Austerity continues needlessly taking money out of people’s pockets
In the immediate years after the Cyprus financial crisis of 2012/2013 there was a compelling need to stabilise government finances with austerity and banks with credit restraint, however, such policies have been relentlessly continued.
Until this day the government has persisted in imposing austerity by exercising tight control over development and social expenditures in order to generate its much- trumpeted budget surpluses.
And Cyprus banks continue to be deficient in meeting the needs of businesses and households for affordable loans to finance worthwhile investments. Instead, they selfishly and inequitably make profits by selling impaired loans and related property collateral and by receiving lucrative interest income through depositing their huge piles of cash at the ECB.
In truth, fiscal austerity and resultant government surpluses take money out of people’s pockets, while banks make large amounts of their profits from activities that hardly provide any returns to the economy and society.
Government
The government with its budgeted-targets of mounting surpluses has piled-up deposits at banks amounting to nearly €6 billion or over 18 per cent of GDP at end-September 2024.
While the government needs reserves to safeguard against contingencies and repay its debt, the level of its cash balances at banks are grossly excessive by any standard. Thus, the claim of the government that it does not have the money to support social needs, the care economy and other essential expenditures is bogus.
Furthermore, with the impact of recent inflation raising government revenue substantially from VAT and income taxes, fiscal austerity seems no longer necessary.
Although the government needed to apply austerity on overall public expenditure in the initial years following the 2012/2013 financial crisis, it has, apart from serving its own political and financial interests, especially in boosting the government payroll, continued after 2015 to apply austerity on other important areas of government expenditure so as to ensure budget surpluses.
Undeniably, budget surpluses have resulted in large part, at least compared with many other EU members recording deficits, from the Cyprus government spending relatively much smaller amounts on social protection.
Such expenditure amounted to a mere 11.8 per cent of GDP in 2022 compared with the EU average of 19.4 per cent of GDP. Notably, pensions paid by the Cyprus government are around two-thirds of the average level of those in the EU in relation to GDP.
Furthermore, by failing even to adequately spend the very limited amounts of funds annually budgeted for executing planned development projects, the government is contributing to the string of surpluses.
In fact, in most years less than two-thirds of the budgeted amounts for development are disbursed, with the implementation rate in the first nine months of 2024 being a lowly 37 per cent.
Banks
Cyprus banks compared with many other banks in the euro area are playing a much weaker role in supporting the economy and society. In fact, over the last ten years banks have done little in financing investment projects outside of the property sector, but have concentrated on restructuring and calling-in impaired loans and in piling-up cash to draw interest income from the ECB.
While top bank executives and some businesses, mostly property developers and hoteliers, have benefited handsomely from their transactions with banks, many enterprises and households have suffered from unaffordable interest rates and the inability to repay loans often resulting in the loss of their premises and properties.
After strengthening their liquidity and capital ratios, by 2016 Cyprus banks were in a position to finance the balanced growth of the economy with productive loans. But, since end-2015 they have more than halved their outstanding loans and advances by €34.8 billion to reach €25.3 billion at end-2023, despite their deposits rising by €11.4 billion to €57.4 billion over the same period.
This extremely large contraction in outstanding bank loans was attributable mainly to the massive removal of non-performing loans (NPLs) from their balance sheets through writing off these loans and/or selling them to third parties. And from such transactions, including the sale of the delinquent borrower’s property collateral at large discounts, Cyprus banks have made considerable profits.
Notably, the shedding of NPLs from bank balance sheets has not relieved many distressed borrowers of their debt burdens as a great number of these loans have been acquired by third parties such as predatory debt collection agencies. In fact, the private sector comprising the Non-Financial Corporations and households still remains heavily indebted with loans outstanding of €61.6 billion or over 190 per cent of GDP at end-June 2024.
However, in the period since 2015, apart from banks getting NPLs off balance sheets, their activities have been highlighted by the relative failure in using their abundant reserves to extend loans to support the economy and society.
Cyprus banks have just accumulated cash and cash balances at the ECB, with interest income from the latter institution being the main source of their very large profits over the last two years.
Indeed, between end-2015 and end-June 2024 cash and cash equivalents held by Cyprus banks rose by €9.6 billion to reach €20.8 billion or 32.9 per cent of total assets, compared with their loans and advances of €26.1 billion or 41.3 per cent of total assets on the same date.
In sharp contrast systemically important banks in the other euro area countries recorded loans and advances averaging a much higher 61.1 per cent of their total assets at end-June 2024, a ratio together with their very low NPLs indicating undoubtedly that many of these banks are performing better than Cyprus banks in driving their economies.
Cyprus bankers complain that their dearth of lending reflects the lack of creditworthy customers. Unfortunately, they base most of their limited lending on the security or collateral provided by the borrower, rather than on an assessment of the loan applicant’s ability to repay.
In this connection, bankers do not appear to have the willingness and/or the competence to evaluate the capacity of the borrower to repay loans, especially in cases where estimation of the income from planned investments is required.
Indeed, with such lending practices Cyprus bankers are not only failing to finance worthwhile investment projects, but risk creating NPLs and also widening inequalities as it is those households and businesses with considerable property wealth that are mainly financed.
What must be done
The bottom line is that the government and banks in their self-serving behaviour and relentless pursuit of surpluses and profits are falling far short in their willingness and ability to support the economy and society.
The government must rid itself of its overwhelming objective to generate sizable budget surpluses and allocate more of its ample resources to efficiently implementing key, but economically viable, public investment projects as well as targeting deserving persons, such as single mothers, and pensioners with adequate social assistance.
Banks need to be induced to deploy a greater amount of their funds in extending interest bearing loans to businesses and households to make reasonable profits instead of just accumulating cash in order to receive “unearned” interest income from the ECB.
Accordingly, serious consideration should be given to taxing net interest income from bank transactions with the ECB at a much higher rate than the rate levied on profits from other sources.
And banks should be persuaded to move their lending practices away from security-based loans to credit premised on the ability of the borrower to repay. Furthermore, banks have to exercise more social responsibility in setting affordable loan interest rates and in offering more attractive deposit rates.
A crucial and festering problem is that Cyprus sadly lacks the institutional and technical capacity, that is untainted by political factors and corruption, to effectively implement investment projects needed for sustained economic development and for protecting the environment.
While the government and banks can recruit and train employees to raise their competence in evaluating, financing and negotiating investment projects including PPPs, it has been the repeated view of economist Savvakis Savvides and this author that the effective and timely implementation of large-scale investment projects can only be accomplished with profound institutional changes.
Most importantly, an independent development-type finance agency needs to be set-up staffed with apolitical technical experts who would be tasked with evaluating and financing large-scale investment projects.
And the Tenders Review Authority should be reformed and staffed with experts who can better assess which bidding contractor would be able to efficiently implement and complete a specific investment project. Furthermore, the procedures of this authority need to be streamlined through, among other things, significantly limiting the number of appeals that can be made by unsuccessful bidders.
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
