Important steps but major challenges still ahead

[Accountancy Cyprus, No. 116, September 2014.]

Two important financial milestones marked the summer of 2014. In June, Cyprus tapped international capital markets for the first time since January 2010, raising €750 million of fresh funds. The return to the markets after a 4.5 year absence was certainly a significant and gratifying event, not because it took place just 15 months after the big shock of March 2013.

One of the reasons for this success is that the Cypriot economy is faring much better than almost anyone expected; the fiscal situation has improved substantially and the recession is not as deep as feared. The strict implementation of the Memorandum of Understanding (MoU) has proven successful in bringing stability to the country and has contributed to the improvement in the international image and credibility of Cyprus.  

The return of investor confidence in international markets was another important contributing factor. The markets are flush with liquidity, bond yields are very low and international investors are looking for investments that will deliver some return without undue risk. The timing was very good for Cyprus and the government wisely seized the opportunity. The success improved the image of Cyprus abroad and at the same time provided a psychological boost at home.

But perhaps the most important consequence of the bond issue is that it paved the way for Cypriot banks – particularly the Bank of Cyprus – to tap international markets themselves. The Finance Minister made this point emphatically at the time, which suggests that pushing the banks in this direction might have been one of the government’s prime motivations all along.

Intentional or not, the Bank of Cyprus got the message and quickly moved to issue new capital. This process was concluded at the end of August, when the bank’s shareholders approved the injection of €1 billion in additional share capital. The successful conclusion of the capital increase was the second major event of the summer. It puts the bank in a very strong position with a core Tier 1 capital in excess of 15% that will allow it to absorb any losses due to declines in the value of its assets, particularly the loan portfolio. 

These developments are certainly positive, but the road ahead is still long and full of challenges. In a sense, fixing our fiscal house was the easy part. Raising tax rates and cutting expenditures are relatively straightforward things to do. Implementing structural reforms is much more difficult, both for practical and for political reasons.

The practical aspect is that structural reforms (such as privatizations, implementation of the national health system, public sector reform, etc.) are complex endeavors that require resources and commitment from the government. Politically, these issues are also much more sensitive because they impact powerful entrenched interests that will not go down without a fight. We have already seen this in the vocal protests against privatizations; but opposition to reform is working in more subtle ways in other areas also.

The difficulty of reform is exacerbated by the fact that the government does not have a majority in parliament. This has been made painfully obvious in the endless wrangling about the foreclosure law. In any other country, the government would only have to convince its coalition partners. In Cyprus the government has to struggle to convince one or more of the opposition parties to support its bills. This state of affairs has been an almost permanent feature of our political system and is probably the main reason why practically no major reforms have ever been implemented in Cyprus in the absence of outside pressure. Political uncertainly could be a major obstacle as we try to implement the most difficult aspects of the MoU.

The improvement in public finances and the successful return to the markets have led to suggestions that Cyprus may be able to exit the program ahead of time, in 2015 instead of 2016. It is true that a key objective of the MoU is to support Cyprus until it can finance itself. But an equally important objective is to reform the economy and to build the foundations that will put Cyprus on a path of sustainable growth. Major challenges still lie ahead: privatizations; public sector reform; implementation of the national health system; further stabilization of the financial sector; and thorny negotiations over COLA and civil service pay and benefits.

We must not get ahead of ourselves. The measure of our success should not be the time that we will exit the program but the extent to which we will improve the institutions and strengthen the foundations of the Cypriot economy.