Hardouvelis Gkonis Cyprus Vs Greece's Economy
Hardouvelis Gkonis Cyprus Vs Greece's Economy
Abstract
The paper compares the recent economic crisis in Cyprus with the much larger
and still on-going crisis in Greece, traces the causes behind their differences and
assesses each country’s future economic prospects. Cyprus entered its crisis with
less onerous macroeconomic imbalances, yet with less robust financial and real
estate sectors. Cyprus delayed signing its MoU with the lenders but subsequently
delivered quickly on the program requirements, front-loading the fiscal policy
restrictions. Greece reduced its fiscal deficits, yet, after its economy stabilized and
began recovering in 2014, it suddenly adopted in 2015 a very naïve and backward-
looking confrontational strategy with its lenders, which brought a second
recession. Today, at the end of 2016, Cyprus has managed to keep its international
comparative advantages and has the luxury to focus on its long-term growth
strategy, having lost only 5% of its pre-crisis income. Greece, after having lost
over 22% percent of its pre-crisis income, has not yet escaped its crisis, is still
burdened by economic stagnation, an unsustainable public debt and unusually
high tax rates that constrain growth. The two countries share common risks today:
A very weak financial sector with unusually high no-performing loans, and an
unusually low ratio of investment to GDP.
Keywords: Cyprus, Greece, crisis-comparison, macroeconomic imbalances,
banking-crisis, NPLs.
1. Introduction
As the year 2016 comes to an end, Cyprus is slowly and robustly emerging
out of its economic crisis, while Greece continues to remain deep inside it.
Today economic output in Cyprus is only 5% below its 2011 pre-crisis GDP
level, whereas in Greece output is far below its own 2009 pre-crisis GDP
level, showing an astonishing 22% gap. In current prices, Cypriots have
We would like to thank Theodoros Stamatiou as well as the editor of the journal and two
anonymous referees for their comments. The paper extends an earlier presentation of the
first author in Nicosia, Cyprus on April 21, 2016 in a conference organized by the Cyprus
International Institute of Management on the topic: “How to kick-start growth.”
Corresponding author, Address: University of Piraeus, Department of Banking &
Financial Management, Karaoli & Demetriou 80 Piraeus, GR 18534.
Email :[email protected]
4
lost €1,569 in income per capita, but Greeks have lost €5,263. 1 These
differences are even bigger when the comparison is made on disposable
incomes, as taxes have gone up a lot more in Greece. And on the social
front, Cyprus has almost closed its unemployment gap relative to 2012Q2,
whereas Greece remains 12 full percentage points above its own 2010Q1
unemployment level.
Today Cyprus has access to the international markets and can borrow
freely at reasonable rates, whereas Greece is shut out of the market. In
Cyprus, capital controls are a distant memory, whereas in Greece they
remain in full force. Year 2016 economic growth is projected at 2.7% in
Cyprus, but negative in Greece, just below zero. Sovereign yield spreads
are declining in Cyprus but are stuck at high levels in Greece. And
economic sentiment is rising fast in Cyprus and in synchronization with
the rest of Europe, whereas sentiment in Greece is relatively flat and stuck
alone on its own, having decoupled from the rest of Europe for more than
a year and a half, since early 2015.
These differences in economic fortunes are striking and raise a number of
questions: Are they due to differences in the two countries’ initial
conditions before their respective crises hit? Are they due to the different
policy responses? Or perhaps are they due to both of the previous reasons?
Did other factors - related to the different timing of the two crises or the
nature of shock that hit each country, contribute to the outcome we
observe? Did the lenders treat each country in a different manner, hence
contributing to the differences? More importantly, is the present economic
situation a prelude to what the future may bring? What is the appropriate
policy recipe for each country? We tackle these and many other questions
in the present paper.
The rest of the paper is organized as follows: Section 2 describes the origins
and the two phases of the Greek crisis, the first which ended in late 2013 -
early 2014, and the second which began in January 2015 and is still with us.
Section 3 describes the crisis in Cyprus and its particular special banking
roots. Then, armed with the knowledge of what actually took place in the
two countries, Section 4 compares the experiences in the two countries
from the time markets denied them access and, hence, the countries were
forced to ask for official help, until today. The analysis flushes out a
number of interesting differences as well as similarities and thus digs
deeper into true causes of the crises. The comparison enables the reader to
form an informed opinion on the correct policy recipe for each country.
We provide our own recipe in Section 5, which also concludes.
1 The drop in Cyprus is from €22,535 in 2011, to €20,966 in 2016, and in Greece from €21,386
in 2009 to €16,123 today. (Source: AMECO data base).
