By Alexander Apostolides on February 24, 2011

New downgrade of the economy: Knock knock on the (deaf's?) government's door!

Despite myself (in The Economist, and the Cyprus Mail) and many others, including the IMF, warning the government repeatedly that drastic action is needed to avoid the downgrade of our credibility the present government has failed to listen. AS a result we have suffered our greatest ever downgrade by Moody's Credit Rating agency, down two pips to A2.

I have stated time and time again that credibility is easily lost and then it is very difficult to regain it. The previous, smaller downgrade has cost the Republic of Cyprus approximately 20 million euros in increased interest premiums, and this downgrade bring us ever closer to the point where structured financial assets in the USA might need to begin to offload Cypriot debt in order to remain within their strict limits of the type of top quality paper they need to keep in their portfolio. This will make our borrowing harder and more expensive, at a time when the government needs to borrow more that ever since its revenue has fallen substantially relative to its expenditure.

All of us urged the government to make drastic actions on the government budget bill of 2011 and especially the wage bill of the central government's employees in order to send a message of its willingness to do what it takes to put its finances in order. This would be the best answer to halt more credit rating drops and thus be able sooth the fears of foreign agencies about its ability to support the banking structure, fears that are unfounded as as Cypriot banks have not yet used the massive ECB lifeline and have maintained enviable liquidity.

The government has also argued that the economy is now out of a recession and thus a massive restructuring of the government's expenses were unessential. After all as the graph from the statistical service shows below, the worse was over for the Cypriot economy.



The international and local calls for brave action against the large and structurally unsound system of government wages led to the government promising reforms during the 2011 budget. Yet the budget that came out in December 2010 was a wish-wash of compromise between the two ruling parties. There has been no radical restructuring of government wage system. Wages will keep growing due to the socially unfair system of wage indexation, where taxation on basic staples such as medicine will be used in part to pay the increase in wages for government employees even on the highest paying scale. The greatest emphasis of the budget was in increasing government revenues rather than reducing government expenditures.

The latest detailed statistics on the government finances as submitted to EUROSTAT bear this out. Below is a graph of government expenditure (red line) by quarter from 1995 to 2010, and of government revenue (green line).



Note how for almost all governments since 1995, with the notable exception of late 2007 / early 2008 when the Ministry of Finance was in the hands of Dr. Michalakis Sarris, expenditure was higher than revenue even if very good economic years. This has led us into problems today, since the government is already saddled by substantial debt that it should have paid off during good economic years, when government revenues are increasing.

However note that is the last quarter of 2009 the wage bill of the central government exploded, and as a result the wage bill of the government was 48% of the total revenue! Since then the government has stemmed the rapid increase but not the underlying trend of increasing wages: even in the third quarter of 2010 the wage bill has increased relative to the third quarter of 2009.

Its about time we realise that we are loosing our credibility on our ability to maintain our standing as a solidly conservative financial destination because we are unwilling to solve the issues that we neglected for decades, such as the increasing government wage bill and the lack of government savings during times of prosperity.

2 comments:

  1. "There has been no radical restructuring of government wage system. Wages will keep growing due to the socially unfair system of wage indexation"

    Precisely, although it's not just that. This supposedly progressive government proves to be utterly conservative, not daring even to touch the real problems of the economy.

    They‘ve got no balls.

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  2. Well it increasingly seems to be so.
    To be fair to them, quite a lot of the issues where there before they came to power, but you can "ignore" them if the economy is growing.
    Don't get me wrong about ATA /wage indexation. I think its a great policy for the lowest incomes (and i would love it to be universal for them), but i can not understand why someone on a scale of A18 + needs to get a proportional raise to his income, which could mean a raise of several thousand pounds a year.

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