As the EU counts the cost of Greece’s fiscal crisis and austerity programme, Charles Charalambous considers the potential effects and prospects for Cyprus
AS THE heads of the Eurogroup governments wrangle over the economic and political costs of the €110 billion Greek rescue package agreed by the EU with the IMF, local attention is focusing on how Cyprus might be affected and what lessons we should draw from Greece’s fiscal crisis.
Of particular concern is a possible knock-on effect on the financial sector, especially given the interconnectedness of the two countries’ banking sectors.
The three biggest Cypriot banks – Bank of Cyprus, Marfin Popular Bank and Hellenic Bank – all have operations in Greece and are listed on the stock exchanges of both countries. Greek banks such as Alpha Bank, Piraeus Bank and Eurobank also have a growing presence here.
On the debit side, the preponderance of bank shares on both the Athens Stock Exchange (ASE) and Cyprus Stock Exchange (CSE) has meant that the general index and banking index in both exchanges have taken a hammering over the last eight weeks or so.
Since mid-March, the ASE and CSE banking indexes have fallen by some 26 per cent and 22 per cent respectively.
Another evident direct effect has, on the face of it, been positive: over the last few months, there has been a steady flow of Greek capital to Cyprus – estimates vary from €1 billion to €3 billion or more – as richer private individuals and businesses have moved their liquid assets here.
The generally held view is that this is a question of confidence – the relative security and reliability that Cypriot banks can offer in a time of uncertainty, rather than their higher deposit rates.
Barclays Wealth Cyprus country manager Evan Gavas told the Sunday Mail: “There does seem to have been quite a significant movement of funds from Greece to Cyprus, as well as Switzerland and the UK. It seems to be moving from what the public perceives as weaker institutions to more solid, stable institutions with better credit ratings.”
But former Finance Minister Michalis Sarris believes the special connection between the Greek and Cypriot banking systems has its downside, as any increase in interest rates in Greece will most likely have unfavourable consequences in Cyprus.
“The cost of borrowing is sure to rise, because the Greek banks will have to borrow at a rate that is at least as high as the one being paid by the Greek state. There is a close connection between the two banking sectors, so we can’t avoid that,” he said.
For Sarris there are two distinct aspects to the crisis – how the economy here might be affected, and what lessons should Cyprus learn to avoid similar pitfalls?
Speaking to reporters on Monday, Central Bank (CB) Governor Athanasios Orphanides described a causal link between “the deterioration of the fiscal situation in Greece, caused by problems related to the economic policy” and the difficulties faced by Greek banks in drawing liquidity from financial markets, following the downgrading of the country’s debt by the credit ratings agencies. “Otherwise, the Greek banking system was not suffering but was robust and in a good condition,” he said.
“I insist on this point because I want to stress how important it is to address fiscal policy if we want to avoid side effects on the financial and banking sector, especially in countries where the banking sector contributes decisively towards the growth of the economy.”
Speaking to reporters after last Thursday’s meeting of the European Central Bank’s Governing Council (GC), ECB President Jean-Claude Trichet echoed this view, making it clear that the GC viewed the Greek “economic and financial adjustment programme” as part of “safeguarding financial stability in the euro area as a whole”.
“As regards fiscal policies, we call for decisive actions by governments to achieve a lasting and credible consolidation of public finances. … The longer the fiscal correction is postponed, the greater the adjustment needs become and the higher the risk of reputational and confidence losses.”
Barclays Wealth Equity Strategist Henk Potts agrees that timing is crucial. He told the Mail that the situation in Greece “just shows you how vulnerable and fragile the financial system still is. It only takes a few things to produce a run on the banking system, and once investors and customers have lost confidence, it very quickly falls into pandemonium.”
He added: “When you look at the interest payments the market is requiring now, you can see that the economic recovery is still very hesitant. We are seeing the practical implications of the solutions that have been implemented to deal with this crisis over the course of the past two years. Effectively, many authorities are mortgaging the future in order to pay for the present.”
Because public borrowing has gone through the roof and public deficits have increased dramatically, Potts believes in the second half of 2010, Europe especially will have to embark on the “most protracted period” of fiscal tightening in history – probably lasting some five years.
Sarris fears that if the government needs to borrow for whatever reason – for example, to help the banks with liquidity – the markets will not be kind if common sense and good management are perceived to be lacking.
“We need things to be much better than last year, in order to send the message that we are serious, that we can cut back on spending without causing social unrest,” Sarris said.
“Doing this in a timely way will send out the message that we should be bracketed with the seriousness shown by Germany, Finland, Austria or Holland, not with the nonsense displayed by Greece, Portugal, Spain or Italy.
“Our choice is very clear – but that choice must be made now, before it is too late. Because as we saw with Greece, if they had decided two years ago to take the milder medicine for a milder illness, then the consequences would have been far less strong – people would not be at each other’s throats.”
Last December, speaking in a panel discussion at the University of Cyprus, Sarris said he was “very pessimistic” about the political will being shown to make necessary structural changes to public finances, particularly on big issues such as civil service working hours, wages, pensions and salary grades. “Unfortunately we are following in Greece’s footsteps, perhaps at a slower pace,” Sarris said at the time.
Some five months later, Sarris told the Sunday Mail he could see nothing that might change that opinion.
“Look, we had the warning signs long before then, and it looks like now we have still not come to our senses.
“You don’t have to be an expert to understand these things. A householder who knows he has been spending more than he is earning over many years, knows that one day he will have to deal with the shortfall – unless he has a rich uncle in the US who can send him the cash.”