5
2 Under the first economic adjustment programme for Greece, the Euro-area member states
disbursed to Greece €52.9bn and the IMF €20.1bn (European Commission (2012)).
8
economy had stabilized and the new investors were forecasting a brighter
future for the banking sector (HFSF (2015)).
Indeed, as year 2014 was moving along, the economy showed signs of
revival. Economic sentiment was rising, new FDI had surpassed its
previous pre-crisis peaks, investment in machinery and equipment became
positive after years of decline, unemployment began declining and
privatizations picked up momentum. Gross domestic product rose in 2014
by 0.6% and was forecasted to rise further to 2.7% in 2015. The government
was even able to access the markets twice and issue a 5-year bond in April
with a coupon of 4.75% (yield 4.95%) and a 3-year bond in July with a
coupon of 3.375% (yield 3.5%).
The budget for 2015, which was submitted to Parliament in November
2014, was balanced, as it forecasted a primary surplus of 3% of GDP, equal
to the interest expenses. Furthermore, in the fall of 2014, when the newly
formed Single Supervisory Mechanism (SSM) conducted the first European
wide asset quality review and stress tests, it found the Greeks banks in its
dynamic scenario as adequately capitalized all the way to the end of 2016
(ECB (2014)).
The new government caused the economy to stall, thus bringing Phase II
of the crisis. It ignored the economy’s supply side and the need for
continuing reforms and, instead, wrongly focused on a possible nominal
debt haircut. It followed a very naïve confrontational strategy with the
lenders, attempting to bring the negotiating clock for debt relief back to
2010. It thus deprived the economy of the necessary cash installments and
forced the ECB to decline cheap funding to the Greek banks (ECB (2015a))
just one week after the elections. Greece was subsequently exempted from
the ECB’s Public Sector Purchase Programme (PSPP), the quantitative
easing (QE) that started in March 2015 (Claeys et al (2015)). The earlier
expected smooth exit from the rescue program, which had been
orchestrated with great care back in 2014, was destroyed. State arrears
went up to €6.1bn, drying up liquidity of the private sector, while €7.6bn
were squeezed out of the state entities’ cash buffers.
The erratic and experimental policy of the first half of 2015 created fear and
anxiety in the population, who gradually pulled about €45bn from the
banks or 25% of their deposits. Economic sentiment fell drastically,
splitting away from its earlier European trend, the flow of new
investments stopped and the economy froze. Everybody was kept on hold,
essentially searching for survival in an environment of uncertainty of what
the next day would bring. And capital controls were put in place in late
June 2015 to prevent further deposit drainage, thus dealing another blow
on the private sector and on exports (Gogos and Stamatiou (2015)).
By mid-year 2015 the economy was in front of imminent collapse, so the
penniless Greek government finally woke up to the danger, yet chose to go
through a political gimmick of calling a yes or no referendum for July 5th
for agreeing with a new rescue program, which would include further
austerity measures. The government openly favored the No vote on a
presumably lenders’ program. 3 A referendum on fiscal matters is
unconstitutional in Greece for obvious economic reasons. It nevertheless
took place.
The population objected to new austerity and delivered a No vote with
61.31% majority (Yes vote at 38.69%). Yet, despite the overwhelming No
vote, which the government itself had openly supported, within three days
after the referendum the government switched its policy by 180 degrees. It
was dragged to accept even stricter conditions than it had negotiated three
weeks earlier, and a specific third rescue program for 2015-2018, for
otherwise it faced “Grexit.”Under the third economic adjustment
programme for Greece, an amount of up to €86bn would be lent to Greece
(ESM (2015a)).
3 Yet the Government had previously agreed to more than 90% of its content.
10
New elections were soon called for September of 2015 as the policy switch
and the third program created waves of departures within the leftist party
of SYRIZA, the major coalition partner. Many of its members objected to
the earlier “surrender” and the third rescue package and openly called for
Grexit. The September elections brought again the same coalition of left-
wing SYRIZA with right-wing ANEL to power. Apparently, the
population had not yet absorbed the deeper causes of the new negative
Phase II economic shock and what had actually happened during the first
eight months of 2015, and thus gave the earlier government the benefit of
doubt and a second chance. At the same time, the previous SYRIZA
“Grexiteers” did not manage to muster 3% of the popular vote and thus
failed to enter the Greek Parliament, which shows that despite the pain,
the Greek population continued to perceive participation in EMU as an
anchor of long-term economic and political stability.
