Cyprus Mail
CM Regular ColumnistOpinion

Wealthy households, high debt and low incomes

comment les labour productivity per employee for cyprus was 18 per cent below the eu average in 2021
Labour productivity per employee for Cyprus was 18 per cent below the EU average in 2021

Cypriots own a lot of property but that hides the true story

Ultimately, economics is about people. In this connection the ECB Household Finance and Consumption Surveys (HFCS) provide valuable data for assessing developments in the levels of economic and financial well-being of households of countries in the euro area. Thus, this piece using the most recent HFCS for 2021 focuses on the economic and financial situations of Cyprus households relative to the average of households in the euro area.

Ever since 2010 according to HCFS surveys the net wealth of Cyprus households has remained well in excess of the average of counterpart households in the euro area despite the deposit haircut in 2013 and the large decline in house prices from their peak in 2008.

The latest HFCS indicates that the median net wealth of Cyprus households was estimated at around €200,400 in 2021 compared with an average of €123,500 for the euro area. Only households in Luxembourg and Malta are estimated to have higher median net household wealth than Cyprus. The average Cypriot household owns much more real estate, mainly comprising their prime residence, than counterparts in the euro area with the median value of these holdings for Cyprus estimated at €267,000 compared with a euro average of €208,000. Conversely, the median value of the holdings of financial assets by Cyprus households are much lower at €5,500 compared with the average of €15,000 for households in the euro area.

Owing mainly to Cyprus households owning relatively higher amounts of debt-financed real estate their average financial liabilities were more than their euro area counterparts. In fact, in 2021 it is estimated that the median value of the outstanding debt of Cyprus households was €66,400 as against a much lower €30,400 for euro area households.

In contrast to the relatively high value of net wealth of Cyprus households, their average incomes have been lower than the average of euro area households. In 2021 median annual gross income per household in Cyprus was estimated at €28,000 compared with a median of €34,000 for euro area households. And with lower incomes, but much higher debt, the debt servicing burden of Cyprus households is much greater than that of European households.

Indeed, in 2021 the debt service to income ratio of Cyprus households was 20.5 per cent compared with 12.8 per cent for indebted euro area households. But what is most striking is that lower income households had much higher debt service ratios averaging well over 30 per cent making it extremely difficult for them to not only repay loans, but to save and add to their wealth.

 

Composition and use of household wealth

Real Assets

How can the discrepancy between the relatively high levels of household wealth and relatively low levels of household income in Cyprus be explained?

Much of the explanation lies in the inability of Cyprus entities in using their resources including household wealth to raise productivity to the higher levels of many euro area countries. Indeed, Eurostat estimates show that labour productivity per employee for Cyprus was 18 per cent below the EU average in 2021.

Low productivity is attributable partly to households in Cyprus having a much higher proportion of their physical wealth in real estate comprising mainly residential housing. It is estimated that over 80 per cent of Cyprus households had real estate wealth in 2021 compared with an average of 66 per cent for euro area households and 49 per cent for a high productivity country like Germany. And a considerable part of the wealth of Cyprus has been invested in sparsely occupied apartment buildings and commercial establishments, capacity that adds little to production and in effect diminishes productivity.

But apart from the relatively less-productive composition of the physical assets of Cyprus households, it is the inefficient use of its real and financial assets as well as that of human capital by Cyprus entities that has contributed most to its relatively low productivity levels.

In response to government policies promoting property investment, private consumption and mass tourism, resources have been channeled into the more labour-intensive construction, retail, and food services and accommodation sectors of the economy. And with employers in the retail and hospitality sectors at least employing mainly unskilled labour the resultant productivity and wages are low. Furthermore, the relatively modest levels of capital intensity of economic activities in Cyprus keeps total productivity quite low. In fact, Eurostat data reveal that investment per employee in Cyprus ranked 17th among 27 European countries.

While the low capital to labour ratio has been important in determining relatively low labour productivity and wages in Cyprus, the sectoral structure of wages indicates that other factors also have kept down the remuneration of most private sector employees. Although labour shortages exist in the rapidly expanding hospitality and retail sectors, hoteliers and large retailers have used their market power to suppress wages of workers below productivity levels. Indeed, in 2021 the average gross monthly earnings for employees in the hotel and retail sectors were estimated, respectively, at €950 and €1,306 according to Cystat, that is, well below the total economy average of €2,056.

In addition, despite the lack of employment opportunities in other areas of the economy low wages have made many Cypriots reluctant to take on jobs in the hospitality and retail sectors. But, labour shortages have been overcome by foreign workers, including asylum seekers, willing to accept meagre wages, thus contributing to Cyprus remaining a low wage economy.

Furthermore, the human capital resources of Cyprus are not being used efficiently owing partly to the government appointing and promoting many employees on the basis of their political and personal affiliations rather than on merit. Also, with the relative absence of high-tech companies in Cyprus there is a dearth of decent jobs for skilled and well-qualified persons in the private sector. Consequently, many talented younger persons are under-employed or remain unemployed, while others decide to emigrate, resulting in Cyprus being robbed of their potential for raising productivity.

Financial assets and liabilities

It is very concerning that Cyprus banks are not using a large proportion of the financial assets of their customers in the form of bank deposits to help finance productive activity by extending loans to non-financial corporations and households. In fact, a large amount of the assets of Cyprus banks lay idle in that their cash and cash balances held at the central bank have constituted at least 35 per cent of their total assets since mid-2021. This compares with an average share of such liquidity in total assets of 16 per cent for the systemically important banks of 17 other euro area countries.

Also, with much of the lending of Cyprus banks being based on property collateral rather than on a proper assessment of the borrower’s ability to repay from income, many loans become impaired resulting in Cyprus banks having the highest ratio of NPLs to total loans in the euro area. Indeed, reflecting the relative inability of Cyprus banks to use their funds productively their return on assets has over recent years has always been below that of most other banks in the euro area. For 2021 the return on assets of the two systemically important banks of Cyprus was estimated at 0.09 per cent, whereas the average for the other systemically important banks of the euro area was 0.41 per cent.

The continued heavy debt burden of many Cyprus households is impeding their ability to undertake productive investments. In truth, bankers complain that many potential customers with their relatively high debt-to-income ratios are uncreditworthy and should not be extended new loans. And bankers seem also to have a reluctance to restructure many impaired loans to enable the continued operation of many small businesses, but rather prefer to call in and sell these NPLs and the related collateral of the borrower to third parties. However, with such transactions, NPLs of banks are reduced, but households remain in debt. Moreover, the investments and production of small businesses are curtailed, while wealth assets are just transferred to usually richer entities.

With their much higher ownership of real estate Cyprus households by 2021 remained wealthier than their counterparts in most euro area countries. However, continued sizable investments in the over-supplied luxury property sector and higher rates of consumption, especially of motor vehicles, by Cyprus households compared to their euro area counterparts together with government policies have contributed to the abundant channeling of resources to the lower productivity property, retail and hospitality sectors that pay relatively low wages. This in turn has meant that the incomes of the many households dependent mainly on the remuneration of private sector employees have remained subdued, thus curtailing their ability to save, accumulate wealth, and, most importantly, repay their heavy debt obligations.

Indeed, given their lower remuneration levels, the debt servicing requirements of lower and middle-income Cyprus households became particularly burdensome by 2021. And, furthermore, as a result of the recent higher inflation and the sharp rise in interest costs and bank charges, the financial fragility and economic well-being of lower and middle-income households must have worsened since 2021, thus, narrowing more the wealth gap between Cyprus and euro area households.

 

Les Manison 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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