Independent institutions and democracy

[Accountancy Cyprus, No. 120, September 2015.]

One of the defining features of political life in Cyprus over the last few years has been the frequent clashes between politicians and independent officials. There have been such instances in the more distant past, as when Attorney General Solon Nikitas resigned in 2005 because he felt that he was being undermined. But the frequency and intensity of the clashes has risen significantly in the last few years.

It is certainly not pleasant to watch a country’s politicians and top officials exchanging blows in public. But I will argue that there is a positive development underlying this ugly picture. What is happening is that our independent officials are finally beginning to assert themselves.

Many people hold a very narrow view of democracy as rule by the majority. There is much more to democracy than holding an election once every four or five years and handing power to the winner. Protecting the rights of the minority is just as important as allowing the majority to rule. An independent judiciary that protects individual rights from abuse by elected governments has long been recognized as a necessary complement to majority rule.  No-one today disputes the need for  a strong and independent justice system.

Well-functioning and mature democracies have also developed other independent institutions designed to function as a check on the executive. Government finances are checked by independent auditors to minimize corruption and graft; official statistics are produced by independent statistical agencies to avoid government manipulation; regulatory functions are carried out by independent agencies in order to ensure a stable operating environment free from political intervention.   

The realization of the importance of strong, independent institutions has been one of the most significant developments in economics in the last 10-15 years. A large body of research now shows convincingly that well-functioning institutions that safeguard the rule of law and guarantee the protection of property rights and the enforcement of contracts contribute significantly to economic growth.

There is but one difficulty. Well-functioning institutions are very hard to build. This is especially true in young countries without a long and established democratic tradition. As Gordon Brown famously quipped, “in establishing the rule of law, the first five centuries are always the hardest “.

In addition to being a young republic, Cyprus has also had a tumultuous history that did not allow its institutions to develop and mature. The country’s accession to the European Union in 2004 was a game changer as the EU places great emphasis on the development of independent institutions. Adopting the euro gave further impetus to the process, particularly with respect to the Central Bank.

It is no surprise then that it was Central Bank governors who first publicly clashed with successive governments over matters of policy. More recently we witnessed public sparring between the government and both the Attorney General and the Auditor General. Analyzing each case is beyond the scope of this short article, though I would argue that in most cases the independent officials were right and the politicians were wrong. Leaving the substance aside, however, the way governments (but also usually the opposition) have conducted themselves in these cases suggests that our political system has not accepted the independence of our country’s institutions.

No-one is infallible; that includes politicians and technocrats, presidents and top officials. A well-functioning democracy must nurture independent institutions to safeguard the rule of law and keep a check on the executive. Politicians must learn to respect those institutions, even when they do not agree with them. Perhaps most importantly, presidents must take great care to appoint competent and upstanding individuals to these crucial posts.

We can do better with SOE reform

[Accountancy Cyprus No. 119, June 2015.]

The (mis)management of state-owned enterprises (SOEs) is widely recognized to be a major and chronic problem in Cyprus. The SOE label covers a large number of very diverse organizations. They are often classified into two groups on the basis of their legal status: the large majority are so-called semi-governmental organizations (SGOs) operating under public law, while a smaller group operates under private law. The distinction is not very helpful, however, as within each group one can find organizations that are very different in nature. The SGO group in particular includes commercial companies, universities, regulatory agencies, the CyBC (RIK), the CSE (XAK), and others. 

Governments set up SOEs for several reasons: to provide services that the private sector cannot provide; to manage state assets; or to provide regulation and oversight. Over time these reasons often cease to exist or the circumstances change significantly, giving rise to a need for change or even dissolution. But change is hard, especially in Cyprus. Cyta is a prime example. It was set up in the 1950s as a state monopoly to unify the island’s telecommunications network. Today’s telecommunications landscape is radically different and continues to evolve rapidly, yet Cyta must continue to operate within the archaic and inflexible framework of an SGO.

Although the problematic governance of SOEs has been long and widely recognized, the Cypriot political system has been unable to deliver change. Enter the Memorandum of Understanding (MoU), which forced Cyprus to take a hard look at the way its SOEs operate. SOEs that no longer serve a meaningful purpose are to be closed, while others are to be turned into public companies (operating under corporate law) and possibly privatized. But progress has been slow as there is a lot of resistance to these much belated moves toward modernization.