The reversal of economic fortunes in 2015 has created an annual loss of
about €14bn in real GDP relative to earlier forecasts. Now the economy is
expected to be at 76% in 2017 of where it was back in 2007, instead of being
at 82%, as was expected back in 2014. 4 Moreover, Crisis-Phase II has
added to Greek nominal debt approximately another €40bn. To see the
latter, observe what happened to only one item, the value of State holdings
in Greek banks. The new recession in 2015 took a heavy toll on bank stock
prices, which fell to almost zero by the fall, creating a loss of close to €25bn
for the State. 5 Banks’ capital base also shrank from new losses originating
from a new generation of rising non-performing loans. The SSM
performed a new AQR and new stress tests on the Greek banks, one year
before the scheduled time for all European banks. New capital needs of
about €14.4bn were discovered (ECB (2015b), ESM(2015b)). A third
recapitalization took place in November 2015, in which two of the four
systemic banks failed to find all the necessary funds from the private
sector. The other two are now completely in private hands, with the State
owning a very small percentage of the outstanding shares.
By the fall of 2016, the economy remains in recession and non-performing
loans continue to rise. Non-performing exposures, which include some of
the restructured loans and are higher than NPLs, have jumped up by ten
4 Authors’ calculations.
5 Among other items, the most prominent is the foregone primary surpluses for three years
in a row, which add to the nominal debt ca €22bn based on the IMF(2014) and IMF(2016)
projections. Ironically, the current Greek government considers this loss as a gain because
it was not forced to take restrictive measures! Yet, the surpluses would be naturally
generated by a growing economy, without any new fiscal measures, had the new 2015
government continued on the earlier policies.
11
parentage points relative to 2015 and are now in the vicinity of 50%. And
on their liability side, banks are unable to bring back, but very little of the
lost deposits. Their dependence on Eurosystem borrowing and on the
expensive ELA remains high, although ELA is on a declining path as the
stock of loans on the asset side of their balance sheets to be financed is
declining.
By the end of October 2016, the government did manage to close the first
review of the 3rd rescue program with a one-year delay and now is trying
to expedite the second review. Government arrears to the private sector
are declining – thanks to tailor made European funding, and some
liquidity has come back to the system. Yet economic policy is heavily
leaning on new higher taxes, which are bound to trap the country in a low
growth trajectory over the long term.
Consensus private forecasts for 2017 by foreigners point to an exit from the
recession and a positive growth rate of 1%, while official forecasts are
higher, at 2.7%.6 The IMF’s official forecast assumes that substantial debt
relief is coming soon (IMF (2016a), (2016b)), and that the country would be
able to join ECB’s Quantitative Easing program after its debt would be
deemed sustainable. The Greek government is hoping and betting on
achieving both.
6 According to Focus Economics (2016b) the consensus 2017 real GDP forecast was at 1.1%
in October 2016, down from 1.5% in January (Focus Economics (2016a)).
7 Clerides (2014) discusses the nature of the Cypriot crisis and emphasizes that the crisis in
The bank bail-in of March 2013 was shocking, yet Cyprus managed to
absorb it and subsequently recover slowly. Below we first describe the
events that led to the Cypriot crisis of 2013 and then analyze the economic
adjustment program and the overall successful response to the crisis from
2013 on.
During the pre-crisis years the Cypriot banking system comprised of four
distinct types of banks: the domestic commercial banks (Bank of Cyprus,
Cyprus Popular Bank, Hellenic Bank), accounting for around 60% of total
assets, the subsidiaries of Greek commercial banks, the co-operatives, and
the international banking units. The total Cypriot banking sector grew to
become one of the largest in the EU-27. Total assets jumped from €61bn in
2005 to €155bn in 2010. The expansion was even more remarkable if
9 Some of the financing also occurred because of FDI, for example, by the inflow of foreign
capital in order to buy real estate. Some of the financing represents foreign deposits in
domestic banks, yet this is still borrowing.
13
400
300
200
100
0
2008 2009 2010 2011 2012 2013 2014 2015
12 Hardouvelis (2016, pp. 235-236) compares all EU 27 countries and shows that given its
cyclically adjusted primary fiscal balance of 2007 of +5.5% of GDP, Cyprus in 2009 ought
to have had a cyclically adjusted primary surplus of +1.7% of GDP. Instead, it had a
deficit of -3.9% of GDP. Cyprus fell in the ranking by 23 places among the 27 countries,
indicating a switch to enormous fiscal laxity from 2007 to 2009.
13 Including the €1.9bn capital injection to Laiki Bank by the State in June 2012.
15
Cyprus (BOC). The European Commission estimates that the PSI cost
Cypriot banks €4.5bn or 20% of GDP.14
FIGURE 2
The fiscal position of Cyprus 2000-2015
120% 8%
General Government
Primary Balance (Right, %
100% of GDP) 6%
Gross Public Debt (Left
Axis, % of GDP)
80% 4%
60% 2%
40% 0%
20% -2%
0% -4%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
15 This number includes also the Greek operations of the Cypriot banks, which may not be
reflected in the ECB data.
