* Deficit likely to hit 9% of GDP in 2011
Last week, I ran an article on the banks and the budget in which I essentially argued that we were not yet in a crisis situation because the banks had plenty of cash to keep lending to the government.
While there is still plenty of evidence that the banks are sound, three developments since last week have made me question my view about the budget.
First, the fact that we still have no government and no economic policy. This has seriously dented confidence among local and international business, and has raised concern about the economy to panic levels.
I learned this week that one prominent Cypriot family is moving its cash out of Cyprus. I hope for all our sakes that they are the only ones.
Second, and not related to the first, the veiled warning from Bank of Cyprus, the country’s largest bank, that while it does have the funds to keep lending to the government, it needs to see credible policies to do so.
The banks know better than I do how willing they are to lend to the government, so this unprecedented warning underlines quite how worried the business sector is about the lack of agreement on economic policy.
Last but not least, the latest figures on the public finances, showing that the budget deficit reached EUR 637.2 mln in the first half of the year, compared with EUR 850.2 mln for the whole of 2010.
Spending shot up by 9.2%, while income dropped by 0.2%.
In the past two years, the budget deficit for the full year has been 2.5 times higher (around 160% more) than the budget deficit in the first half of the year.
If the same pattern emerges this year, we shall have a budget deficit of EUR 1.7 bln (9.1% of GDP) by the end of the year. And that is without taking into account the additional costs of the Mari explosion.
That is exactly the kind of fast increase in debt and deficit levels I warned would gain the attention of the rating agencies.
Moody’s already downgraded Cyprus last week, citing the lack of decision-making on public finances. It also stated that the outlook was negative, meaning another downgrade is on the cards.
If we don’t have a deal with the public-sector union by the end of next week, when everyone goes on holiday, I wonder if we won’t see another downgrade before the summer is out.
Fiona Mullen
Director, Sapienta Economics Ltd.
