It looks like the ruling Progressive Party of Working People (AKEL) finally gave into pressure from its coalition partner, the Democratic Party (DIKO), this week and will concentrate efforts on cutting spending rather than raising taxes.
What is somewhat surprising is that, despite legislative elections in May 2011, DIKO has been unofficially joining forces with the opposition Democratic Rally (DISY) to call for cuts in spending so that the government can rein in a budget deficit that hit 6.1% of GDP in 2009 and will shrink only a little in 2010, according to the latest predictions of the finance minister, Charilaos Stavrakis.
AKEL, on the other hand, would rather raise corporate tax or VAT.
There are many reasons why DIKO has changed its tune. Perhaps it is looking beyond the not-so-influential parliamentary elections to the much more important presidential elections in 2013.
Having seen its fortunes fall in coalition with AKEL, perhaps it is planning for a DISY-DIKO partnership in 2013.
Or perhaps it has run some opinion polls and realised that, even though every public-sector worker who passes an initial test is appointed with the political backing of one party or another, these public-sector workers are ultimately fewer in number than the rest of the voting public, who would rather see pay cuts for the privileged few than tax rises for the many.
Or perhaps it is simply doing the right thing for the economy of Cyprus. It has seen the financial markets ruin one eurozone economy after another and fears that Cyprus is next.
Yiannis Constantinou, from the spokesman’s office of Diko, told the Financial Mirror that Diko has “a good track record” on the economy, suggesting that it wants to maintain its good reputation.
By the end of the term of the late President Papadopoulos, the Diko-led government had shored up a budget surplus of 3.5% of GDP, which rapidly disappeared under the Akel-led government.
Diko believes that Mr Stavrakis will need to find more than the predicted EUR 150 mln to meet its pledge to the EU to cut the budget deficit to 4.5% of GDP in 2011.
Disy’s motives also appear to be honourable. The Disy spokesman, Haris Georgiades, noted that their call for a cut in public finances long preceded the Standard and Poor’s downgrade.
Yet the downgrade probably has concentrated minds, since it has put Cyprus on a map from which it had hitherto been happily absent.
Worse still, S&P pointed the finger not so much at the public finances, but at the banks, about which financial markets are currently fretting the most.
Despite Cypriot banks’ enormous deposits, amounting in September to more than EUR 44 bln (440% of GDP) excluding non-resident deposits and EUR 67 bln (more than 660% of GDP) including non-residents, it raised concerns about the EUR 5 bln exposure of banks to Greece.
The S&P downgrade pushed up the yield on Cyprus’s recent ten-year Eurobond and also meant that the Cyprus economy made a rare appearance in this week’s Economist magazine.
“Only three years after joining the euro, will Cyprus need the currency club to rescue it?” it asks, adding that the government’s draft budget is “light on austerity”.
Why cutting makes sense
But the back pages this week’s Economist also gave another reason why both DIKO and AKEL should focus on spending cuts, rather than appeasing the public sector.
In an article called “Vote for Agony”, it cited new research by Alberto Alesina, Dorian Carloni and Giampaolo Lecce entitled “The Electoral Consequences of Large Fiscal Adjustments”. “In only 20% of elections in the countries that slashed spending did the government lose power, compared with a 56% rate of being booted out of office for governments which chose to raise taxes,” noted the Economist.
In other words, raising taxes is much more likely to lose you an election than cutting spending. Of course, AKEL members probably don’t read magazines written by unapologetic capitalists. But perhaps they should make a temporary exception. According to this research, it might be worth a vote or two.
Fiona Mullen
Director, Sapienta Economics Ltd
