Fiscal consolidation compared: Greece vs Cyprus


Foreword

In April 2010 Greece asked for its first international bailout making Greece the 1st Eurozone country to seek a bailout. Shortly thereafter Ireland and Portugal sought an EU bailout themselves.

In the summer of 2012 two more Euro members Spain and Cyprus asked for EU money, with Cyprus gaining international notoriety in 2013 due to the terms of its bailout package that involved for the 1st time ever in the Eurozone the forced closure of one of its systemic banks and a raid on uninsured deposits of another.

As noted in the Guardian, Cypriots fear that harsh austerity will cripple their economy as in neighbouring Greece.

Cyprus and Greece found themselves in a tight spot for different reasons altogether (as we shall see), however Greece’s experience with the Troika is often used as the bogeyman by Cypriot political parties that want disentanglement from Troika scrutiny.

The main counter argument I often project, is that Cyprus was not forced (so far) to endure the same level of austerity in the form of taxation and public spending cuts that Greece had to endure. This post is an attempt to quantify that claim.


  • Note: some links are in Greek apologies to English speakers in advance

Country profiles: Crisis Factors
  1. Greece

Greece malaise is attributed to a bloated state running high structural deficits tax evasion and an uncompetitive economy. In fact it has been well established that Greece fiddled with national statistics and used credit swaps to mask its debt pile for years.

In 2009 a newly elected government in Greece overhauled the Hellenic Statistical Authority (EL.STAT) under increased pressure from EU partners. The revised figures exposed the true extent of Greece’s debt pile and deficit alarming international bond markets.

The country’s bond yields shot up with many bond holders refusing to roll over existing debt let alone lend the country anew. Combined with the economic slump after Lehman’s collapse Greece was teetering towards a sovereign default.

In an emergency session of the Eurogroup in March 2010 Greece agreed to cut its deficit from 12.7% to 8.7% while Euro members pledged “ to take determined and coordinated action, if needed”.

On the 23rd of April of 2010 Greece’s Finance Ministry sent a letter to the Eurogroup the ECB and European Commission requesting assistance citing the March decision.

The details of the bailout were finalised in the ensuing months.

2. Cyprus

The Cypriot crisis is a two legged crisis an out of control increase in public spending, coupled with a brewing banking crisis.

In 2008 the 18bn economy of Cyprus became a member of the eurozone the country enjoyed nearly 30 years of growth and it is characterised by an open free market economy with little or no government interventions. In late 2010 the economy stopped growing as a result of the on going turmoil in the rest of the Eurozone and in particular Greece which happens to be one of Cyprus’ biggest trading partners.

Cypriot banks had grown exponentially in the pre-crisis period with assets totalling 143bn (as of March 2012) or 794% of Cypriot GDP and were brutally exposed to Greece on multiple levels.

Cypriot banks were exposed to the Greek market to the tune of 24bn euro (approximately 150% of Cypriot GDP) on top of that Cypriot banks had on their balance sheets 8-10bn euro Greek debt.

In October 2011, at the eurogroup summit, members reached an agreement to trim Greece’s privately held debt by 50%. This blew a 4-5bn euro hole on banks’ balance sheets. Compounding the issue further was the economic downturn in both Greece and Cyprus that saw Non Performing Loans on banks’ balance sheets sky rocketing.

In 2012 PIMCO carried out a due diligence report on the Cypriot banking and established that Cypriot banks would require a 10bn euro cash injection half of which due to the Greek PSI.

In 2008 the socialist government of Demetris Christofias a Soviet educated die hard communist took office.

In 4 short years Cyprus’ public debt nearly doubled from 8.5bn (49% of GDP) to 15bn (86% of GDP). These funds were funnelled to unproductive unnecessary ventures such as welfare benefits and party affiliated entities. Not a single cent was spent on resuscitating the now stagnant economy.

Eurostat databse

In the summer of 2011 Cyprus debt yields made borrowing prohibitive and the Communist government requested a bilateral loan from Russia totalling 2.5bn, despite on going calls from EU officials to apply for an EU bailout.

In June 2012 Cyprus having burned through the Russian loan in just six months after the first instalment was disbursed applied for an EU bailout.

The intransigence of the Communist die hard Cypriot president delayed the signing of a bailout agreement with the EU compounding the problems even further creating the “perfect crisis”. In fact Cyprus is the record holder for taking the longest time to sign a bailout agreement out of all 5 bailout applicants (Spain, Greece, Ireland, Portugal).

In February 2013 Cyprus held elections and president Christofias (who was not running for re-election ) left and in came Nikos Anastasiades.

On March the 15th the eurogroup convened to discuss the Cypriot bailout package. The initial proposal was to apply a one off levy on all deposits both insured and uninsured held in all banks in Cyprus. That proposal was rejected by the Cypriot parliament and on March 25th both parties settled in winding down the largest bank (Cyprus Popular Bank or Laiki Bank) while uninsured deposits in another (Bank of Cyprus) would be confiscated for the bank’s capital needs as per PIMCO’s due diligence report. An additional 10bn was agreed for Cyprus’ fiscal financing needs.

Bailout agreements.

For this exercise I shall attempt both to quantify and qualify the austerity measures agreed between the IMF/EC/ECB (colloquially the Troika) and the governments of Cyprus and Greece.

Additionally since Greece received 2 bailout packages I shall only focus on the 1st bailout package drafted in 2010 and the austerity measures described therein.

