By Alexander Apostolides on September 09, 2011

From a series of bad choices, we chose the one with unknown repercussion.

That the Cypriot state is facing a serious an immediate liquidity crisis was known for a while. Most analysts who saw the first package of measures realised that they were mainly measures to aid the reduction of the structural deficit in the future and less about raising finances for the present. The new package of measures was expected to introduce deep cuts to government expenditure and increased revenues through taxation in order to alleviate the short term issues of liquidity for the government.

The news of the Republic of Cyprus borrowing 2.5 billion from the Russian Federation is instead a much more worrying development. Although the amount sounds small by global standards it is huge by Cyprus standards as it represents about 25% of yearly Government expenditure. The deal is for five years at a high (4.5%) but sustainable interest rate.

The concern is twofold:
1) This will reduce the pressure on the government to introduce very unpopular reforms that need to be addressed.
2) Such a huge aid package offered directly from the Russian Government is not given without giving something back. In choosing between the very bad decision to resort to the EU support mechanism (the DEVIL we know), we instead chose the one with unknown consequences - both in our economic and political sovereignty.

The DEVIL we do not know might in the end compromise our national sovereignty in more significant ways that resorting to the EU support mechanism. The EU support mechanism shows a way out and offers a return to fiscal policy sovereignty in recovery; a loan by a government keen to influence EU decisions by proxy can be an open ended commitment.

We must avoid such open ended commitments just because we panic about the present; The lesson of Dr. Faustus, who sold his soul to the devil in order not to die, but lived perpetually in damnation, should make us cautious in making open ended borrowing commitments in order to avoid making hard decisions now.

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  1. Dear Alex

    I think that you exaggerate. It is widely accepted that during a recession both fiscal and monetary intervention is needed. However, both tools have their limits and this is why countries like UK fear of a double recession. The fiscal government funds run out of money. This is because countries, even UK, instead of saving in good times, keep their debt low, they were over-expending. When a government reaches its limits it will either increase its debt through the credit market or accept a support mechanism, whether is IMF or EU.

    However, entering such a mechanism will not help the country get out of a recession. By construction these mechanisms impose strict rules on restructuring the economy which drives a country’s recession even deeper, even though in the Long run it will be helpful. Thus, I believe that if a country can borrow money, whether from Russia or China or whatever country, then it is wiser to do so. Note that, I believe that the private sector is quite efficient and any structural problems (except of government influenced sectors) will be corrected.

    Last, I don’t believe that our country’s sovereignty will be threatened; I am not expending a communist era in Cyprus. I do accept that the loan might not be just a loan and must probably some bilateral agreement (maybe with respect to political issues as well) might have been agreed. But I can’t see what is wrong about it. Don’t forget that Russia’s relationship with Turkey has been improved (due to economic agreements, I think with respect to EU’s gas supply). Thus, we need as many allies as possible. Moreover, EU itself has been trying to improve its relationships with Russia because they do recognize that Russia will play an important geopolitical and economic role in the future (in present as well).

  2. Dear Mr. Doe,
    Thank you for the comment.
    I also do not like the idea of entering a EU support mechanism with serious short term repercussions to our economy and loss of fiscal autonomy. But at least I know what is expected of Cyprus in order to get out of the control.

    I would not be worried if the loan was from a Russian bank, and just slightly worried if the loan was from a state sovereign fund. I am also not on the right fringes who still thinks of Russia as communist country.

    What worries me is that governments, especially the Russian one, consistently use its economic clout to make a political gain. Its not like meritocrats in Russia had a budget surplus and they decided that 4.5% was a good deal; some sort of financial or worse still some non-financial trade off is expected.

    Secondly, I really think that there was a building momentum to change very large structural problems in our society, mainly the gross wage gap of government employees and the huge scale of tax evasion. I really worry that the lack of immediacy that this deal will bring will lead those who are responsible to go back to the "do nothing" approach, which has plagued us since 2007 and which got us into a mess in the first place...

  3. Dear Alex,

    We do seem to agree on general points. But since we do not really know what kind of agreements have been reached between Russia and Cyprus we can only speculate. Thus, I will not comment further on this matter.

    I do also agree that the wage gap needs to be tackled. But still I don't believe that this is an excuse to enter into any kind of mechanism (if not necessary, with respect to government debt). Last, I haven't seen any data on wage gap in Cyprus but I got the feeling that the wage gap has been decreasing anyway. Not only because of the economic crisis but also because of the relative increase of wages in the private sector. Don't forget that an absolute comparison on wages will not be reliable. Since 10 years ago (maybe more) the private sector in Cyprus has focused mainly on agriculture and tourist industry. This means that the private sector has not employed much of the high skilled workers. This in contrast to the public sector, see hospitals, University, ministries and so on.

    As for tax evasion, again I don't believe Cyprus has a huge problem with that. Since Cyprus corporate tax is one of the lowest in EU and actually tax avoidance from other countries benefits Cyprus (offshore companies). Notice that the biggest part of the tax revenues comes from the corporations rather than small-medium companies. Last, tax avoidance and tax evasion (I would say corruption as well) is a world-wide problem. In UK for example tax avoidance is quite common with Tesco, Vodafone, Boots being only of a few corporations that have been widely using this method (just Vodafone has avoided paying in taxes an amount of £6 bn). See the following webpage for some very interesting finding on tax avoidance in UK .

  4. Dear John Doe,
    It is nearly two months since the post and we heard little about this deal. My suggestion is that the Russian government is playing hardball and the demands keep rising as predicted in the article. I would personally prefer to see this loan stall until the government pulls its finger out and finds immediate savings in government wages.