Thursday, 7 April 2011

The credit rate slide in Cyprus is mostly due to government actions

The other night the President has called that the problems of the economy were partly inherited by the previous government and mostly from abroad and that his government did nothing to make things worse.

I have mentioned previously how this is actually not true. The economic crisis started in the US in 2007 and spread in most of Europe and the world by 2008. Despite warnings that Cyprus will be affected, and the emerging problems in several sectors, such warnings were ignored by this government. The serious slowdown in taxation revenue and investment was a warning sign of a economic recession that lay ahead, but the government again ignored these warning signs.

The statistics Cyprus submitted to EUROSTAT indicate that just as revenues of the government were falling at an all time low in the last quarter of 2008 and in the first quarter of 2009, the expenditure of the government, and particularly wage expenditure, was rising dramatically. When revenues were falling, expenditure was rising, causing the government to need to borrow exactly at the time when the international markets were nervous of governments that refused to reign in the expenditure in the face of such revenue shortfall. The credit downgrade of our government was thus in part due to government actions; although most credit rating agencies cited the large size of our banking sector as a concern, the inability of the Government to live within its means became an ever more important factor in our continuing loss of credibility.

The fact that in 2008 and early 2009 the government increased its wage expenditure just when revenues were dramatically reduced resulted to the government wage expenditure rising to 50% of government revenues by the end of 2009. This meant that just when the economic recession was reaching its peak in the private sector, the government cancelled an alarming number of investment projects in order to satisfy the need to pay its employers. Government investment is crucial when private business is facing uncertainty: it replaces the investment that private business holds back and provides the momentum for the economy to begin the road towards recovery. The retraction of government investment in the third quarter of 2009 in order to pay government wages meant that the recession was both made worse and was prolonged for at least another quarter.

Any attempts to reduce the wage bill came to late (in early 2010) and have so far have managed to just reverse the mass increases in the wage bill expenditure that this government initiated; they have failed to stop the upward trend of government wage expenditure. In fact the government's emphasis has been on increased taxation and borrowing, further crowding out private business and increasing the size of government to the GDP. This is serious: there is not doubt that interest rates are high in Cyprus, but this just might be because the government sucks it a substantial number of domestic savings due to its large borrowing needs, the credit available to private business men and households is reduced, leading to high interest rates.

This government can not play the role of Pontius Pilatus and wash its hands of the economic problems of the island. It was not responsible for the economic crisis, but it has a large share of the blame for the poor management of the crisis. It made bad decisions and it showed a lack of courage to get important reforms through. The government was aware that revenues were falling, but it seemed that the message did not percolate through to the persons hiring government employees and raising government wages.

The President should look at his advisors: did they not warn him of the outcome of such decisions and the need to tackle the government wage bill forcefully and immediately as the Governor of the Central Bank asked him to do? If they did and they were ignored then the onus of the poor management lied to bare with himself and his cabinet.

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