Policies of Government, Banks and Employers Depressing Cyprus Economy

Accounts and behavior of the government, banks and many employers in the first six to seven months of 2022 indicate that their policies and activities are having a depressing impact on the economy. Only the expenditure of foreign tourists is enabling Cyprus to avoid recession. In this respect are the Cyprus authorities trying to reduce “cost-push-inflation” by curtailing domestic demand and/or is the government saving up funds for the Presidential election campaign? Indeed, it is very disappointing that the government, banks and many employers during this period of steep rises in the cost of living and business operations are doing very little to assist households and businesses financially and instead are imposing austerity on the economy.

Government Policies

Despite rising costs and prices the Cyprus Government cut back its total expenditures by 3.5% or by nearly 10% in real terms in the first 6 months of 2022. This expenditure restraint together with higher prices boosting tax receipts enabled the government to produce surpluses in recent months meaning that the government is taking more money out of the economy than it is putting in.

What is particularly disturbing is that the government is earning greater revenue from VAT and excises from expenditure on higher-priced goods and services, yet outlaying only very small sums for those suffering the most from steep increases in the costs of living and business operations. In addition, the Government receives substantial revenue from the Carbon Emissions Trading Scheme which is supposed to be used primarily to assist vulnerable persons with their high energy bills; however, such revenue is mainly deployed by the government for other purposes.

It is ludicrous for the Government to claim that it does not have the resources to meet the needs of vulnerable households most adversely affected by the higher cost of living. With its generation of increasing monthly budget surpluses the government is piling up reserves with its deposits at the Central Bank and commercial banks reported to be over 5.5 billion euro and around 1.2 billion euro, respectively.

Apart from not injecting sufficient funds into the economy through its total expenditures the government’s allocation of funds is inequitable and is increasingly unproductive. While wages of government employees rose by 5.3% in the first six months of 2022, payments to pensioners recorded a small increase of 1.3%. Although social security payments to vulnerable persons have risen by over 8% during the January to June period of 2022 their level is still insufficient to eke out a decent standard of living, especially when facing consumer prices rising at rates exceeding well over 10%.  And at a time when many households are descending toward poverty there are questions as to whether the Ministry of Labour and Security under its new leadership has the willingness and administrative capacity to target deserving households with adequate social benefits!

Reflecting the lack of administrative capacity and technical competence and the related considerable recruitment of largely unqualified staff for political purposes, the government is falling substantially behind in implementing development projects. In fact, real development expenditures declined by over 5% in the first half of 2022 with the Government failing miserably in executing investment projects and required reforms under the Recovery and Resilience plan.

Banks

In March 2016 Cyprus exited the adjustment program with the “troika” of international institutions comprising the IMF, the European Commission and the ECB with the government claiming that financial stability had been restored. And in this connection it was contended that banks were well-capitalised with adequate liquidity giving them the potential to contribute to enhancing the performance of the economy. However, the poor quality of the asset portfolios of banks highlighted by non-performing loans (NPLs) in early 2016 amounting to around 45% of their outstanding loans impeded the extension of productive financing by banks. Indeed, bankers argued that despite the economy beginning to recover there was a dearth of creditworthy customers to lend to.

While this was the situation that banks faced in 2016 data on the subsequent activities of Cyprus banks indicate that they have an overall contractionary impact on the Cyprus economy and have focused too much on the transfer of wealth through the selling of NPLs and related property collateral.

Since early 2016 there has been a steady accumulation of bank deposits, but a huge contraction in outstanding loans, by over 50% or 29 billion euro between March 2016 and June 2022, as banks reduced drastically their levels of NPLs through write-offs and selling them and related property collateral mainly to “credit-acquiring companies”. However, with these sales of NPLs the private sector continued to be burdened with overwhelming indebtedness with loans outstanding of households and NFCs totaling 56.5 billion euro or 225% of GDP at end-March 2022. In contrast, the productive rescheduling of loans and the extension of new credits to households to finance productive investments and the real economy has been very subdued since March 2016 with loans outstanding to domestic NFCs falling by nearly 50% or more than 10 billion euro.

Moreover, during the last two years plus when businesses and households have been severely hobbled by the impact of the Covid virus and related restrictions, banks despite their abundant liquidity have failed to support the private sector with productive debt rescheduling and the adequate extension of new credits. Rather banks have continued to be pre-occupied in selling their NPLs and related collateral. In fact, the two largest Cyprus banks have increased their holding of cash and cash balances at the central bank “earning” negative interest by a whopping 67% or 6.7 billion euro over the two years to March 2022, but have reduced their outstanding interest-bearing loans by nearly 700 million euro during this period.  Thus, banks are failing to transform savings into economically viable investments and are just piling up loss-making cash and together with their increased charges on depositors and on customer transactions harming the economy and society. It is no wonder that Cyprus banks have been by far one of the worst performers in the EU in recent years with their return on equity falling to 0.18% in the first quarter of 2022.

Employers

In the face of rising costs and labor shortages most employers are endeavoring to keep their wage costs low and are reluctant to boost payments to employees to protect them from surging inflation. Surely businesses such as supermarkets, which have substantially raised their prices over the last year, can afford to increase the wages of lowly-paid shop assistants and cashiers that are estimated to earn between 900 and 1,100 euro monthly! Furthermore, the delay in agreeing on minimum wage legislation appears to be providing an excuse to some employers for not raising the wages of lower-income employees.

Such wage restraint by employers impovershises the real spending power of private sector employees and causes further weakness in the overall economy. And by next winter with energy and food prices continuing to be elevated and with many families having not received any meaningful increases in their incomes even many middle-income households could face an unpalatable choice between eating and heating.