(Updates with council’s chairman comment in fifth paragraph)
By Stelios Orphanides
The Fiscal Council, an independent body tasked to monitor the drafting and implementation of the budget, said promises given ahead of next year’s presidential elections are one of the major risks the economy is facing.
Despite the economy expanding for the third consecutive year, the unemployment rate dropping, the financial sector stabilising, and sovereign credit rating upgrades, the island’s “non-investment rating shows the significant underlying risks,” the council said in its autumn report on Thursday.
Other risks threatening the economy include a possible deterioration of the currently “favourable” external environment, the banks’ non-performing loans stock, the low savings rate of households, the high public and private debt, and reform fatigue.
In 2015, the Cypriot economy emerged from a prolonged recession caused by a fiscal and financial crisis, which peaked in March 2013 when the government agreed to the terms of an international bailout.
The fiscal watchdog said that it believes the most effective way of achieving sustainable growth rates and protect against risks, or at least mitigate their possible impact, is to continue immediately with reforms that “improve the economy’s competitiveness and the containment of public spending which will reduce the likelihood of fiscal derailment that would threaten economic stability”.
“Improving competitiveness and achieving sustainable and high economic growth rates will allow the economy to tackle important challenges more effectively,” it said.
The chairman of the council, Demetris Georgiades, who was speaking to reporters on the occasion of the publication of the report, said that after the 2013 experience Cyprus should be wiser to avoid committing similar mistakes.
With public debt, following a recent debt repayment by the government to the Central Bank of Cyprus, currently still over 98 per cent of economic output and public debt as of 2015 at over three and a half times the size of the economy, an increase in interest rates by 2 or 3 percentage points could result in ‘an immense cost for the economy’, he said. Georgiades added that the tourism bonanza, partly a result of geopolitical factors in the area, which helped the economy and public finances perform better than expected, may not continue for ever.
A sensitivity analysis carried out by the council based on a scenario of the economy’s growth rate falling to 1 per cent, the inflation rate remaining at 1.5 per cent and the government’s borrowing costs rising to 5.5 per cent, showed that public debt could even fail to full further, depending on when this scenario triggers.
His comments came as the government announced its intention to compensate depositors, bank bondholders and shareholders, for losses in the 2013 banking crisis, compensation schemes for farmers, and its intention to write off outstanding value added tax (VAT) owed by football clubs.
Georgiades declined comment on the specifics of the plan to compensate victims of the banking crisis, as the council had not seen its specifics.
He instead referred to the fiscal council’s August statement in which it warned about the systemic risks from giving in to union demands to further increase compensation to pension funds for losses incurred during the banking crisis.
Georgiades said that if the attorney-general opined that the matter is of legal nature, then it could go ahead with compensation “and we cannot intervene”, he said.
If not then the matter is political and therefore possible “collateral losses” should be taken into account, including whether the government is encouraging bad practices.
The chairman of the council said that Cyprus should give workers incentives to save more for their retirement or ditch disincentives, as the savings ratio in Cyprus is well below that of the European Union average.
“Every year that goes by without saving makes each future pensioner’s plight worse,” he said adding that even Cyprus’s international creditors which financed its bailout had not paid sufficient attention to the pension system. “Today’s system has the wrong incentives; we tax pension outlays but we exempt lump sums on retirement”.
Georgiades said that Cyprus should also resume the reform process to enhance its competitiveness, and address the problematic aspects in remuneration in the public sector, including state owned enterprises such as Cyta, the state-telecom company.
At the same time, Cyprus should resist those who demand linking wage rises in the public sector to nominal gross domestic product, he said as the nominal economic out may increase as a result of other factors such as an increase in the number of workers and labour force.
From 2003 to date, economic output expanded 46 per cent in nominal terms compared with a 26 per cent increase in gross domestic product generated per worker in the economy and a 30 per cent increase in earnings per employee, he said.
According to fiscal council data, a public-sector worker earned last year on average €2,757 per month, excluding pension benefits, or 57 per cent more than the private sector, where a worker earned on average €1,752. The crisis did not effect a significant change as in 2010, a public-sector worker earned on average €2,824 every month while those in the private sector earned €1,783.
Georgiades said that the reforms should also take into account Cyta’s falling revenue and shrinking market share, as the state-owned company – which evaded privatisation early last year when opposition parties rejected a government plan to sell it to a private investor – lost €128m in revenues over the past eight years, conceded more than a quarter of its market share in mobile telephony to competitors also in eight years and 7 per cent market share in fixed telephony in the past two years.