17
TABLE 1
Time line of the Crisis in Cyprus
Jan 1st, 2008 Cyprus enters EMU
Feb 17th, 2008 First Round of Presidential Elections in Cyprus
Feb 24th, 2008 Run off round between DISY candidate Kasoulidis and AKEL candidate Christofias. Christofias elected
President with 53.36% of the vote
Jan 13th, 2011 Moody’s places Cyprus on negative watch for the first time
Jan 17th, 2011 Fitch places Cyprus on negative watch for the first time
Feb 24th, 2011 Moody’s downgrade to A2
Mar 30th, 2011 S&P downgrade to A-
May 16th, 2011 Moody’s places Cyprus on negative watch again
May 31st, 2011 First Fitch downgrade to A-
July 11th, 2011 Ammunitions explosions in Naval Base Mari. 50% of the power generation capacity is destroyed
July 27th, 2011 Moody’s downgrade to Baa1
Oct 27th, 2011 EU leaders summit decision on 50% haircut on Greek public debt
Aug 10th, 2011 Fitch downgrade to BBB
Nov 4th, 2011 Moody’s downgrade to Baa3
Dec 16th, 2011 Fitch places Cyprus on negative watch again
Jan 13th, 2012 S&P downgrade to BB+, the first rating agency to rank Cyprus below investment grade
Jan 27th, 2012 Fitch downgrade to BBB-
Mar 13th, 2012 Moody’s downgrade to below investment grade (Ba1)
May 3th, 2012 Panicos Dimitriades took office as the new Central Bank governor to replace Orphanides
Jun 13th, 2012 Moody’s downgrade to Ba3
Jun 25th, 2012 FITCH downgrade to BB+, below investment grade
Jun 25th, 2012 Cyprus application to ESM
Jul 1st, 2012 Begins Cyprus Presidency of the European Union Council
Jul 25th, 2012 Troika submitted the terms of the bail-out program for Cyprus. The Cypriot government expressed
disagreement over those terms and continued negotiations with Troika
Sep27th, 2012 Central Bank of Cyprus commissions PIMCO to carry out the an independent due diligence exercise
18
Aug 15th,2015 CYSTAT announced the flash estimate of Q2-2015 which showed the second positive QoQ growth
Sep8th,2015 S&P upgrade to BB-
Sep23rd,2015 IMF Completes Eighth Review of Cyprus’ EFF and Approves €126mn Disbursement
Sep 25th,2015 S&P upgrade to BB-
Oct10th,2015 ESM disbursement of €500mn in cash
Oct23th,2015 FITCH upgrade to B+
Nov15th,2015 Moody’s upgrade to B1
Nov16th,2015 Staff teams from the Troika visited Nicosia during November 3-13 for the 9th quarterly review
Jan27th,2016 IMF Completes Ninth Review of Cyprus’ EFF and Approves €126.3mn Disbursement
Mar7th, 2016 Ministry of Finance asks IMF for the early termination of EFF arrangement & Euro-Group supports Cyprus
graduation from the economic adjustment program. The last prior action of the completion of the review
(CYTA corporatization) was not satisfied
May22nd, 2016 Parliamentary elections: The ruling right-wing party DHSY gained 37.6% (18 seats), the main opposition left-
wing party AKEL gained 25.7% (16 seats), and DHKO gained 14.5% (9 seats)
Sep16th, 2016 S&P upgrade to BB
Oct21st, 2016 FITCH upgrade to BB-
21
16 The last ESM review (the 8th) is not considered to have been completed successfully.
17http://www.esm.europa.eu/pdf/2016-03
07%20Eurogroup%20statement%20on%20CY.pdf
The Eurogroup also noted that the last prior action of the last program review with respect
to the approval from the parliament of the corporatization of CYTA-the telecom public
utility-has not been satisfied. Yet this did not preclude Cyprus’ graduation from the
program.
22
relatively resilient as both of them are less credit dependent but also more
extroverted and internationally competitive.
4. Crisis in Greece and Cyprus: A revealing comparison
4.1. Differences prior to the rescue package
Our earlier discussion revealed important differences between the two
countries in the factors which led to their respective crises. The first major
difference was the much larger fiscal and competitiveness imbalances in
Greece. This is shown in Figure 3, which depicts the original EMU
countries plus Cyprus, and illustrates the average fiscal (horizontal axis)
and current account (vertical axis) balances over the period from 1999,
when EMU was created, to 2009, before the start of the Greek and EMU
crisis. In both the internal and the external imbalance dimension, Greece
was a clear outlier among all EMU countries and carried double the
respective deficits of Cyprus.18 It follows that the required macroeconomic
corrections for Greece were twice as big, which naturally led to a much
worse recession.
