Cyprus: bread and olives
by George Hatjoullis
The Cyprus crisis is, as yet, of little consequence to the eurozone. It may never be of any consequence. It is, however, matter of devastation for the economy of the Republic of Cyprus. The true horror of what is unfolding is such that many seem unable to grasp it. Perhaps it is number blindness. Huge numbers have become commonplace in the media. So what is the significance of 23 billion euros?
In order to get some perspective let us compare the nominal GDP of two countries; the UK and Cyprus. According to the IMF (http://bit.ly/YRlgbM) the nominal GDP of the UK was about USD 2.434 trillion in 2012. The nominal GDP of Cyprus is estimated at USD 22,446 billion.If we convert both numbers to euro at 1.30 we obtain 1.872 trillion euro and 17,266 billion euro respectively. A trillion is a one million million. A billion is one thousand million. The GDP of the Republic of Cyprus is about 1% of the GDP of the UK. Are we getting some perspective here?
The finance package agreed with the eurogroup yesterday is for 23 billion euro or 133% of the nominal GDP of the RoC. If the UK had agreed a similar package then the amount would have been 2.5 trillion euro. To get even more perspective note that the total fund of the ESM is only 500 billion euro or half a trillion. The relative size of the RoC financing package is unprecedented. Of the 23 billion the RoC will be loaned only 10 billion euro and must find 13 billion euro from its own resources. It must generate from the residents of the Republic a sum equal to 75% of nominal GDP. If the UK government were so tasked, it would need to find from its citizens 1.41 trillion euro.
Of the 13 billion to be found by the RoC government it seems 10 billion euro will come from the uninsured bank depositors, 4 billion more than was originally thought. In UK terms this is the equivalent of bank depositors losing 814 billion euro. This is not a dissimilar sum to the one that might have been ultimately lost if the UK government had not used taxpayer funds to bail out HBOS and RBS. Imagine the economic consequences in the UK if this had been allowed to happen. Note how severe a recession the UK has experienced since 2008 and imagine how bad it could have been. It is quite hard to get your head around is it not? I will take this opportunity to remind all readers that taxpayers in the UK did not bail out the banker bonuses. They bailed their own uninsured deposits (and as i have argued, possibly insured deposits) and in the last analysis many of their own jobs.
In order to stay in the eurozone the government of the Republic of Cyprus has agreed to an economic shock of unprecedented and unreasonable magnitude. Yet the eurogroup believe this will lead “…to a sustainable path…”(http://bit.ly/17wce7c). How can it possibly lead to a sustainable path?
The single biggest source of revenue, the financial services sector, has been decimated. There is no possibility that the remaining productive sectors can grow to compensate in a reasonable time frame. This is especially so because other sectors such as tourism, agriculture and manufacturing, are price sensitive and subject to competition from nearby non-eurozone states. The financial services sector was much less price sensitive. The RoC cannot devalue to restore its competitive advantage so it can only achieve a restoration of competitiveness by internal devaluation through lower wages. This will be a struggle. The RoC economy is highly unionised.
The ‘rescue’ package condemns the citizens and residents of the Republic to bread and olives for an indefinite period. Over this period the Republic will accumulate huge debts that might eventually be paid off if the gas reserves deliver up their bounty. In effect the package mortgages these reserves. The question must be asked whether the deal justifies the determination of the RoC government to stay in the eurozone.
A negotiated exit from the eurozone offers a potentially less severe adjustment. The economy and its people will still suffer. Moreover, many of the reforms that the troika demand still need to happen. The civil service is bloated and overpaid and over pensioned. The unions are too powerful and this could negate the main benefit of exit which is to devalue the currency. The net effect may be simply inflation. Some state run entities might indeed benefit from privatisation (I am thinking of telecoms in particular). The culture of the people needs to move away from who you know and towards what you know. It needs to become more meritocratic. Laiki and Bank of Cyprus both needed to be recapitalized and restructured. The Greek bonds fiasco had eliminated their capital. None of this is changed by an orderly exit and in this respect I agree with Mario Draghi. However this is beside the point.
Outside of the eurozone the Greek Cypriots will have to face up to these economic and cultural realities and it is for Greek Cypriots to decide their own fate. The common view was that the greatest threat to Cyprus is Turkey and that the RoC is safer in the EU. A negotiated exit from the eurozone may allow them to stay within the EU though this is unclear. However, it is unclear that the RoC is any safer from Turkey in or out of the EU. It is unclear that Turkey is any longer a threat if not provoked. A negotiated end to the events started in 1974 is long overdue. It is time to move on and this may ironically be more likely outside of the eurozone and maybe even outside of the EU. As my earlier blogs have argued, the RoC entry into the EU was seen as duplicitous by the EU and the antipathy it generated may lie beneath the callous treatment. This is not going to change.
Outside of the eurozone the RoC can start again. It can reorganise the economy how it sees fit and spread the burden of adjustment accordingly. It can deal with the issues outlined or not. It must then live with the consequences. Outside of the eurozone it has many more degrees of freedom and if it utilises these correctly it can achieve adjustment with less pain and less social disintegration. It can implement all the reforms it has been asked to implement if it so chooses. In my opinion it should do so but not because it must to get some crumbs from Berlin and the IMF. It should do so because it chooses to do so. Only then will such reforms be healthy. It can devalue and ask the unions to behave. It can seek equity participation from the many sovereign wealth funds in its major projects. It can negotiate gas pipeline development with Israel and Turkey and it can build this into a reunification strategy for the Island. It can recreate its offshore banking business. It can look to Switzerland as a model for all these developments and it can only do this outside of the eurozone and perhaps EU.
To achieve this the RoC requires imaginative and strong leadership. This is something the Island has failed to produce and may never produce. However, if it cannot produce this then it is damned in or out of the eurozone. The real case for a negotiated exit however is far simpler. The conditions for staying in now are so severe that the RoC cannot possibly meet the conditions imposed. In any attempt to do so it may experience a breakdown of domestic order. The ultimate result will be a disorderly exit. Such an event will pile misery onto agony and destabilise the Island. A threat from Turkey in such circumstances might become real.
Gentleman you have made a fine mess of the Island. Everyone is condemned to eat bread and olives for many years whatever happens. It is time to step back and take a good look at the situation and start again. You have no friends except Cypriots abroad. It may be time to start listening to them. They have your interests at heart and do not suffer from the myopia of the Island-centric view that living there generates.