At this stage I would like to clarify one sticking point that may arise later.

The 1st adjustment programme for Greece run from 2010 till 2014, Troika projections/assumptions made therein (such as GDP growth, revenues/cuts envisaged under the programme etc.) were either proven false or never materialised and subsequently the programme was revised. I assume that a number of people will cry foul (and they’d be right). However since the Cypriot adjustment programme has effectively started in 2013 there is insufficient data to update Troika projections on Cyprus; therefore I shall not adjust/revise projections on Greece either, after all I am comparing projections to projections.

Not all austerity packages are made equal; even if the sum of the consolidation package is the same (which is not in the Cypriot and Greek case), some measures may be more detrimental than others. I will go into detail later on.

Cumulative Fiscal Consolidation

Cyprus cumulative fiscal consolidation over a period of 6 years (2013-2018) 11.8% of GDP (excluding privatisations and structural reforms)

Greece cumulative fiscal consolidation over a period of 5 years (2010-2014) 13.0% of GDP (excluding privatisations and structural reforms)

I have tabulated the austerity packages against each other using data from the IMF web site expressing them as a % of GDP. There is a discrepancy of about 0.2% of GDP due to rounding but the overall picture doesn't change.

Footnotes*

Greece

  1. Other revenue: excises on Luxury goods, amending book specification on income.
  2. Other expenditure: reduction of pensions by further cutting allowances and entitlements.

Cyprus

  1. Other revenue: amend annual vehicle road tax based on environmental criteria, increase fees to public sector services by 17%, introduce bus fares for the elderly and students. Increasing fees to non beneficiaries for healthcare, abolishing entitlements for class b healthcare beneficiaries , introduce fees for the use of emergency healthcare services for non emergencies, fees for unnecessary laboratory test medicinal exams and pharmaceuticals.
  2. In December 2012 (before signing a bailout agreement in March 2013) Cyprus approved an austerity package which was incorporated by the IMF in their calculations and is depicted in the above table.
Observations.

Apart from the obvious (Cyprus to undergo less consolidation and with more time to adjust) there are certain items in Greece’s consolidation drive that make austerity much more odious than the Cypriot package.

Greece applies a so called crisis levy on profitable companies for 4 years to generate 600mn in additional revenue. That by and in itself is nothing less than the proverbial shot on the foot. Greece raids companies generating profit forcing them to pay over and above the 25% tax (which they normally paid), a disincentive to businesses to stay in the country, discouraging them from investing in Greece or expanding their operations there. It is little wonder that huge Greek companies such Coca Cola-3E, Viochalko and FAGE have fled Greece.

Presumptive Tax, in a nutshell taxation on income is not based on normal accounting practises but on assumptions made by the country’s tax authorities. Tax authorities estimate how much tax is owed by the taxpayer based on a number of criteria (see link above) without the taxpayer declaring income.

It is unfair for a number of reasons. Assume 2 farmers growing wheat, they each produce on average 75 tonnes of wheat per year while the fields’ full capacity is 100 tonnes. One farmer has an exceptional year and produced 80 tonnes of wheat the other just 70 tonnes. By applying presumptive taxation the 1st farmer will pay tax on 75 tonnes (instead on his produced 80) while the other will also pay tax on 75 tonnes (instead on his produced 70).

As I searched through the literature I found that presumptive taxation is applied in countries where there is wide spread tax evasion and tax corruption (admittedly Greece fits the bill on both accounts), but that doesn't make presumptive taxation any less unfair.

Move services from the reduced to the standard VAT tax rate. Now this is a big one and it is still a contentious issue in Greece. The effect was that tourism related businesses (restaurants hotels) now charged 21% VAT instead of the reduced rate.

Increase tax on wages in kind. Assume your employer gives you a car allowance (or a car) phone allowance etc. Greece taxes you on those allowances.

Excises on non alcoholic beverages, this is my favourite one. They even taxed soft drinks!

Reduction in public consumption and public investment. Admittedly reducing what one consumes is the quintessence of austerity however in Greece’s case that translated into delaying payments to suppliers scarcity of even the most basic items in hospitals such as syringes and bandages and even iodine .

Means Test Unemployment Benefits. A means test implies that the applicant for unemployment benefits will be scrutinised by authorities to ascertain whether he (or his immediate family) have the means necessary to sustain him (savings, property etc) . In the event they do then the applicant is rejected. This is particularly strange since it involves huge administrative costs and red tape. Greece’s package envisages reductions in bureaucratic and public administrative procedures but the means test works towards the opposite direction.

Furthermore, the means test for unemployment is alleged to create a poverty trap. Under normal circumstances unemployment benefits aim to cushion the blow from the loss of income, so that the applicant does not slip into destitution. The means test unemployment benefits regime forces the unemployed to sell/divest any property/savings they may possess before they can be eligible for the benefit. In other words the unemployed have to become destitute before they can claim unemployment benefits.


Conclusions

When I started writing this entry I had a feeling that the Cypriot austerity drive was not as painful as that of Greece. After searching through the bailout agreements of Greece and Cyprus I noticed that Greece had to achieve cumulative consolidation of 13% of GDP in 5 years whereas Cyprus had to achieve 11.8% in 6 years.

Even more damning certain terms in the Greek package are absolutely appalling and it is fairly obvious why Greece’s economy was decimated, heavy and unfair taxation, levies on everything under the sun and the wholesale destruction of the social welfare system.

In all fairness Cyprus got off fairly easy compared to Greece.