FIGURE 3
Imbalances across the Euro Area
Current Account Balance % GDP, avg. 1999-2009
15
Twin Surpluses
10 LU
5 NL FI
DE BE
AT FR EA
0 IT
IE
-5 SP
CY
GR PT y = 1.48x + 2.535
-10 Twin Deficits
R² = 0.5096
-15
-8 -6 -4 -2 0 2 4
General Government Balance% GDP, avg. 1999-2009
18 The crisis in Cyprus started three years later in 2012, hence the figure does not include
the large Cypriot fiscal deficits of that period. Yet, still those deficits were small in
comparison to the historical Greek ones.
23
TABLE 2
Initial Conditions prior to the Crisis
Greece Cyprus
(April-May2010 (March2013)
or 2009) or 2012)
Primary Balance19
-10.3% -2.9%
(% of GDP)
General Government20
Balance -15.2% -5.8%
(% of GDP)
Gross Public Debt
126.7% 79.3%
(% of GDP)
Current Account21
-12.3% -6.0%
Balance (% of GDP)
Doing Business Distance
62.44
to Frontier22 69.1
(2010)
(best = 100)
REER
123.0 110.2
(ULC total economy
(2010Q1) (2013Q1)
deflated, 1999Q1=100)
Private Sector
Indebtness 116.8% 328.3%
(% of GDP)
Banks assets
212.7% 750%
(% of GDP)
Notes: Seven of the eight statistics above refer to full years 2009 for Greece and 2012
for Cyprus. The eighth statistic, the real effective exchange rate (REER), refers to the
end of the respective quarters 2010Q1 and 2013Q1. The most recent Doing Business
data for Greece and Cyprus are from Doing Business 2017. The earliest comparable
Doing Business series available for Greece are dated in 2010. In the Private Sector
Indebtness statistic, the numerator refers to the stock of liabilities (loans plus debt
securities) held by the non-financial corporate sector and households on an non-
consolidated basis, i.e. taking into account transactions within the same sector. The
GDP levels in the denominator of the last two financial sector statistics refer to 2009
for Greece and 2012 for Cyprus.
Source: Eurostat, ECB, National Authorities, World Bank Doing Business.
19 & 18 Without banking sector recapitalization costs (the Laiki Bank Recapitalization Bond of
2012).
21BPM6 definition.
22World Bank (Doing Business, Distance to Frontier definition): The distance to frontier
score aids in assessing the absolute level of regulatory performance and how it improves
over time. This measure shows the distance of each economy to the “frontier,” which
represents the best performance observed on each of the indicators across all economies in
the Doing Business sample since 2005. This allows users both to see the gap between a
particular economy’s performance and the best performance at any point in time and to
assess the absolute change in the economy’s regulatory environment over time as
measured by Doing Business. An economy’s distance to frontier is reflected on a scale
from 0 to 100, where 0 represents the lowest performance and 100 represents the frontier
25
Both previous reasons made Cyprus worse off relative to Greece. But there
is also a third reason that made Cyprus better off. The difference in timing
benefited Cyprus in the sense of being knowledgeable about the potential
consequences of different responses to the crisis. Cyprus had the benefit of
hindsight, observing Greece and then Ireland and Portugal enter a crisis
and responding to it. Each of these countries had a different policy
response with their populations behaving differently. The Irish did not
strike as much against the austerity measures as the Portuguese or the
Greeks did, for example. Cypriots could observe and learn from the
different experiences.
Next to timing, a fourth difference originates from the type of political
parties that ran the two countries prior to their respective crises. Greece up
to September 2009 was run by New Democracy, a center-right conservative
party, whereas Cyprus was run by AKEL, a leftist communist party. The
economic consequences of this difference may not have been major,
however. A closer look at their respective economic policies prior to the
crisis reveals important similarities. They both followed expansionary
fiscal policies and generated huge budget and current account deficits,
which naturally aggravated the pre-existing domestic macroeconomic
imbalances.
A fifth important difference between the two countries relates to the speed
of concluding the negotiations for designing the rescue package. Greece
applied for a rescue package in April 2010 by a relatively new government
and within a month it had signed the MoU and the loan money was
flowing into the country. In the case of Cyprus, the negotiations for the
eventual rescue package prolonged for eight months and in the mean time
presidential elections took place and a change of President occurred.
