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DEVELOPMENT OF THE ECONOMY OF CYPRUS BEFORE AND AFTER THE BANKING CRISIS
Abstract
The paper contains analysis of the Cypriot economy before and after the banking crisis in 2013. Author defines causes of the banking crisis and considers consequences, which the country's economy faced after restructuring of banks and bank deposit levy. Current situation and prospects for development of the Cypriot economy are also examined.
Keywords
Cyprus, financial crisis, offshore, the Cypriot financial crisis, the banking crisis on Cyprus, bank deposit levy, non-performing loan
AUTHORS
Irina Rouiga Anton Shreider
PhD, Assistant Professor Student
Department of Economics and Business Siberian Federal University
Process Management Krasnoyarsk, Russia
Siberian Federal University shreider-a@mail.ru
Krasnoyarsk, Russia
irina_rouiga@bk.ru
As a start point of the European debt crisis, many economists consider the Greek government bonds crisis at the end of 2009. Further development of the crisis associated with problems in the economy of Ireland, Spain, Portugal and Italy. This crisis has threatened stability of the whole eurozone.
Cause of the European debt crisis is a set of interrelated factors. Primarily it is irrational and short-sighted economic policy of many national governments. Possibility of permanent borrowing has led to significant increase of government debts, the risk of default has been identified. Growth of public debt has led to instability of the banking system. Both of these factors are interrelated, as banks are major holders of government bonds.
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Moreover, we should take into account the fact that wages in the eurozone countries had been showing significant increase in recent years before the crisis, which was less than productivity growth. Domestic demand in these countries had been increasing, causing inflation; economy had been growing through development of service sector and expanding number of government employees, while share of export in GDP was not increasing. As a result, debts of households and governments increased dramatically.
This crisis has shown fundamental problems of the eurozone as a union of countries with different economies, some countries have stable economies with growth potential, while the main source of income for other countries is tourism and financial services. Furthermore, the eurozone countries are united only by a single currency, but states can implement different fiscal policies, and only this had a negative impact on ability of the eurozone countries to jointly and promptly react on the coming crisis.
Greece had a problems because of high public debt, according to the Eurostat, in 2007 it was 107,2 of GDP and reached maximum of 170,3 % in 2011. Greece had large expenditures on pensions and salaries of government employees. It was not enough incomes and government borrowed more and more, this has led to the situation when the country was spending big portion of revenues on interest payments on bonds. Portugal had the same problems, in period from 2007 to 2012, public debt has grown almost twice and reached 123,6 % of GDP. Unlike Greece, Irish crisis was not caused by excessive government spending, real estate market instability had provoked banking crisis, which was the main reason of the following economic crisis. Spain's also had social oriented economy with dominance of low-tech industries and negative trade balance. These factors have led to record level of unemployment and mortgage crisis, which in turn has led to a banking system failure. In Italy the value of government debt to GDP ratio was one of the highest and reached 127,0 % in 2012, industrial production has fallen to its lowest level in 11 years. Cyprus faced problems because of dominance of banking sector and financial services in its economy (Rouiga, Shreider, 2013).
According to the IMF, 438 billion dollars were transferring from Cyprus to Russia in 2009-2011. Similarly, Cyprus was the major recipient of Russia's investments, during the same period Cyprus received more than 395 billion dollars from Russia.
Financial crisis in Cyprus was one of the most topical issues of Russian business in 2013. Cyprus faced economic problems in 2012. Firstly, economic crisis in Greece produced negative effects on the Cypriot economy, because the majority of Cypriot banks were Greek bonds holders. Under the treatment of assistance to Greece, Cypriot banks had to write-off a half of par value of Greek bonds.
In addition, Cypriot foreign debt was growing annually. According to the data of the Central Bank of Cyprus, in 2012 there was the highest annual growth of sovereign debt in percent to GDP among countries of the European Union. Country's public debt increased from 12869,3 million euro in 2011 to 15430,9 million euro in 2012, from 66 % to 79,5 % of GDP, in 2008 this indicator was 8493 million euro.
On the basis of data provided by the Central Bank of Cyprus (table 1), we can analyze development of the country's economy before the banking crisis. GDP of Cyprus, after notable growth in 2007-2008, faced not such a big decrease in 2009 as other countries during the global financial crisis, in 2009 GDP of Cyprus decreased on 1,8 %. For example, Russian GDP fell on 7,8 % in 2009. However, public debt started to rise significantly from 56,5 % of GDP in 2010 to 79,5 % of GDP in 2012. Moreover, unemployment had grown annually since 2008.
