DESPITE improved growth forecasts, the island’s economy could be looking at a further downgrading unless immediate action is taken to clean up state finances, Central Bank director Athanasios Orphanides said yesterday.
“A delay in taking such measures poses one of the greatest dangers facing our economy at this moment,” he warned.
He was speaking to reporters after a presentation of the Central Bank’s macroeconomic forecasts for the period up to 2012, where Orphanides painted a gloomy picture for the future of the economy.
The outspoken Central Bank chief flat-out dismissed the notion of raising taxes now, saying this would neither help restrain the rising cost of living nor improve public finances in the long run.
And on the recent downgrading of the Cyprus economy by ratings agency Standard and Poor’s, Orphanides said the smoking gun was the poor state of public finances, and not the purported culprit, an oversized banking sector.
Orphanides stressed that, in the long run, correcting public finances should go beyond efforts to plug the public deficit by also focusing on reining in a spiralling public debt – now €800 million in the red.
According to the Central Bank, the national economy is set to grow by 0.7 per cent this year, and the recovery is set to continue into 2011 and 2012, when Gross Domestic Product (GDP) is expected to increase by 1.8 and 2.4 per cent, respectively.
The Central Bank said the upward revision followed positive performances by the tourism and financial services sectors.
Despite this positive outlook, the rate of economic growth projected for 2012 would still be lower than the average registered in Cyprus before the economic crisis hit home, Orphanides noted.
An economic rebound should be therefore backed up by structural changes and steps to clean up state finances which would “guarantee the substantial and sustainable improvement in the living standards of all Cypriots,” he said.
According to the Central Bank, the rate of unemployment is expected to drop below the seven per cent mark this year, decreasing further to six per cent in 2012.
Orphanides said the outlook was better than the last forecast six months ago, but was quick to add that more Cypriots are now out of a job than prior to the financial crisis.
On the downside, the rate of inflation – currently standing at 2.7 per cent – is set to increase to 3.4 per cent next year and then drop to 2.4 per cent in 2012.
Orphanides described as encouraging the growing calls to curtail public spending, and expressed the hope that the economic measures now under discussion would be passed before parliament votes on the 2011 government budget later this month.
Orphanides avoided directly answering a question as to whether the necessary “corrections” amounted to €150 million – as estimated by the government – or closer to €500 million.
He referred, however, to the European Commission’s latest “disheartening” forecast, according to which Cyprus’ public debt has soared from 53 per cent – as predicted a year ago – to 58 per cent of GDP now and was poised to hit more than 68 per cent in 2012.
The five per cent revised increase in the public debt corresponds to some €800 million.
“This is much larger than the numbers being floated around as corrective measures,” Orphanides remarked.
“In my view,” he added, “what’s more important is to put our country’s finances on a solid footing for the long run. It does not matter so much whether the deficit for 2010 will be cut by €200 million or €500 million.”
Again citing European Commission statistics, the Central Bank chief said Cyprus’ public debt, registering at 48 per cent of GDP at the end of 2008, would swell to 68.8 per cent of GDP by 2012, and this despite the expected economic growth.
This was an especially worrying trend, Orphanides noted. “If the public debt has deteriorated by 20 percentage points in the space of four years, or €3.5 billion, then you begin to realise what sort of improvements our public finances need,” he said.
Nevertheless, Orphanides welcomed the government’s commitment to the European Union to slash the deficit to 4.5 per cent of GDP by 2011 and to three per cent by 2012.
Asked whether containing the state payroll and downsizing the public sector are a “cure-all”, he said reported plans to reduce the number of civil servants by 1,000 per year were a step in the right direction.
And citing International Monetary Fund Executive Director Age Bakker, who was on the island last month, Orphanides said Cyprus was the only eurozone country which, far from reining in wages and reforming its pensions systems in the public sector in the midst of an economic crisis, “has instead introduced salary increases that are disproportionate to both the increase in GDP and productivity”.
Orphanides also dismissed out of hand the notion that raising taxes would consolidate state finances.
“When we speak of straightening out public finances in this country, we mean limiting expenditures and not raising taxes,” he commented.
“Financial consolidation in the long term does not entail increases in taxation, rather it entails cutting spending and of course by cutting spending we would have had a resulting decrease in prices,” Oprhanides added.
The Central Bank chief also cast doubt on the official reason for the recent downgrading of Cyprus’ economy by ratings agency Standard and Poor’s. The agency had cited the banking sector’s high exposure to debt-ridden Greece as the reason for the downgrading.
“It was somewhat strange,” Orphanides said of the explanation given for the downgrading.
Whereas the downgrading itself was probably justified, in his view it was linked to the state of public finances rather than to the size of the local banking sector.
“I am troubled by some of the references in the [agency’s] analysis, which seem to question the robustness of our banking sector, which is inaccurate.”
Far from being negative, a large banking sector was a plus for the economy, he argued.
He cited the example of Luxembourg, which despite having an economy roughly the size of Cyprus, its banking sector was three times larger. Despite this, Orphanides noted, the robustness of Luxembourg’s economy – with an AAA rating –has never been questioned.
In fact, the only telling difference with Luxembourg was that country’s state finances, which fare much better than Cyprus’; Luxembourg’s public debt is projected to reach 20 per cent of GDP by 2012, compared to Cyprus’ 68.8 per cent, Orphanides said.
The Central Bank director went on to call for the creation for a financial stability fund, which would act as an additional “cushion” and would enhance the credibility of the local banking sector.