Cyprus paid a huge penalty for that delay, as it ended up absorbing a
surprising eventual bail-in.
A final sixth difference prior to the rescue package is in the relationship
between the government and the central bank. In Greece there was
unanimity between the Prime Minister and the Central Bank governor
about the required policy responses. This was not the case in Cyprus.
President Christofias did not renew the appointment of Governor
Orphanides in May 2012 and later tried to cast the banks as the villain,
thus aggravating the country’s vulnerabilities.
Overall, prior to the rescue package, it seems Greece had tougher domestic
initial conditions, while Cyprus faced a more acrimonious external
environment and a less robust financial sector. Cyprus was also slow to
come to terms with the details of the rescue package.
26
23 The Presidential political system in Cyprus also helps in reaching a more balanced and
consensus point of view. The President can decide on the execution of the economic
program and then try to find a majority coalition in the Parliament for the various
components of the program. The President can thus push a compromise solution among
the different political parties. The same compromise is harder to accomplish in the Greek
parliamentary system.
27
Third, in Cyprus the program was executed remarkably well, and in the
words of a representative of the lenders, “almost like a clock”
(Hardouvelis and Gkionis (2016)). The authorities showed commitment to
the program conditionalities and established a strong track record of
timely and continued policy implementation. The quantitative targets were
met ahead of time and by a wide margin. Thus three years after the MoU,
the country had gained credibility, capital controls were lifted and the
country graduated from the program.
In Greece, the opposite happened. Politicians tried to avoid delivering on
what they had signed, fearing the political cost. The lenders gradually
became increasingly dissatisfied and began micro-managing the reform
process. For example, the second MoU is relatively voluminous and a lot
more detailed than the first MoU. And after the third rescue program of
2015, lenders put a tighter auditing grip to ensure complacency and avert
the back-tracking of earlier reforms.
Fourth, in Cyprus the package of fiscal measures in 2013-2014 was decided
and legislated upfront, which minimized uncertainties. In addition, the
fiscal adjustment was front-loaded, splitting the burden almost equally
between revenue enhancing and expenditure spending cuts, thus, making
the policy mix of the measures balanced. As the initial IMF MoU25 & EU
24 The Government Effectiveness Index, the Corruption Perception Index and the Rule of
Law, World Bank & Transparency International.
25 Page 19, http://www.imf.org/external/pubs/ft/scr/2013/cr13125.pdf
28
Commission program26 states: “The total package of 6.8ppts of GDP was split
between 3 ppts expenditure cuts and 3.8ppts in revenue enhancing measures.”
Cypriots also resisted the enormous pressure to drastically increase their
corporate tax rate, and thus kept their international comparative tax
advantage.
In Greece, the inability to come to terms with economic reality resulted in
three consecutive rescue programs covering the period from 2010 to 2018,
with the third program being self-induced and completely unnecessary.
The disastrous policy of the first half of 2015 brought a new recession and
reduced asset values further. It caused a huge loss to the State from the
collapse in bank stock prices. Since 2015, the Greek government also
resorted to over taxing households and businesses, hence stifling away any
incentives for work and investment. Since 2015, the Greek policy reaction
has been diametrically opposite from the Cypriot experience.
4.3. A different economic trajectory following the outbreak of the crisis
This section compares the evolution of the respective economies after the
beginning of the rescue package. Based on the earlier discussion on the
initial conditions prevailing prior to the crisis and the different policy
responses in the two countries, it ought not to come as a surprise that the
economy’s negative trajectory after the outbreak of the crisis was much
more benign in Cyprus.
Figure 4 sets as date 0 the quarter before the agreement of a rescue
package. It then shows the evolution of real GDP in the following quarters.
For Greece, quarter 0 is defined to be the first quarter of 2010. For Cyprus,
quarter 0 is the last quarter of 2012. At quarter 0, for both countries the
level of real GDP is set to be 100.
Figure 4 shows that the depth and length of the recession in Cyprus were
much smaller than in Greece. In Cyprus, the lowest point of the recession
occurred 10 quarters (2.5 years) after the rescue, when the GDP level was
at 90.5% the original GDP level, and then a recovery began. In Greece, a
recovery began much later, after 15 quarters and at a much worse GDP
point, at 78% of the original level. Moreover, subsequently, the recovery
was stopped short by a new phase of the crisis. The figure shows that
Greek crisis Phase II currently costs over 6 percentage points of 2012-GDP,
or about €14bn per annum.
