Recent economic developments in the birthplace of Aphrodite (Cyprus), as outlined in the recent report on the IMF’s Consultation paper for Cyprus, have been ‘very’ encouraging, with growth expected to turn positive in 2015. According to the IMF (2014), growth should continue to gradually recover in the coming years. The Cypriot public finance developments have been also promising, with the budget deficit falling more quickly than anticipated (Troika, 2014). Nevertheless, public debt is still high, and continued efforts to strengthen public finances will be necessary to steer public debt on a sustainable downward path. Numerous analysts have acknowledged that Cyprus has made great progress on its reform programme since March 2013, and continuing these reforms will be critical to ensuring a sustained recovery of growth in the economy and employment.

What will be particularly important for Cyprus is to address the rising level of non-performing loans (NPLs), which now stand at close to 54 percent for the whole banking system. Troika has emphasised that the level of NPLs is high by any standard, and is higher than what can be explained by the recession and/or increase in unemployment. The problematic loans place a significant burden on the economy because it is very difficult for financial institutions to provide new loans. However, the government and the local banking institutions need to acknowledge that new lending for individuals and corporates is necessary to support investment and other economic activities. Thus, solving the NPL problem is necessary to get growth going and reduce unemployment (S&P, 2014).

The portfolios of Cypriot banks comprise more loans than deposits. Even after the banks have been recapitalised (or some are to be recapitalised), their balance sheets are deep in the red. Whereas a ‘healthy’ banking system seeks to lend out depositors’ ‘stagnant’ savings (in order to collect a loan interest greater than the savings interest), the banking system in Cyprus is running a deficit which is currently being covered through liquidity guarantees from the ECB and the ELA mechanism. It seems that the local authorities have a strategy for turning around the rise in NPLs focused on a reform of the framework for debt restructuring. The first step is the ‘modernisation’ and application of the foreclosure legislation. The recent legislative changes are a step forward and implementation will be important (we need to review and examine what the banks will do with all the ‘repossessed’ real estate assets in a market with a very limited liquidity). The second step is the modernisation of the insolvency and/or bankruptcy framework that would allow debtors to either restructure their loans, or for those that truly cannot pay, allow for a “fresh start”. Both of these steps taken together will encourage banks and borrowers to move more quickly to solutions, all of which will allow a speedier clean-up of old problematic loans, which will then create room for new lending. Of course, it will be very important to pair these changes with effective implementation of the new safety-net reform that is being phased in (IMF, 2014).

To this end, some local corporates turn recluse and inert, refusing to try out anything new or to make a new start – particularly when their businesses are in financial hot water. Others are ‘cautiously optimistic’, believing that the crisis is temporary and that it will pass, continuing to behave as they did before and thinking that, at some point, the ‘economy has to get better’, an attitude which prevents rethinking past habits. To us, both these outlooks are ineffectual. We must not allow ourselves to turn inert amid the current situation in Cyprus; on the other hand, we must also not become too optimistic, thinking that all the problems will vanish from one day to the other.

The banks are desperately trying to collect on as many delinquent (or problematic) loans as possible, thus draining liquidity from the economy and from businesses, which have seen their profits evaporate (and turn into losses), thereby exacerbating those very conditions that make a business non-viable.

Our businesses have morphed into ‘machines’ that churn out unpaid and artificial debt. Not because they are necessarily poorly run, but because of the simultaneous contraction of the private sector, the sharp decline in their turnover, the banks tightening restructuring and debt collection mechanisms and, last but not least, the loss of income of the businesses’ clients.

A concluding remark: we must adapt, trusting in ourselves and being open to the view that, whereas the crisis has created problems that need addressing, at the same it presents opportunities. This is an opportunity to change mentality, both with regard to the banking system and to the country as a whole. Let’s engage in some self-criticism, identify our mistakes, and try to overcome the impasses, shedding old habits; and this goes for businesses and of course banks alike. It’s time for us to change.

Dr George Mountis is the Managing Partner of Delfi Partners & Company and visiting lecturer at Neapolis University

 

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