The government has drafted a new bill aiming to streamline the operations of SOEs and bring them under tighter ministerial control. The move is motivated by the large number of financial scandals, mismanagement and corruption that have plagued SOEs. Although the frustration is understandable, this is not the right response. SOEs are very diverse; it is impractical to have a single framework for all of them. Moreover, SOEs are set up as independent organizations for a reason. If this reason no longer applies to some organizations, they should be folded into the civil service. If not, they should retain their operational flexibility and autonomy and be judged on the basis of their performance. Handing additional powers to ministers will lead to the overt politicization of these supposedly independent organizations. If tighter control is deemed necessary, it should be granted to an independent entity, as recommended by the OECD.

The draft bill does not address one of the main problems plaguing the management of SOEs: the selection of directors. It stipulates that appointments will be made by the Council of Ministers on the basis of recommendations by the responsible minister. This is just a continuation of the failed policies of the past, where positions on SOE boards were one of the most lucrative spoils of power. Positions on boards were divvied up among political parties, with the governing parties receiving the lion’s share. SOE boards have significant authority over tenders, appointments and promotions, which are an important way of doling out favors.

The appointment of SOE directors needs to be radically overhauled. The process needs to be transparent and meritocratic. For each SOE, an assessment needs to be made for the type of skills needed on the board. In addition to basic managerial and financial skills, some boards may need directors with expertise in engineering, economics, or other specific areas. Once the desired profile of each board is determined, positions should be widely advertised. Expressions of interest should be submitted to an independent body that will evaluate the candidates. A set of suitable candidates will be selected and passed on to the Council of Ministers to make its choice. The private sector can be involved in the selection process as it has the required expertise.

The government has done well to take an initiative to reform SOE governance, but it can do better in terms of many of the details. The time is ripe and the opportunity must not be lost.

Cyprus must stick to the plan

[Accountancy Cyprus, No. 118, March 2015.]

The Cypriot economy’s path towards recovery was put in jeopardy during the last few months of 2014 but more recent developments hold promise for a return to a positive trajectory.

The damage was primarily due to exogenous developments. Foremost among them was the economic crisis in Russia (highlighted by the collapse of the ruble), and the imposition of EU sanctions against Russian interests. In addition, a deterioration of the climate in Greece that led to rising Greek bond yields last fall also affected Cypriot bonds at the time. Domestically, the impasse over the foreclosure law and the consequent delay in the Troika’s evaluation of the Memorandum of Understanding (MoU) contributed to the climate of uncertainty.

As a result of these developments, the improvement in the Cypriot GDP growth rate reversed itself slightly in the second half of 2014. The year closed with a -2.3% growth rate, compared to -5.4% in 2013.

Fortunately, the climate reversed itself again in January due to the European Central Bank’s announcement of its Quantitative Easing program (QE). This important development had an immediate impact, leading to a depreciation of the euro and a drop in European bond yields. Cyprus stands to gain from both of these developments.

Actual implementation of the program starting March 9 led to further declines in both the value of the euro and bond yields. The yield of the Cypriot 10-year bond dropped below 4%, to its lowest point since 2010. Growth prospects in the euro area are looking more favorable, something that will also benefit Cyprus.

On the domestic front, there finally seems to be light at the end of the tunnel on the controversial issue of the foreclosure law. The political parties appear to be converging and – barring any unforeseen surprises – the law should be passed before the end of March. This will open the door to an evaluation by the Troika in April. A positive evaluation will allow Cyprus to participate in the QE program.

Given these developments, the outlook for a return by Cyprus to international markets within 2015 currently seems very positive. The major downside risk to the economy now comes – yet again – from Greece. The newly elected Greek government has adopted a confrontational stance towards its European partners. This has led to a rapid deterioration in the country’s position: tax revenues have declined, deposit withdrawals have increased significantly and talk of “Grexit” has returned. Greece’s “tough” stance caused some excitement in Cyprus and there were suggestions that it should adopt a similarly confrontational approach.

These voices have fortunately died down since the Eurogroup decision of February 20th, which showed that Greece’s approach was not paying off. Nonetheless, the situation in Greece must be monitored closely. The links between the economies of Greece and Cyprus are not as close as they used to be, but Greece remains an important trading partner and subsidiaries of Greek banks operate in Cyprus.

Yet the most important risks to Cyprus of continuing tension in Greece and even a Greek exit from the euro are not economic but political. Many outsiders view Greece and Cyprus as similar. If Greece heads towards the exit, some might be tempted to think that Cyprus will follow along. Cyprus must fight this perception and convince the outside world that, despite the similarities, Cyprus is not Greece. There is one surefire way of achieving this: stick to the plan of sound fiscal management and timely completion of the MoU.