Figure 5 presents a similar story about the rate of unemployment. It shows
the change in unemployment relative to date 0, which is the quarter before
CYPRUS
95 (2012Q2=100)
GREECE
90 (Autumn
Forecasts 2014)
-9.5% from T0 in 10 Quarters
85
80
T+10
T+11
T+12
T+13
T+14
T+15
T+16
T+17
T+18
T+19
T+20
T+21
T+22
T+23
T+24
T+25
T+3
T+1
T+2
T+4
T+5
T+6
T+7
T+8
T+9
FIGURE 5
The Evolution of Unemployment after the Crisis Outbreak
20
ppts Cumulative Change in Unemployment Rate Greece vs. Cyprus
15
10
ppts
GREECE 2010Q1=0
CYPRUS 2012Q2=0
5
0
T0
T+10
T+11
T+12
T+13
T+14
T+15
T+16
T+17
T+18
T+19
T+20
T+21
T+22
T+23
T+24
T+25
T+1
T+2
T+3
T+4
T+5
T+6
T+7
T+8
T+9
4.4 Different perceptions about the crisis and the country abilities to
withstand it
Turning to how markets perceive the crisis, Figure 6 presents Greek and
Cypriot yield spreads vis-à-vis Germany.27 Financial markets became more
aware of the Cypriot economic problem after the Mari accident in July 2011
and the simultaneous discussions on the Private Sector Involvement (PSI)
for Greek bonds, which began in the summer of 2011. The figure also
shows that the Cypriot spreads grew higher than the Greek spreads from
the summer of 2012 to the end of 2014, essentially during the time of the
Cypriot crisis. When Greek crisis Phase II began, the Greek spreads
overtook the Cypriot ones for a second time. Another interesting feature is
the more or less continuous decline of the Cypriot spreads since July 2013.
This is not the case with the Greek spreads, which peaked for a second
time in the summer of 2015 and remain stuck at high levels by 2016Q4,
around 700-900 bps.
FIGURE 6
Interest Rate Spreads over Germany
4000
SPREADS GREECE VS GERMANY
3500
SPREADS CYPRUS VS GERMANY
3000
2500
2000
bps
1500
1000
500
0
Apr-10
Apr-11
Apr-12
Apr-13
Apr-14
Apr-15
Apr-16
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Oct-15
Oct-10
Oct-11
Oct-12
Oct-13
Oct-14
Oct-16
Jul-10
Jul-11
Jul-12
Jul-13
Jul-14
Jul-15
Jul-16
Source: Bloomberg.
27 Figure 6 portrays the evolution of the sovereign spreads of the ten year generic
Greek government bond vis-à-vis the German one. The same graph also
includes the spread of the long-term Cypriot bond of initial ten-year maturity,
the last one issued by the Cypriot government in 2010 before the country was
cut off from the international financial markets vis-à-vis a German government
bond with maturity date very close to that of the Cypriot bond.
31
FIGURE 7
Index of Economic Sentiment
120
EA
110
100
90
80
Greece
70
Cyprus
Cyprus Euro Area Greece
60
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jul-07
Jul-08
Jul-09
Jul-10
Jul-11
Jul-12
Jul-13
Jul-14
Jul-15
Jul-16
FIGURE 8
Private Sector Deposits before and after the Imposition of Capital Controls
(in million euros), (T0=imposition of capital controls)
75,000 175,000
Greek
70,000 parliamentary elections 170,000
Jan15 T0: Capital Controls
65,000 Cyprus: Mar13 165,000
Greece: Jun15
60,000 160,000
Figure 9 portrays the change in sentiment before and after the imposition
of capital controls. Here the differences between the two countries are not
as striking as in Figure 8. The imposition of capital controls decreased
economic sentiment in both countries, which subsequently recovered.
28 In Cyprus, capital controls were imposed on the last day after a two-week bank holiday
after public announcements of the decisions of the Euro group on the restructuring of the
banking sector without program funding. In Greece capital controls were imposed
concurrently with a bank holiday. They aimed at averting a bank-run after the lengthy
multi-month antagonistic negotiations between the government and the international
lenders had collapsed.
33
FIGURE 9
Economic Sentiment Indicator before and after the imposition of Capital Controls
(T0= capital controls)
115
Greek Elections
110 T0: Imposition of capital controls
Cyprus: Mar13 Greece
Greece: Jun15 2nd Review
105 begins Oct16
Greece
100 Greek Banks Recap 1st Review
Prior Actions Jun16
Dec15
95
EU parliament elections
90 May14
85
80
Cyprus
75 Application to ESM/IMF Cyprus
Jun12 Presidential Elections Cyprus
70 Feb13 Greek Elections Troika Reviews
Sep15 July13-Nov13-Feb14-May14
65
T-18 T-16 T-14 T-12 T-10 T-8 T-6 T-4 T-2 T0 T+2 T+4 T+6 T+8 T+10T+12T+14T+16T+18
CYPRUS GREECE
29 https://www.eba.europa.eu/documents/10180/1360107/EBA+Report+on+NPLs.pdf
34
of new NPLs stopped as the economy started growing, while thanks to the
new laws some of the past non-performing borrowers began settling their
accounts. As a result, the level of NPEs has declined to €24.7bn in July 2016
down from a peak of €27.8bn in April 2015. Yet, the ratio is still at very
high levels mirroring the ongoing deleveraging which impacts the size of
total loans in the denominator of the ratio. The NPL reduction is a good
piece of news, yet it is too early to be able to say the risk is definitely going
down.
