WITH THE time given to Cyprus to sort out its public finances running out, the government has still not given a clear indication of what it plans to do. But decisions will need to be taken in the next few weeks because the credit rating agency Standard and Poor’s is set to review Cyprus’ long-term credit rating next month. The agency put Cyprus on a negative credit watch last July, while Moody’s, whose representatives were here at the same time, made similar noises.
A downgrading of our credit rating would be disastrous for the economy. This would mean the country’s creditworthiness would fall, which would make borrowing both by the public and private sector more expensive; lenders charge higher interest rates when a borrower’s credit rating falls. The state would have to pay higher interest on loans to cover its deficits while banks would also be charged higher interest for funds, which would be passed on to their customers. Rising interest rates would not only delay a possible recovery but could deepen the recession.
The Governor of the Central Bank was reported as saying that a downgrading would have immediate, negative consequences in all sectors, a view echoed by the President of the Chambers of Commerce. What’s worse is that the measures needed to limit the deficit would not be painful – the government needs to save €150 million to meet the target of a deficit of 4.5 per cent of GDP for 2011 – and it would be grossly irresponsible of the government to allow the Republic’s creditworthiness to be downgraded because it is incapable of taking a slightly unpopular decision.
As an IMF official, who was in Cyprus in July, warned: “following Greece’s debt crisis, it is wise to do whatever possible to avoid attracting the market’s attention.” Worryingly, this government has not shown great wisdom in its management of the widening budget deficit. Its proposal for increasing corporate tax, and tax on real estate, was rejected by the legislature, but it insists on reducing the deficit through increasing revenue – higher taxes on tobacco, alcohol, food and drugs as well as special levy on bank profits – rather than reducing expenditure.
The finance minister made vague reference to measures to “contain the public payroll”, but given the control trade unions have over the president and his proletarian ideological fixations, nobody would bet on anything being done. This year, when the public sector unions agreed to zero pay rises and 1,000 posts were supposedly cut, the pubic wage bill was still expected to grow by 9.0 per cent. In 2011the wage bill will grow by a minimum of 5.0 per cent, thanks to incremental pay scales and the Cost of Living Allowance. The increase could be even bigger if the cost of living index is higher than expected.
Under the circumstances, the finance minister would deserve hero status if he does persuade the representatives of Standard and Poor’s agency, whom he will meet in London this week, not to go ahead with the downgrading next month. The odds are stacked against him as he could cite no government measures guaranteeing the reduction of the deficit. The main measures included in the 2011 budget, aimed at generating the €150 million – increased corporate and property taxes – were rejected by the legislature in July and would be rejected again by the parties.
These are not the most effective measures anyway, a point made by the IMF and the European Commission which have said that cutting spending was the only sure-fire method of reducing the deficit. Steps to increase revenue are based on too many unforeseeable factors and are not certain to yield the desired result. But the minister has to work within the boundaries set by a president who has been obdurately refusing to touch the public payroll and pensions, because of his pro-workers ideology, even though he knows that there is no other way of maintaining our A+ long-term credit rating.
We all wish Charilaos Stavrakis succeeds in persuading Standard and Poor’s agency not to downgrade Cyprus’ credit rating, but the best we can hope for is that he will buy some time, and the review is put back by a couple of months. Perhaps this will allow him to explain to the president that the buck stops with him – if he does not agree to cutting the public sector wage bill he will be pushing the economy deeper into recession.
