In his article Those Crucial Judgment Calls, Minister of Finance Tonio Fenech compares Malta’s economic performance with that of Cyprus and claims that Labour Leader Joseph Muscat made a massive error of judgment in saying two years ago that we should emulate that country. What are the facts?
The world did not begin in 2008, as Finance Minister Tonio Fenech conveniently assumes- Frans Camilleri
Muscat was probably spurred by the fact that Cyprus’s GDP in Purchasing Power Parity at that time had risen by 5.4 per cent per annum compared to Malta’s 3.4 per cent per annum during the period 2004-2010. They must have been doing something better.
The immediate cause of the Cypriot crisis was the naval base explosion in July 2011 that damaged the power station, coming on the heels of its exposure to the Greek sovereign debt crisis. Cyprus’s banking industry was disproportionately hit by the haircut taken by creditors due to its amassing of €22 billion of Greek private sector debt.
A main reason for the country’s financial problems derived from its oversized banking system at more than 700 per cent of GDP, and whose exposure to Greece amounted to over 140 per cent of Cyprus’s GDP. Following losses from their Greek sovereign debt holdings in the restructuring in early 2012 – equivalent to 25 per cent of Cyprus’s GDP – many banks became insolvent or in dire need of capital infusions to adhere to the EU’s new bank capital targets.
The Cypriot case resembles that of Ireland in late 2010, where capital shortfalls in a collapsing oversized banking system also caused the collapse of government finances and the need for international financial aid. No one wants to pay for bailing out banks, especially in other countries, so the Cypriot government has faced substantial obstacles in its quest for a bail-out from the eurozone and the IMF.
Public finances deteriorated rapidly in the last few years. Yet the country’s public debt, currently 85 per cent of GDP, remains below that the eurozone average. Weakening domestic macroeconomic conditions have also contributed to the deterioration in public finances and the significant consolidation efforts made in the last year or so have not managed to correct the excessive government deficit.
Over the last 18 months, the Cypriot Government has tried to consolidate the public finances, but its efforts have been countered by losses in the banking sector that have further strained government financial resources and essentially cut off Cyprus’s access to financing from international markets. The weakening of the public finances has led to rising government debt. The fast growth of public sector wages also drove economy-wide labour costs higher, resulting in a loss of competitiveness.
Fiscal adjustment measures since January 2013 have concentrated on the expenditure side. In particular, public sector wages increases are being reversed, the wage indexation mechanism is being reformed, the mandatory retirement age is being raised, tax evasion is being targeted, and measures are being taken to improve the efficiency of state-owned and semi-public enterprises. On the expenditure side, excises, VAT rates andproperty tax rates have been raised to contribute to the front-loaded adjustment.
But Cyprus has something that Malta doesn’t. The recent discovery of substantial off-shore natural gas means that the Cypriot Government could earn revenues of up to €300m annually from exploration rights, royalties, etc. from 2013 onward and further very large profits from natural gas production and exports from 2018 onward. So, there are good prospects that proceeds from natural gas exploration and exploitation will reduce the debt burden substantially over the longer run.
The world did not begin in 2008, as Minister Fenech conveniently assumes. I believe looking at the period 2004-2011 is fairer. A good idea of how both Malta and Cyprus have fared during this period can be gleaned from the 2013 Alert Mechanism Report published by the EU Commission, based on a number of parameters. It is a pretty mixed story, where Cyprus performed relatively better than Malta up to 2007 (for example, in unit labour cost competitiveness, house pricing, private sector debt, government debt and unemployment) but relatively worse after that. Of course, 2012-3 are Cyprus’s annus horribilis.
Before we gloat too much, we need to make sure that some of our own vulnerabilities are addressed. The European Commission has already signalled the vulnerability of the financial sector in view of its size in proportion to the domestic economy, with total liabilities close to 900 per cent of GDP in 2011. The growth rate of total financial liabilities has exceeded the indicative threshold several times in the past decade.
Though a significant part of these inflows have been to internationally-oriented banks that have very little exposure to the domestic economy, the Commission intends to delve deeper into this.
Moreover, it has pointed out that close monitoring of the domestic banking system is warranted due to its high exposure to the property market, which has seen very dynamic price growth followed by a relatively limited correction over the past decade, and the low level of provisions for loan impairment losses.