CYPRUS’ economy has benefitted for the last two decades both from exogenous factors and the entrepreneurship of Cypriot businessman with little support from government policies which intervened with mostly supportive legislature only when necessary. This economic progress was sustained by credit expansion by the banks whose financial position was generally pretty well supervised by the Central Bank. Business services flourished due to the most attractive tax jurisdiction in the EU but also prior to joining the EU a very attractive tax jurisdiction for offshore companies. Hence accountants, lawyers and business services companies attracted many overseas companies, employed many young staff and earned lots in administering the companies they registered. Tourism revenues grew as foreign travel in the EU took off because of cheaper air fares and general prosperity in the EU. The Cyprus Tourism Organisation only had to promote tourism in Cyprus by advertising in the traditional markets and Cyprus enjoyed a boom in arrivals and eventually in second homes for British sun-seekers. In the meantime, the public sector also grew as did the numbers of civil servants. (As the description of civil servants is an anachronism I prefer to call them public sector privileged employees or PSPEs.) The most striking development has been the increasing cost of salaries and pensions for PSPEs, an expenditure which is now so troubling to the Ministry of Finance. This must not be viewed the problem of this government as it has been a development which has taken place over the last 20 years.
It is a very daunting task and I wonder whether the Ministry of Finance really has the guts to take on the PSPE union, the island’s strongest union. It would be particularly surprising as President Christofias’ government is the government of the workers and the PSPEs consider themselves workers. How then can the ruling coalition, whose voice on most issues is split two or even three ways, realistically shoulder the responsibility for reforming the outdated system of PSPE recruitment, promotion, reward and pensions? The truth is that no government in Cyprus has ever been able to take on the PSPE union successfully, so why should this government do differently? Yet, the answer is that unless the PSPE fund in part their pensions, which is not unreasonable, and the cost of this privileged class of workers is brought into line with the private sector, economic progress will not be so lucky in this new decade.
For the last 12 months I have been saying that the mandarins of the Finance Ministry and the government at large got their diagnosis of the financial crisis all wrong. If one looks at the Ministry of Finance’s predictions about the economy, interest rates and economic recovery one can see that the decisions and policies pursued have brought little result. Cyprus has one of the highest levels of interest rates in the EU; development projects that can attract investment and foreign investors remain only on paper and unemployment is reaching record levels. The Ministry of Finance cannot entirely take the blame as their former head Michalis Sarris had warned that the tax revenues which helped Cyprus join the eurozone would not be repeated. Hence it begs the question why the ministry is now looking to raise 500 million euros in revenues when it knew very well the structural increases in expenditure in the last two years. Did the budget office not know what it had produced three years earlier? Of course they knew, but the social face of the new government took over and the minister was happily reminding us every time he announced the increased expenditure that this was the Christofias’ government pledge.
Well, in fiscal matters a government reaps what it has sown and now the ministry is looking at tax evasion and taxing the rich who own expensive villas. In addition the government is asking the political parties to share the responsibility of tackling the mess it created. The problem with this government is that it will not depart from economic thinking reliant on short term measures/fixes which will get popular support in terms of seeming to be doing something but in fact fail to achieve anything. This is more Panglossian economics than sound financial management.
Unless the government gets serious about funding PSPE pensions in a more equitable manner and puts medium term financial policy at the centre of its strategy, the mess will get worse. If one were to add to the domestic problems the banking difficulties which may be present in 2010, it is a recipe for a worsening economic outlook. In case government economists consider the feeble economic recovery in the EU as a positive factor they should think again and wait to see what happens to bank lending in the EU (still in decline) and also see what the EU economies do when the extraordinary measures taken by the central banks are withdrawn. If the announced taxes on property are in fact implemented the private sector, the backbone of the Cyprus economy, will take another hit but this may be temporary as Cypriots have a short memory unless pessimism takes over and investment in general is not forthcoming. The Cyprus economy at its current stage needs the private sector to have certainty about the future and access to cheap credit; it now has neither. The government’s strategy must be to support the poorer classes of society but in order to pay for these socially acceptable policies the economy needs to grow so that the tax revenues also grow. A weak economy and lower tax revenue is now the order of the day and seeking short term fixes is not the way out.
Erol Riza
Director Euromed Corporate Advisors
Former Managing Director of DEPFA Investment Bank