TABLE 1. DYNAMICS OF ECONOMIC INDICATORS IN 2007 - 2014 (MILLION EURO), BASED ON DATA OF THE CENTRAL BANK OF CYPRUS (ECONOMIC BULLETIN DECEMBER 2014; ANNUAL ECONOMIC INDICATORS 2014)
Year/ Indicator 2014 2013 2012 2011 2010 2009 2008 2007
Nominal GDP 17506,3 18118,9 19411,1 19486,7 19062,9 18423,1 18768,8 17327,8
Change in % -3,4 -6,7 -0,4 2,2 3,5 -1,8 8,3 9,4
Real GDP in constant values 15007,6 15353,9 16222,9 16619,2 16575,9 16348,5 16689,4 16106,2
Change in % -2,3 -5,4 -2,4 0,3 1,4 -2,0 3,6 4,9
Public debt 18818,6 18518,8 15430,9 12869,3 10769,7 9964,9 8493,0 9370,2
% of GDP 107,5 102,2 79,5 66,0 56,5 54,1 45,3 54,1
Negative growth rates were recording by the secondary sector of the economy (Construction, Manufacturing), as well as in the sectors of Trade, Transport and Services (Public Administration, Recreational and Cultural Activities). Growth presented by the sector of Legal & Accounting Activities.
Furthermore, increasing part of government expenditures in the structure of GDP was also a problem. Increase in government spending and growth of budget deficit had been observing since 2009 and in 2011 reached 6 %.
The banking crisis on March 2013 should be considered as a consequence of instability and economic problems mentioned above. To receive financial support from the Eurogroup, the European Commission (EC), the European Central Bank (ECB) and the International Monetary Fund (IMF), Cyprus had to reorganize two recessionary banks. This implied liquidation of the "Cyprus Popular Bank" (Laiki Bank), and provision of assistance to the "Bank of Cyprus" using deposits more than 100000 euro in volume as a source.
"Cyprus Popular Bank" (Laiki Bank) has been liquidated, its guaranteed deposits, which were less than 100000 euro, have been transferred to the "Bank of Cyprus". Non-guaranteed deposits, which were more than 100000 euro, have been converted into reorganized bank shares, money from the deposits has been used for recapitalization of the "Bank of Cyprus". This increased bank capitalization, but reduced shareholders proportions, among these shareholders were many Russian investors.
TABLE 2. DYNAMICS OF ECONOMIC INDICATORS IN 2007 - 2014 (MILLION EURO),
BASED ON DATA OF THE CENTRAL BANK OF CYPRUS (ECONOMIC BULLETIN DECEMBER 2014; ANNUAL ECONOMIC INDICATORS 2014)
Year/ Indicator 2014 2013 2012 2011 2010 2009 2008 2007
Budget surplus -1045,3 -327,3 -563,3 -691,9 -516,8 -578,6 656,6 1050,3
Unemployment rate 11,1 11,0 8,5 6,7 5,5 4,3 2,9 3,0
Inflation rate -1,4 -0,40 2,40 3,30 2,40 0,30 4,70 2,37
Consequences of these measures were essential for the Cypriot economy. Firstly, a decline in the banking sector caused decrease of GDP on 6,7 % in 2013. Rate of unemployment increased and reached 11,0 % in the end of 2013. Public debt also increased significantly by 20 % from 15430,9 million euro in 2012 to 18518,8 million euro in 2013 (table 1, table 2).
More importantly, Cyprus has lost its position of one of the best offshore jurisdictions for business activities. Russian investors, who often used Cyprus as a place to keep money, were the most affected by the restrictions on movement of capital. By implementation of the anti-crisis plan, Cyprus has shown its dependence from the EU. So companies and
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investors no longer consider Cyprus as a reliable jurisdiction for keeping financial resources.
Some experts and researches were expecting changes in the Cypriot offshore economic model and considering resource-based economy as new model for the Cypriot economy. Earlier, offshore sector covered almost 60 % of GDP, officials argued that developing of energy industry may be perspective, the Ministry of Trade of Cyprus was estimating gas and other hydrocarbon compounds reserves in the shelf area on 300,5 trillion euro.
Despite the all positive predictions, in 2014 GDP of Cyprus in the current values reached 17506,3 million euro, by comparison, in 2013 it was 18118,9 million euro - 3,4 % decline in 2014. In 2012 GDP was 19411,1 million euro. Unemployment increased from 8,5 % in 2012 to 11,1% in 2014. Public debt increased from 79,5 % of GDP in 2012 to 102,2 % in 2013 and 107,5 % in 2014 (table 1, table 2).
Cyprus became the first and so far the only country in the eurozone, which imposed capital control when its banking system faced challenges in 2013 and depositors began to rapidly withdraw money. Cyprus had to write-off up to 80 % of funds on accounts of the major depositors of Cypriot banks to get 10 billion euro financial support from the European Union.
Restrictions on the movement of capital had imposed within the country, which have been removed in May 2014. At the same time, mandatory approval from the Ministry of Finance of Cyprus on large money transfers abroad by commercial organizations, as well as private individuals, if the transfer amount exceeds 10000 dollars, has been canceled.
According to the Central Bank of Cyprus, at the end of March 2015, 46,8 billion euro were on deposits in Cypriot banks. However, before the crisis, in December 2012, this amount was 70,2 billion euro (table 3).
