Disappointing IMF Statement on Cyprus

The concluding statement of IMF staff outlining their preliminary findings at the end of a visit to Cyprus is disappointing in many respects.

In their assessment of the performance of the Cyprus economy the IMF staff focus simplicitly on numbers on real GDP and employment growth and the fiscal balances per se rather than on the quality of economic growth and the government finances. Furthermore, the IMF staff do not address certain key problems afflicting the Cyprus economy namely the lack of decent jobs, prolific tax evasion, the very low public investment rate, the failure of banks to adequately finance productive investments, and pressures on the external accounts. These shortcomings in findings means that the IMF staff are giving unwarranted praise to the Cyprus authorities in their management of the economy and downplaying the policy actions and reforms required to rectify certain of the economy’s key problems.

Need for Quality Economic Growth

IMF staff seem to be sacrificing quality to quantity in their obsession with the cult of GDP growth. Any economy including that of Cyprus needs economic growth that benefits the well-being of the bulk of its population. And GDP growth in Cyprus in recent years has not been associated with the creation of decent jobs and incomes in the private sector and in providing adequate social protection. It is mainly the more highly paid public sector and bank employees and managers as well as the profits of large retailers, hoteliers and property developers that have benefitted from GDP growth in most years since the 2012/13 financial crisis.

The  IMF staff refer to the erosion of household disposable incomes by the upsurge in inflation, but in their policy recommendations they neglect any measures to protect the purchasing power of most employees and only state that the “Minimum Guaranteed Income be adjusted to improve its effectiveness and protect the purchasing power of vulnerable households” and that “in case downside risks materialize, automatic stabilizers should be allowed to operate and targeted support provided to vulnerable groups”.  The IMF staff essentially argue against protecting the living standards of most households that depend mainly on incomes of private sector employees by “recommending against any upward revision to the Cost-of -Living (COLA) mechanism” on the dubious grounds that it “would weaken economic resilience and competiveness and deepen duality in the labor market since it is mostly public sector employees and around  a third of private sector employees which are covered by collective agreements”. It is noted actually that all IMF staff receive full cost of living adjustments to their tax-free salaries each year.

Quality and Impact of Fiscal Policies

While the role of fiscal policy in providing support to households affected by cost-of-living pressures is acknowledged, the IMF staff assess the performance of the Cyprus government in managing its finances mainly by whether it achieves progress in improving its fiscal balances and putting the government debt to GDP ratio on a downward path. And by being obsessed with improving fiscal balances rather than the quality of the government finances and their impact on the economy and society, the IMF staff are implicitly supporting the ongoing inadequate fiscal policies of the Cyprus authorities[1]. Such policies reflecting fiscal austerity have been characterized by the harsh cutting-back of public investment expenditures and containing social protection expenditures in order to enable payment of the bloated wage bill for public sector employees and the achievement of fiscal surpluses. As the year 2022 unfolded Minister of Finance Constantinos Petrides claimed that the government did not have enough money to support the payment of increased social benefits to households, despite the government having reserves or bank deposits of over 5 billion euro.

Apart from recommending the re-instatement of the immovable property tax the IMF statement does not comment on the glaring regressive and inefficiently administered tax system of Cyprus highlighted by widespread tax evasion. Surely the need to raise tax revenue through a more progressively structured and broader based  tax system as well as by combatting tax evasion to enable Cyprus to finance productive public investments and social protection compatible with advanced European countries should be addressed in the forthcoming IMF staff report on Cyprus.

The Way forward with Investments and Reforms

The IMF staff are not sufficiently critical of the capacity of the government to move forward with promised investments and reforms included in the Recovery and Resilience Plan (RRP) agreed with the EU. This lack of criticism leads to unwarranted optimism about medium-term growth prospects with the IMF stating that ”growth will gradually pick up from 2024 and average 3 per cent in the medium term , supported by public investments and structural reforms under the RRP, large ongoing and planned private investment projects, and a further expansion of the ICT sector”. However, the extremely low rate in implementing public investments, the reluctance and delays in carrying out structural reforms, and the inability of banks to identify and finance more than a few economically viable investment projects should make the IMF more circumspect as to the economy’s growth outlook.

Also, in view of the need to achieve equitable and inclusive growth and not growth of GDP per se there is a need to gear the medium-term policy strategy including the RRP more toward the creation of decent jobs and investments in the care economy and social protection.

Questionable Bank Activities

While the IMF staff report progress of Cyprus banks in improving their resilience by boosting their capital and liquidity ratios and outlining their vulnerabilities including the questionable quality of their loan portfolios, it needs to be understood that the pre-occupation of banks in selling NPLs and related property collateral at large discounts to third parties is diverting their resources and attention away from supporting economic growth with new loans and the productive restructuring of existing loans. Furthermore, removing NPLs from the bank balance sheets still keeps the private sector heavily indebted and with property sold at discounts to predatory investment and equity funds inequalities are widened through wealth transfers.

Pressure on Balance of Payments

Despite the huge increase in prices of imported energy products having a large impact on the foreign trade balances of Cyprus and most other European countries in 2022 there is no mention of this development in the concluding statement. Indeed, the foreign trade deficit of Cyprus is estimated to have increased steeply from 5.3 billion euro in 2021 to over 7,1 billion euro in 2022 owing mainly to a rise of one billion euro in the value of imports of fossil fuels. And with energy prices expected to increase over the-medium term and Cyprus making little progress in shifting to use of renewable energies extremely high foreign trade deficits are likely to place heavy pressures on the current account of the balance of payments and the external financing needs of Cyprus.