Deficit Increased Four Times To 1.2 Bln Euros 2007-2009 - Orphanides
Update: Cyprus' deficit increased four times to 1.2 billion euros from 2008 to 2009, wiping out a surplus of half a billion euros inherited from the previous government, said outgoing Central Bank Governor Athanasios Orphanides in his last speech to the House Finance Committee.
Overall, between 2007-2009, there was a fiscal gap of 1.6 billion euros, said Orphanides. Unlike other EU countries, the rise in the deficit cannot be explained by a deep recession or by unemployment benefit payouts. The problem came from a huge increase in government spending on social benefits, salaries and pensions that is estimated to be 1.3 billion euros between 2007 and 2009, said the economist. The deterioration in the deficit continued in 2010 and 2011 and government spending increased by a rate of 4 percent per year while GDP remained stagnant, he said.
As a consequence of this imbalance, public debt increased to 4.3 billion euros between 2008 and 2011, he said. This had serious implications for interest rates for Cyprus bonds in international markets. Up until December 2010, Cyprus enjoyed low interest rates on external borrowing of up to 4-5%. From then on, however, lending rates rose, particularly since there were no measures taken by the government to counteract the defict.
"At this point, in the first few months of 2011, I tried to explain the need for an immediate reversal of this dangerous situation...Unfortunately, despite the clear risk, the necessary fiscal correction through immediate action did not happen," said Orphanides.
By May 2011, the state was excluded from international markets and long-term bond yields soared. As of June 2011, interest rates on Cyprus bonds reached the same level as those of Greece, Ireland and Portugal and today it is around 13%, he said. Cyprus' lack of access to affordable borrowing affects domestic growth and employment, and adds tremendous pressure to the banking sector due to increased financing costs.
"The government's failure to refinance the debt created doubts internationally over its ability to support banks in an emergency," said Orphanides.
The situation would have been different if the government had been more careful with the country's budget because a banking sector bailout would cost 5-10 percent of GDP, less than half the increase in government spending between 2008 and 2011, he said.
There is a need to restore the sustainability of public finances and recapitalise the banks to reverse the negative spiral in the economy, said Orphanides.
"The economy of our country is going through critical times. Proper handling of the problems must start. Not only is the economy compromised but so is the wellbeing of its citizens and our national existence," he said.
The official's term ends on May 3rd after he was replaced by Dr. Panicos Demetriades. Demetriades studied Economics and worked at the Economic Research Department in the Central Bank, and teaches at the University of Leicester. He was born and raised in Limassol, is married and has three children.
His work frequently challenges mainstream economic theory, and according to Bloomberg, he once advocated that Germany leave the euro so that other economies could be more competitive. He is against cutting public spending and the size of government and according to Wikipedia, his position is that "public investment can actually promote the productivity of the private sector and stimulate trade, employment and long run growth." His research also supports the view that government-owned banks are better than non-government owned banks.
"I am honoured the president has entrusted me in this new role, particularly at this difficult time for Cyprus and the rest of the euro area.
"Although it is a new challenge for me, it is not one that I am ill-prepared for.
"My 12 years at the University of Leicester have equipped me with a range of skills that will help me in my new role," said Demetriades in a statement released by the University of Leicester.
According to government spokesman Stefanos Stefanou, who was asked what the government expects from Demetriades, 'especially in these very difficult times experienced by the Cypriot economy due to the problems that exist in the banking sector, all need to stand next to the Governor of the Central Bank. The government will of course be next to the Governor and will continue the cooperation it has with the Central Bank, aiming to address these problems and open a new horizon on the Cyprus economy."
Orphanides is blaming the government for the banking sector's difficulties when it was his job to supervise the extent to which they were exposed to the Greek government's debt market, said Stephanou in reaction to Orphanides' speech. The lack of liquidity from the banks in the market is the biggest problem faced in the economy, said the government spokesman, who claimed that the government warned about the problems with the banks but Orphanides took no action. Orphanides saw the government (Council of Ministers) as an opponent and joined the opposition in taking shots at it, said Stephanou. Damage from Cyprus' banks exposure to the Greek debt market has resulted in three billion euros of damage, the worst since 1974, said Stefanou.
The Central Bank is an independent insitution which sets Cyprus' interest rates and manages systemic risk, but it should be noted that Greek government bonds are sold five, ten or twenty years in advance. Given Greece's economic woes, whoever bought its bonds would have lost money either in the selling price (a country's bond price drops when its interest rate rises to reflect the risk of its defaulting) or during the 'haircut' when Athens wrote down its debt. Without a crystal ball, the Central Bank could not have predicted that Greece would write down its debt payouts by 50 percent, as the discussion over the possibility started late in 2011, and the CB is obviously not in control of systemic risk linked to government spending in other countries.
As far as Cyprus' high interest rates on its own bonds are concerned, interest rates on government debt rise and fall in proportion to investors' trust in the ability of a government to manage its finances effectively, thus making the spokesman's accusation that the Central Bank is to blame for the island's current economic problems groundless, to say the least.
If the Central Bank were to tell private banks which bonds to buy and sell this would be encroaching on the principle of a free market economy and free flow of capital, a factor blithely ignored by the government spokesman, but generally observed by most central banks in developed countries. In the extreme case of Laiki Bank, which lost 2.5 billion euros on its Greek debt exposure, the bank had actually merged with a Greek bank - Marfin Group - and it is almost too obvious a point to say that its own exposure to the Greek government's debt market would naturally have been much higher.
The entire debate highlights two completely diverging approaches to economic management, a divergence and lack of coordination during a critical period, that has already caused a considerable amount of damage to businesses and the job market.
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