By Paul Rowland
Since their introduction in March of this year capital controls, although preventing a run on the bank deposits, in particular Laiki and Bank of Cyprus (BoC, have had several unwelcome effects.
Among them are: the hoarding of cash by bank customers; an expansion in the informal (cash) economy leading to reduced tax revenues, and a crippling effect on private sector cash flow where the controls meant companies have been unable to meet payroll, pay creditors and otherwise run their businesses.
There is the question of how effective the controls are. A leading Cypriot economist, in a recent interview with the Wall Street Journal, estimated that despite the controls banks are losing (leaking) deposits at the rate of some €30 million per day.
Although in recent months the controls have been relaxed to some extent and a “road map” published by the ministry of finance, the situation remains unclear. To quote from the IMF (Country Report No. 13/293 September 2013): “While motivated by real economic needs, the relaxation of restrictions to date has not been anchored within an overarching strategy, leading to uncertainty in the markets and a hoarding of cash by the private sector.”
Both the president and the minister of finance have indicated that capital controls will be lifted by the end of January next year, though the minister of finance wisely added the proviso that transfers out of the country will continue to be restricted, effectively de facto exchange control. We can only hope in four months time confidence will be restored in BoC and there will not be a run on deposits. If there is a run, all bets are off and the bank will have to be rescued again. The alternative of allowing the bank to fail will mean the government guarantee, on all deposits up to €100k, will have to be honoured which at the present time will put intolerable strains on the exchequer. Should this happen, some form of exchange controls will have to remain in place for some considerable time.
Take the case of the United Kingdom; in 1900 the UK was one of the richest economies in the world. Following the great depression in the 1930s, in order to protect the currency, the UK made it an act of treason for her citizens to use any currency except pounds sterling and in 1939 imposed formal exchange controls. Following decades of decline, by the 1970s the UK was effectively bankrupt, and in 1976 was forced to apply to the IMF for a £2.3 billion rescue package, the largest ever call on IMF resources up to that time. The IMF conditions for the loan included deep cuts in public expenditure, and in effect the IMF took control of UK domestic policy. If it sounds familiar, it should. The troika MoU has much the same effect on Cyprus.
What saved the UK was North Sea oil. In 1979 the oil started flowing and the UK suddenly had a balance-of-payment surplus. Margaret Thatcher came into office in the same year and in the October abolished exchange controls, forty years after they were first imposed.
It is precipitous to think, as was the case with the UK that the gas finds will save Cyprus. It will be some years before they generate revenues and in any case international loan repayments will take priority over discretionary spending. Far better that Cyprus practises some prudent housekeeping first and uses the future gas revenues to help develop an open, diversified and sustainable economy. This view was expressed by the minister of finance who stated earlier this week that Cyprus could not rely on hydrocarbons to fix its economy.
What Cyprus needs to do is tame the tiger, meaning restoring confidence in the banking system, which in turn will allow the orderly relaxation of the capital and possible de facto exchange controls. Failing to do so will result continuing with the status quo: namely uncertainty of the present, a longing for the way things were before the crisis and fear of the future.
A leading economic strategist with Bank of America Merrill Lynch put the case more succinctly: “They need to first fix the banks. If you don’t fix the banks, you can’t have a recovery. It’s as simple as that.”
Paul Rowland is a founder member of a European consultancy for asset protection and debt management and former senior executive in international banking in the Channel Islands. [email protected]