FIGURE 10
Non-Performing loans as of March 2016
(% of total loans)
60%
50%
40%
30%
20%
10%
European Union
0%
RO
DK
DE
BG
BE
LV
EE
LU
GR
MT
ES
LT
SI
AT
SK
GB
PT
FR
CY
PL
IT
CZ
NL
NO
IE
HU
HR
SE
FI
Note: Data provided by EBA on non‐performing loans and forborne loans for total on‐
balance loans and advances per country of origin of the bank (March 2016). These
NPL ratios relate only to exposures qualifying as loans, and do not include debt
securities or off‐balance sheet exposures. For EU banks, the NPL ratio per March
2016 was 5.7% on average.
Source: European Banking Authority.
In Greece, NPLs have not yet stopped growing. They did decline in
2014Q4, but Phase II of the crisis in 2015 caused a resumption of the earlier
upward trend. And the more recent NPL laws continue to have gaps.
Hopefully, if the economy picks up in Greece, few new NPLs will form
and old ones will be restructured. Overall, resolution of the NPL problem
is the hardest challenge for both countries.
35
A second risk factor both countries face is the low rate of private
investment. The fall in investment preceded the crisis in both countries and
was not entirely due to the real estate sector. It is an issue that has to be
addressed. New investment is necessary for the economy’s ability to
continue producing and achieving high sustainable rates of growth in the
long-run.
taxation, which is suffocating incentives for work, jacks up the cost of labor
and tanks competitiveness, keeps domestic and foreign investors hesitant
to invest, and restrains economic activity.
In Greece, there is a definite need to focus on the supply side of the
economy, minimize bureaucracy and lower corporate tax rates and thus
boost domestic production and exports at the expense of domestic demand
and imports. In Greece, public and private consumption represent an
overwhelming 20%+70.2% = 92% of GDP, when the corresponding (EA-19)
EMU average is only 20.7%+54.8%=75.5%. This excess demand relative to
the economy’s productive capacity necessitates a future relative shrinkage
in domestic aggregate demand. While consumption ought-not shrink in
absolute terms for otherwise a continuing recession cannot be avoided,
future growth ought to be higher in investment and exports relative to the
growth of consumption.
The flip side of the Greek domestic excess aggregate demand is a very low
domestic savings rate, which is incapable of supporting domestic
investment. Thus FDI is desperately needed and for this to occur, policy
credibility is a necessary condition. So credibility is necessary not only for
the cyclical recovery and the exit from crisis phase II, but also for a
sustainable rate of growth over the long-run. Yet credibility was destroyed
over the last two years in Greece and its reinstatement remains a challenge.
Crisis Phase II and the forces behind it are hard to erase from households’
and enterprises’ memory. Capital controls are still in place, the over-
taxation continues, the unemployment rate is still high, the youth is
immigrating abroad, many companies are registering abroad, and
economic sentiment remains low.30
Despite their large differences, some of the challenges are similar to both
countries. The first such challenge is the high rate of non-performing bank
loans. As a response to the NPL problem, both countries introduced new
stricter laws that govern corporate and personal bankruptcy (insolvency
framework), foreclosures and moral hazard.31Those laws aim to provide
30 In the midst of Greek crisis Phase II, European lenders seemed to have abandoned
hopes of a quick Greek reinstatement to normality and thus never seriously challenged
the coalition government for a rational economic policy path. They allowed them to
generate fiscal savings exclusively from taxation, something they had never allowed
earlier governments to do prior to 2015. The other lender, the IMF, apparently sensed
the trouble with the new Greek political leaders early on and thus has refrained from
giving any new loan money at all, insisting on the continuation of reforms, the overhaul
of the pension system and on a big fiscal break on the part of Europeans, which would
come in the form of lower future primary surpluses and a more generous relief in the
present value of public debt.
31 To facilitate the restructuring of troubled loans, banks have put in place restructuring
units. However, a state-backed asset-management company (AMC) was not created in
37
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