31 Μαρτίου 2014

A time for reform

[Accountancy Cyprus No. 114, March 2014.]

In March 2013 Cyprus experienced the shock of the depositor bail-in. Bad banking practices, excessive construction activity and a general culture of over-consumption had created huge imbalances during the boom years of 2004-2008. The global financial crisis burst the bubble and a painful adjustment was inevitable. The pain was made much greater by a string of policy failures that culminated in the bail-in, causing in a tremendous loss of wealth, the destruction of the banking sector, a loss of trust and credibility, and significant economic hardship. The economic outlook in March 2013 was extremely bleak.

One year later, things are not as bad as many feared. The contraction in 2013 was about 6%, much smaller than anyone expected. Unemployment has risen but seems to have leveled off and currently stands at 16.8%, not that much higher than the 14.8% it had hit in March 2013. Fiscal targets are being met, with room to spare. The banking sector is moving in the right direction, although the process will be long. The sector’s return to normalcy remains the biggest single challenge Cyprus faces as it strives to emerge from the recession.

With the fiscal situation in check and the banking sector’s reorganization nearly complete, the focus must now shift to structural reform. Cyprus’ track record in this respect is miserable. The political system has an extremely difficult time designing, agreeing to and implementing important reforms. It is not an exaggeration to say that the only major reforms implemented in Cyprus over the last twenty years were those associated with EU accession. It is difficult to think of a single major reform that came from within the system.

The Memorandum of Understanding requires Cyprus to implement a number of major reforms.  Many of those are much-needed, by Cyprus’ own admission; they have been considered and debated by the Cypriot political system, but never carried through to fruition. Examples include the national health system, social security, tax collection, local government, property titles, semi-governmental organizations, and public administration. The MoU provides an opportunity and the seemingly necessary outside pressure to push ahead with reforms that will modernize the economy, increase efficiency and improve competitiveness.

Public sector reform is particularly important. In the World Bank’s 2014 Doing Business report, Cyprus ranks 39th in the world overall but scores much lower in several aspects of public service provision: 86th in dealing with construction permits, 108th in getting electricity, 103rd in registering property, and 110th in enforcing contracts. These are unacceptable outcomes for a country that markets itself as a business center.

Beyond the MoU, Cyprus needs to refocus its economy and correct the economic distortions that built up over many decades and culminated in the boom and bust of the 2000s. The image of Cyprus as a business and financial center took a big hit in March 2013. But the sector has held up very well and there was no mass exodus of international businesses. This remarkable resilience pays tribute to the quality of services provided by Cyprus’ accountants, lawyers and financial advisors and gives hope that Cyprus can maintain and build on its status as a business center. In order to do so, Cyprus must do three things:
  • First, it should focus on the provision of business services and play down the financial dimension (which was probably exaggerated anyway). As a business center Cyprus can continue to provide good quality and cost-effective legal, accounting and other services without requiring a large domestic banking sector and the associated risks. 
  • Second, it should play down its low tax regime and focus on the quality of its services and the other benefits that are truly unique to it. Cyprus has well-trained and highly experienced professionals and a good legal framework (and its location is still great). It would also do well to specialize in particular niches – the success of shipping provides a good model. 
  • Third, it needs to become a model in implementing regulations on financial transparency, money laundering and tax evasion. The laxity of the 1990s still haunts Cyprus; a clean image can attract reputable businesses and bring many benefits to the country. 
It is often said that every crisis is an opportunity. It is a cliche, but it is a good one. Cyprus must use this opportunity to push through reforms that will correct the mistakes and excesses of the past and put the economy on a path of steady and sustainable growth.


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