By Demetris Georgiades
It is in the nature of Fiscal Councils to be prudent and to advocate for fiscal discipline.
But under the unprecedented pandemic, there was a consensus even amongst Fiscal Councils that drastic government intervention was needed.
Such as fiscal measures to support households in need, preserve job positions, throw a lifeline to viable businesses facing temporary cash flow issues, and keep the supply chain intact.
This, however, resulted in a substantial increase in government debt globally.
An equally unprecedented globally-coordinated monetary policy mainly facilitated an increase.
Central banks worldwide took measures to increase cash liquidity and keep interest rates at record low levels.
Most economists believe that interest rates will remain at very low levels for the foreseeable future, thus keeping gross financing needs low.
They also believe that measures taken to support the economy can and should stimulate strong economic growth that will enable most countries to fulfil their debt obligations.
They see little threat to debt sustainability.
Economists like Olivier Blanchard put forward this analysis, reaching certain conclusions based on data relating to the global economy as a whole or by emphasising the state and needs of the bigger economies.
These predictions and useful advice understandably not only contain caveats but it is non-specific.
It is up to national governments and institutions to consider their state of affairs and conditions and fine-tune this advice.
As a Fiscal Council, we stressed two major factors that need to be considered in Cyprus.
The first is the very high level of debt.
A sudden and big jump in interest rates will have a much bigger fiscal impact in countries with high debt levels. The higher the debt, the higher the need for a Plan B.
The second is that the ECB determines Cyprus’ monetary policy. The ECB takes into account the conditions and needs of the Eurozone as a single entity.
It is very important for Cyprus and all other Eurozone members with high debt levels to attain high economic growth rates as soon as possible and certainly before the major players do so.
If the big Eurozone economies start showing signs of overheating with inflation pressures building up.
In that case, the ECB will have to start withdrawing its liquidity support measures, thus pushing interest rates up.
Need for reforms
This is exactly why, as a Fiscal Council, we decided in our last Spring Report to emphasise two areas.
There is a need to control and target public expenditure and, more so, implement policies that will facilitate stronger economic growth as soon as possible.
The latter can only be achieved through structural reforms.
These reforms had been highlighted in detail in the past by the Council and several other national and international institutions and academics, unfortunately with relatively little progress.
Several of these reforms were included in the 2013 Cyprus Economic Adjustment Program under Troika as prior actions.
Nevertheless, the quick economic recovery leading to high budget surpluses and the strong lobbying by interest groups led to reform fatigue.
The current crisis gives Cyprus a second opportunity to implement policies that will boost its competitiveness and create the conditions for a more prosperous, sustainable, and inclusive economy.
The European Commission’s Recovery and Resilience Facility, which sets the promotion of reforms as a precondition for allocating funds to member states, is an additional incentive and an opportunity.
Proper management of the allocated funds will have a double benefit for the Cypriot economy.
Direct benefit from an injection of the funds to Cyprus and most importantly is the medium-long term benefit from strengthening its potential GDP growth rate through the reforms.
It should also be noted that by reforms, we do not mean the one-off design and implementation of some policies or measures.
It is a continuous process that improves the effectiveness both of the public and private sectors and facilitates innovation and inclusive economic growth.
It is difficult to prioritise the importance of reforms to be implemented.
Some of them will have a bigger impact, others will have a faster impact, and most are intertwined.
Furthermore, we usually concentrate on the big reforms or reforms that have a certain attraction in their nature or attached to their name, i.e., green reforms or digital revolution reforms.
In the case of Cyprus, we should focus attention on the following areas:
- The challenge of non-performing loans remains high both inside and outside the banking sector. A transparent and effective legal framework that will create certainty and a level playing field between lenders and borrowers should be implemented as soon as possible.
- The whole education system needs to be reformed given the relatively low results and high public spending. Furthermore, the system should encourage and not discourage students from following careers that meet the economy’s future needs.
- The justice system remains extremely slow and ineffective. This discourages economic activity and foreign direct investments into the country. It also harms property rights, including property prices.
- There is still unnecessary bureaucracy and a lack of transparency, with weak supervision within the government sector. It not only discourages economic activity but also creates the conditions for corruption.
- In certain professions and economic sectors, unnecessary barriers to entry are still present. Closed professions and sectors of the economy should be opened up to make it easier for new players to enter and innovate. Barriers to entry should be kept to the minimum necessary and the extent they protect the rights, health, and safety of the public and not that of the economic benefit of the providers.
- Adopting economic policies that encourage non-sustainable economic growth, which might cause collateral damage to other sectors of the economy, thus increasing the volatility in the economy, should be avoided. They usually absorb resources from activities/sectors that offer more inclusive and longer-lasting benefits.
- Urgent measures are needed to reverse the consistently low household savings rate that raises concern for future pension adequacy for many of the working population. The whole pension framework needs to be modernised to encourage the total working population to participate and save for its future pension needs.
Demetris Georgiades is Chairman of the Cyprus Fiscal Council. The views expressed are his own unless stated otherwise