EDITORIAL, published Jan 18, 2006
The call by Demetris Christofias, as leader of the main coalition partner AKEL, to delay the adoption of the euro by one year to 2009 makes no sense. That is, if one views it strictly from an economic, rather than a political point of view.
AKEL presumably knows that the crunch year for Cyprus’ euro hopes is 2006.
Once Cyprus has spent at least two years in the Exchange Rate Mechanism (ERM2), ie. some time after May 2nd 2007, the Commission, European Central Bank and other member states will sit down to decide on whether Cyprus has met all four Maastricht criteria, namely: (1) deficit and debt; (2) harmonised consumer price inflation; (3) long-term interest rates; and last, but not least, (4) exchange rate stability.
When deciding whether Cyprus has met the budget and debt targets, the decision-makers will use the figures for the whole of the previous year, namely 2006.
For inflation, interest rates and exchange rates, they will take averages for the preceding 12 months, which will also include some of the performance in 2007.
The most difficult of the criteria to meet, as most euro-area states have discovered, is the budget deficit. It must be no more than 3% of GDP.
In fact, if you get the first one right, then the others tend to fall into place, or, in the case of the more flexible debt criterion, it tends to be moving in the right direction.
So this is why 2006 is the crunch year for Cyprus.
At first sight, therefore, AKEL’s call to leave it another year seems like a call to put off difficult measures.
But that theory ignores a few facts.
First, the battle over expenditure in 2006 has already taken place: the 2006 budget was passed late last year and other difficult decisions, such as Cyprus Airways, have been taken.
Second, the government currently estimates that the budget deficit in 2005 was already well below the 3% threshold, at 2.5% of GDP, down from 4.1% of GDP in 2004 and 6.3% of GDP in 2003. A significant amount of fiscal adjustment has therefore already taken place.
Although the government will not have the benefit of the tax amnesty in 2006, its aim to cut the deficit to 1.9% of GDP this year is modest by comparison with previous years.
Third, the fact that the government is aiming well below the target also gives it room for manoeuvre if tax revenue turns out to be lower than expected.
So what is AKEL really playing at?
Four possibilities present themselves. First, that AKEL does not actually know much about the euro, so doesn’t realise that we have already decided on the budget for what will be the crunch year.
Second, that it is playing on the public’s fears that the euro will somehow increase prices in the same way that the public blames EU entry for a rise in prices.
It is worth remembering that prices rose so fast largely because AKEL, among others, resisted the mandatory increase in VAT for so long that we went from 8% to 15% seemingly overnight. Moreover, for lower income earners a large portion of this increase in indirect taxes was offset by a CYP 4,000 increase in the tax-free threshold for income tax. This made a huge difference to those not earning politicians’ salaries.
Third, related to the second, that AKEL will benefit from being seen as the considerate party when it comes to the parliamentary elections in May.
The fourth idea is much more speculative. One of our readers has suggested that since Christofias has decided that he wants to be president after the elections in early 2008, he wants to be the man to bring in the euro.
What better than to lay claim early in his presidential career to a major achievement which can also act as good back-up, if he too fails to solve the Cyprus problem.
