming IMF staff report on Cyprus.
Investments and reforms
The IMF staff were not sufficiently critical of the capacity of the government to move forward with promised investments and reforms included in the Recovery and Resilience Plan (RRP) agreed with the EU. This lack of criticism leads to unwarranted optimism about medium-term growth prospects with the IMF stating that “growth will gradually pick up from 2024 and average 3 per cent in the
medium term, supported by public investments and structural reforms under the RRP, large ongoing and planned private investment projects, and a further expansion of the ICT sector”. However, the extremely low rate in implementing public investments, the reluctance and delays in carrying out structural reforms, and the inability of banks to identify and finance more than a few economically viable investment projects should make the IMF more circumspect as to the economy’s growth outlook.
Also, in view of the need to achieve equitable and inclusive growth and not growth of GDP per se there is a need to gear the medium-term policy strategy, including the RRP, more toward the creation of decent jobs and investments in the care economy and social protection.
Bank activities
While the IMF staff reported progress of Cyprus banks in improving their resilience by boosting their capital and liquidity ratios and outlining their vulnerabilities including the questionable quality of their loan portfolios, it needs to be understood that the preoccupation of banks in selling NPLs and related property collateral at large discounts to third parties is diverting their resources and attention away from supporting economic growth with new loans and the productive restructuring of existing loans. Furthermore, removing NPLs from the bank balance sheets still keeps the private sector heavily indebted and with property sold at discounts to predatory investment and equity funds inequalities are widened through wealth transfers.
Balance of payments pressures
Despite the huge increase in prices of imported energy products having a large impact on the foreign trade balances of Cyprus and most other European countries in 2022 there is no mention of this development in the concluding statement. Indeed, the foreign trade deficit of Cyprus is estimated to have increased steeply from €5.3 billion in 2021 to over €7.1 billion in 2022 owing mainly to a rise of €1 billion in the value of imported fossil fuels. And with energy prices expected to increase over the medium term and Cyprus making little progress in shifting to use of renewable energies, extremely high foreign trade deficits are likely to place heavy pressure on the current account of the balance of payments and the external financing needs of Cyprus.
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 at the Central Bank of Cyprus