Cancellation of restrictions on the movement of capital quickly caused change in the volume of funds placed on deposits in Cypriot banks. Many investors decided to withdraw money from their deposits as soon as it became possible, as Cyprus has lost credibility after adoption of the bank deposit levy.
TABLE 3. TOTAL DEPOSITS AND LOANS GIVEN BY CYPRIOT BANKS IN 2007-2015 (BILLION EURO) (MONETARY AND FINANCIAL STATISTICS APRIL 2015)
Date/ Mar. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec.
Indicator 2015 2014 2013 2012 2011 2010 2009 2008 2007
Deposits 46,8 46,1 47,0 70,2 69,3 70,0 58,2 56,0 52,5
Change in % +1,5 -1,9 -33,0 +1,3 -1,0 +20,3 +3,9 +6,7 +7,1
Loans 64,2 61,6 63,6 72,5 68,5 61,5 57,9 54,4 41,0
Change in % +4,2 -3,1 -12,3 +5,8 +11,4 +6,2 +6,4 +32,7 +15,5
In addition, Cypriot banks have to restructure non-performing loans and it may require considerable time. This follows from the actual data of the Central Bank of Cyprus, prepared in accordance with the new methodology, this data shows that in two years since the start of the crisis banks have been able to restructure less than a quarter of problem and uncollectible debts.
Lowering non-performing loans will allow new credit to be extended to support economic growth. Recently adopted legislation on foreclosures will provide creditors with a credible threat against strategic defaulters - borrowers, who can pay, but decide not to - and will help restore a solid payment culture in the country. The foreclosure law needs to be complemented by a reform of the personal and corporate insolvency framework, allowing debtors to either restructure their loans or, for those who truly cannot pay, to write it off. The combination of the two sets of measures will encourage banks and
borrowers to move towards speedier solutions, which, in turn, will free up capital for new lending and support growth (Guzzo, 2014).
In March 2015 volume of given loans was 64,2 billion euro. Before the crisis, in 2007, volume of loans had been growing rapidly each year and in 2012 reached its maximum 72,5 billion euro.
According to the Central Bank of Cyprus, proportion of non-performing loans in total loan portfolio reached 47,8 % at the end of 2014, or 29,5 from 61,6 billion euro. And only 22,48 % from 29,5 billion euro has already restructured by banks. Level of restructuring loans for individual customers was 22,82 % from total amount of non-performing loans.
Loans for corporate customers are also troubled. By the end of 2014, banks have accumulated loans on 23,6 billion euro, more than half of them (58 %, or 13,7 billion euro) recognized as troubled. Level of restructuring reached only 28,6 %, but amount of writedowns exceeded 31 % of the amount of problem debts of corporate customers, that in absolute terms means a loss of 4,28 billion euro.
We can evaluate the scale of a problem with application of industry analysis. For example, loans given to construction companies reached 6,6 billion euro, 78 % of them (5,1 billion euro) are non-performing. However, banks already have wrote-off only 1,5 billion euro, so the rest of the problem debts requires restructuring or in the worst case should be assigned to losses in the current year.
Thus, the total amount of loans to be written-off as uncollectible debts at the end of 2014 was 9 billion euro, or 32,9 % of the total amount of given loans. According to the opinion of the IMF, in order to achieve recovery of banking system and average European level of write-downs, Cypriot banks will have to write-off of up to 50 % of the outstanding amount. That is to accept losses in amount of 4,5 billion euro. The best way is to try to restructure more non-performing loans.
To conclude, our analysis defined causes of the Cypriot banking crisis, which primarily caused by significant amounts of problem loans and losses on Greek bonds. To settle the banking system and to obtain financial assistance from the IMF and the EU, Cyprus had to restructure its two largest banks, and also convert non-guaranteed deposits in these banks into the shares of a new bank. These actions led to stabilization of the banking system of Cyprus, however, also to losses of depositors funds. Cyprus definitely lost investors' confidence after implementation of these measures. In addition, number of clients and value of deposits declined, GDP shrank, unemployment rose. However, non-performing loans remained and banks will have to write-off these debts if they will be not restructured. Therefore, it is early to expect full recovery and normalization of the economy of Cyprus.
REFERENCES
1. "Annual Economic Indicators 2014", The Central Bank of Cyprus website, from http://www.centralbank. gov.cy/media/pdf/AnnualEconomicIndicAril2015ENG.pdf
2. "Economic Bulletin December 2014", The Central Bank of Cyprus website, from http://www.centralbank.gov.cy/media/pdf/CBC-Economic-Bulletin-Dec-2014-English.pdf
3. Guzzo, V. (2014) "The Prospects for the Cypriot Economy in 2015", The International Monetary Fund publications, November 14.
4. "Monetary and Financial Statistics April 2015", The Central Bank of Cyprus website, from http://www.centralbank. gov.cy/media/xls/2ndMFSApril2015eng.xls
5. Rouiga, I.R. & Shreider, A.S. (2013) "The euro zone crisis: causes, consequences and ways of solving", Journal of East Siberian Open Academy, № 6; from www.es.rae.ru/vsoa/170-733
