The bailout of Greece’s economy and the subsequent action to restore Cyprus’ economy were the big Euro-stories of the last three years. A year on from the Cyprus crisis and a few weeks after the Greek government returned to the private capital markets, all seems to be quiet but is this the lull between storms?
The stories of the fall of both countries’ economies has many similarities yet many differences but neither country is out of the woods yet. In this article we examine the causes of the collapse and what the future holds for each.
Behind the terrible state of the Greek economy which first came to light late in 2009 and into 2010 was the systematic fabrication of economic statistics which hid a growing fiscal deficit which was ultimately to prove unsustainable.
The extent of the problems only came to light in April 2010 when Greek government bonds were reduced to junk status. Yield rates rose so high that no one was prepared to buy the bonds and the availability of borrowing in the private capital markets was closed off to the Greek government. With no other way to finance the deficit Greece was forced to ask the EU for a bailout which initially totalled €110bn.
The country’s fall from grace was initiated by the revelation that it had paid hundreds of millions of euros to banks to ‘hide’ true debt levels by engineering ‘swaps’ which weren’t counted as current debt. Greece was not alone in doing so and other EU countries have come close to a similar fate.
There were a number of re-evaluations of the Greek deficit; May 2010 registered 13.6% of GDP, November 2010 registered 15.4% and it was finally set at 15.7%.
The original bailout pencilled in for Greece of €110bn was based on the falsified data meaning that it would not be enough to stabilise the Greek economy. A second bailout of €109bn was agreed and, with clearer statistics becoming available, it was raised to €130bn and included the wiping out of €110bn of Greek debts.
The debt to GDP ratio, calculated at 198% in 2012, reduced to only 160% because of new debt required to refinance Greek banks.
The austerity measures that the EU required Greece to implement along with privatisation of state controlled industries have proceeded very slowly and outside of the timescale of the EU bailout agreement. Whilst they have quietened down now, protests and riots against the austerity measures caused many Greek MPs to question the aggressiveness of the cuts. Greece is still digging its heels in over the reform of the swollen public sector, fearing political revolt as the unions support political parties.
The slow pace of reform has meant that Greece has had to ask for an extension of two years before it can be self-financed and the delay is believed to require an additional €30bn of bailout funds.
In April 2014, Greece returned tentatively to the bond markets and successfully placed €3bn of five year bonds at a yield of 4.95%. The country managed a budget surplus in 2013 but with desperately slow reform and high unemployment, the country isn’t out of the woods yet.
In 2013, Cyprus announced it would need to seek a bailout from the EU, partly as a result of loans to Greek banks which had turned bad, meaning that Cypriot banks couldn’t meet their commitments and needed refinancing. Additionally and similar to Greece, the island has an overweight public sector with an antiquated pension and other social benefits system. It also had a major problem with mortgage defaults following the 2008/9 financial crisis meaning that many of the island’s banks were saddled with debts in default and holding property as security which was rapidly declining in value. The country had entered recession as a result of the global financial crisis and was struggling to meet its commitments. The final straw came when Cyprus government bonds were reduced to junk status meaning that the government could no longer refinance deficits.
The EU responded very differently to Cyprus’ request. Acknowledging that much of the island’s economy was built on shadowy banking facilities, it decided to make the island’s depositors pay for much of the bailout as well as seeking major reforms of government spending. The previous communist government under Christofias had ignored many of the warning signs of impending fiscal disaster leaving the new government of Anastasiades to pick up the pieces.
The ‘bailout’ or bail in as it has sometimes been called, saw savage clawbacks of deposits over €100,000 and the splitting of Laiki Bank into good and bad elements with one being refinanced and closed, the other being absorbed into the Bank of Cyprus.
Once more protests over job losses and cuts to welfare followed with the government initially voting against them before accepting them knowing that the alternative would be a painful bankruptcy.
One year on, the Cypriot economy is not in as bad a shape as was expected. GDP growth is still negative but hasn’t hit the depths predicted. New business start ups are high and rising and the government is working hard to slowly implement the reforms needed to stabilise the recovery. The expected decimation of the banking system hasn’t happened and overseas funds are returning to the island. Whilst high unemployment is still a problem, it hasn’t reached the levels seen in Greece or Spain and a better tourist season for 2014 has been predicted.
In contrast to Greece, the debt to GDP ratio is expected to reach a high of 126% in 2015 before falling to a much more acceptable 105% the following year. The EU funding will continue until 2016 by which time it’s hoped the Cypriot economy will be in much better shape, hopefully buoyed by sales of public assets and the initial returns on its nascent oil industry. The only cloud on the horizon is the dispute with Turkey over the ownership of oil and gas reserves around the island, something that the politicians hope will be rendered obsolete if a decision on reunification can be reached.
Razi Hammouda can be contacted at FxLords.com