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Cyprus risks making the same mistake that Greece, Ireland and Spain made when they kept drawing the so-called “red lines” from which they would never retreat during the loan negotiations with the Troika, but in the end, they changed the red lines to green when presenting their restructuring plans.
When your lender asks you to draw up a plan on how you will settle your obligations, you will scrap the policies or the so-called red lines that got you into trouble.
This is exactly what will happen irrespective of whether or not Cyprus secures the EUR 5 bln loan from Russia. What the government is attempting to do is cover its financing needs through the Russia loan without any conditions, while keeping the Troika loan for the banking sector in the hope that when the European Support Mechanism is up and running, it will lend directly to the banks. They nevertheless forget that even in such a scenario, the state budget will repay the loans and not the banks.
But with the ESM not yet up and running and the government pressed on the bank recapitalization issue, of more importance is the result of the Troika fact finding report due next week. This will become the blueprint leading to the signing of a Memorandum of Understanding and the loan agreement before the end of August.
For example, on the issue of COLA, the Troika will make its recommendation why it should be scrapped, but it’s up to the Cyprus government to decide how to deal with it. If the government agrees with the unions on keeping COLA and giving 6-8% annual pay increases irrespective of the productivity rate, so be it, but it’s the Cyprus government that needs to find the money.
The same applies to the corporate tax rate. It was never an issue and never on the Troika’s agenda. When our failed political leaders saw this – that the tax rate was not on the agenda – they decided to make it an issue. Even President Christofias jumped on the bandwagon and drew yet another “red line” saying the tax issue was not up for discussion. But it never was. Nevertheless, Christofias and now a number of professional organizations are giving the impression that they managed to win a major concession from the Troika. As usual that is a big lie.
Rest assured, if the Troika wanted to force us to change the tax rate, we would, no question about that. Very correctly, the Troika has decided not to tamper with the corporate tax rate, which if increased, would hurt the economy and lead to more unemployment.
The same people who keep drawing up red lines fail to explain to the public how the bailout process will evolve.
First the Troika will make its recommendation on how much the country needs.
While identifying the financing needs of the state is easy – it’s obvious how much debt will mature in 2013 and 2014 and how much the projected deficit will be – the big mystery is how much the banks will need, first to recapitalize and then to cover their additional non-performing loans that they have swept under the carpet.
As the Troika immediately spotted, the banks in Cyprus were not counting as non-performing loans against which property had been pledged, thus lowering substantially their non-performing loans, which is immediately reduced from their profits, resulting in need for more capital.
Fortunately the new Governor of the Central Bank also agrees with the Troika that banks should be forced to reveal the true state of their situation, both in Greece but equally importantly in Cyprus as well.
So if the banks need EUR 10 bln, plus EUR 5 bln that the government needs for a total of EUR 15 bln, a loan agreement will be signed at a rate of say 3%. That’s an annual interest charge of EUR 450 mln which the Cyprus government will need to pay.
Since Cyprus does not have EUR 450 mln, it needs to present a coherent plan to the Troika on how it will raise the new funds. The money has to be raised either through tax increases or cost cuts or a combination of both.
The Troika will not tell Cyprus how to raise the EUR 450 mln. The Cyprus government will present a plan detailing how it plans to do so. The government may propose increasing VAT, personal income tax, or even the corporate tax, or decide to scrap the civil servants’ 13th salary and all allowances, and similar to Ireland, Greece and Portugal, order an across-the-board civil servant salary cut ranging from 10 to 20%.
Once the plan is presented, it will be evaluated by the Troika and then followed up by fact finding missions every three months to check on the progress. If the targets are being missed, similar to the case in Greece, the Troika will ask for more measures (more cuts). If the targets are met similar to Ireland and Portugal, the Troika will say bravo and well done and return home.
It would be great if those in power explain to the public how and when they will scrap the so-called red lines and stop blaming the Troika for our ills. The Troika is here to help because we screwed up with our economy and especially with our banks, and now we need the Troika to put our house in order!
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(Shavasb Bohdjalian is a certified Investment Advisor and CEO of Eurivex Ltd., a Cyprus Investment Firm, authorized and regulated by CySEC, license #114/10 and approved by the Cyprus Stock Exchange to act as Nomad for listings on the Emerging Companies Market. The views expressed above are personal and do not bind the company and are subject to change without notice)
