Tuesday, 18 March 2008

The ugly beast rears its head: Inflation and the new president in Cyprus.

The ugly beast rears its head: Inflation and the new president in Cyprus.

The new president of Cyprus has plenty of issues to clear: the previous presidency has left several unresolved issues in terms of the Cyprus problem and domestic social policies. However I am predicting that one of the hardest issues for the new president will be inflation and the expectations of the Cypriot working class who in their majority have voted consistently for the party he represents (AKEL).

Cyprus entered the Eurozone in the 1st of January 2007 with an economy that was already showing signs of overheating: this was partially caused by the Euro entry – the interest rates cuts to align the Cypriot interest rates to the Europe area took place at a time that conventional monetary policy advised an interest rate rise. One of the side-effects of this was a property market boom (one could say buble?) as cheaper loans were made available. This was confirmed by an influential member of the Cypriot Monetary Policy Committee, Professor Pissarides the Swansow Professor of Economics at the London School of Economics at a public meeting in February. The data provided by the Central Bank and the Statistical Service indicate that by November inflation was already above 4%, and possibly increased in January and February with the entry to the Eurozone and the world price increase in commodities. High inflation is not desirable as it creates a negative economic climate for saving and makes important industries of Cyprus (such as naval and tourism) less competitive to other countries linked to the dollar rather than the Euro.

Professor Pissarides also raised concerns that the economy would suffer from inflation as the increases in the world price of oil, wheat and fodder trickled through the economy. The result of such an overheating economy and high costs will create the biggest headache for the new President: How to prevent the increase in militancy when unions demand above inflation wage rises. However the government can not raise interest rates, the most effective way in combating inflation: interest rates are now controlled by the ECB and Fiscal Policy measures to control inflation are considered weak and market distorting.

It is important to note here that Akel’s history is similar to Labour’s in the UK in the fact that the unions were the driving force within the party. PEO, the largest union in Cyprus, is very closely affiliated with the party and campaigned hard for Mr. Christofias presidential candidacy. Many people within Peo feel that they finally have “their” President: Although Both Mr. Vasiliou and Mr. Papadopoulos were elected with Akel’s (and thus Peo’s) support, their business background meant that the union felt that the rights of its members were not fully represented.

As a result of “their” man being elected, I am expecting the unions to demand welfare rights and wage increases that were denied to them in previous administrations. And that is exactly what Mr. Christofias will have to deal with the renewal of the first collective bargaining agreements during the summer. If the president gives in to above inflation demands, it is possible that a inflationary spiral occurs, fuelling more inflation. The unions will feel that their members are being squeezed by the increased inflation and thus be more vociferous in their demands for wage increases.

Mr. Christofias may try to shoot two birds with one stone: he may resist union demands for above inflation wage increases, but sweeten the deal by offering substantial increases in welfare benefits. The rapid development of the economy and the resulting fiscal drag due to inflation (were more people are taxes in higher rates due to the general rise in real incomes) could produce enough of a budget surplus to allow this to happen. But the solution is not a sound one: even temporary welfare benefits tend to become permanent and thus drag budget resources at times of hardship, and that the inflationary spiral may still take place if the real value of the benefits exceeds the rate of inflation.

This will be the most difficult challenge for Mr, Christofias: it will be the first challenge were the President will have to prove to his own party members that he is now president and not the general secretary of Akel by resisting unreasonable wage demands. However doing so is against the core of his role as the general secretary of the party, which ideologically supports the rights of workers. To be fair to Akel and Mr. Chirstofias, the power balance has shifted and now Akel dominates Peo: thus Mr. Christofias maight find it possible to force Peo to moderate wage and welfare claims prior to entering collecting bargaining arrangements. It remains to be seen if Peo will remain loyal to “their” man if their long cherished demands are disappointed yet again.

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