The future prosperity of Cyprus depends on the Cypriots themselves. This might sound simplistic coming from a man who used to teach Engineering Economics at ColumbiaUniversity in New York and has written extensively on the Greek and Cypriot financial crises. Nevertheless, George J. Prokopakis believes that this view is realistic. In this exclusive interview with Gold, the former management consultant at the Athens Stock Exchange, who is now Vice President and Chief Operating Officer of SPEC Business Consultants S.A., argues that exiting the eurozone would be catastrophic and that the Government needs to implement the bailout agreement and be honest with the Cypriot people about the lack of “magic solutions” to the country’s problems.
By Kyproula Papachristodoulou
Gold: What were the alternatives that the Eurogroup could have considered regarding the Cypriot bail-out/bail-in? Were there alternative solutions and, if so, why were they not pursued?
George Prokopakis: The previous Cypriot administration let the problem drag on for some 20 months. What was a manageable liquidity problem –I would characterize it as rather minor – in the summer/autumn of 2011 became an avalanche. The solution had to be drastic, because the problem had become enormous. The alternatives were limited to (a) a “Greek-style” package, which would cover all needs, would transfer the private debt (banks) to the Cypriot taxpayer and result in a Memorandum with devastating provisions for the Cypriots, since the debt would have been unsustainable; and (b) a package that would “send the bill” to the actual debtors, i.e., the banks.
Gold: Only two alternatives?
G.P.: Any other alternative would have worsened the situation. For example, a debt write-off would have returned as a bigger problem, since over two thirds of the state debt was held by Cypriot banks and lenders. Any other solution would require the financing of the problem under unknown terms and conditions. Allow me to draw your attention to the fact that at the time of the Eurogroup decision, Cypriot banks had some €75 billion in deposits and only €1.7 billion in “loans”. Lenders and investors had had 20 months to get out of the growing mess. Any bank restructuring was bound to hit depositors – this was known to the Cypriot administration since November 2012 and to the entire world since late January 2013 (I am referring to an Economist article and leaked documents published in the Financial Times).
Gold: Cyprus’ economic growth over the past years has largely relied on the financial and professional services sector. Many analysts are of the opinion that the “medicine” administered by the Eurogroup, on the recommendation of the IMF and the ECB, was designed to finish off rather than cure the patient. What is your view?
G.P.:. There is no question that the “medicine” administered by the Eurogroup and the ECB, will affect banking activities in Cyprus – with all the adverse consequences. However, the “financial hub” model is still up in the air. Cyprus has all the know-how, skill set, institutional and legal framework developed over a period of some 30 years, and it is second to none on this part of the planet. It is up to the Cypriot government to implement policies that will restore banking stability and support this industry. Even after the Eurogroup’s decision, the country’s corporate tax rate is still the lowest in the eurozone – there is an incentive for Greek entities, for example, to have a base in Cyprus (the difference in tax rates is enormous: 12.5% in Cyprus vs 26%-36% in Greece). It is debatable whether the banking model (high interest on deposits and higher rates on lending) really helped the “real economy”. It pumped money into the “real estate bubble” but left the Cypriot middle class over-exposed to lending. Don’t forget that the construction industry, one of the pillars of the economy, had already collapsed long before the Eurogroup’s decision and unemployment had already hit a threatening 14%.
Gold: Taking the 25 March agreement as a given, what is the optimal action plan for the Cypriot government?
G.P.: In my view, the highest priority is the restoration of trust in the banking system and the smooth lifting of capital movement restrictions. This is no easy task and the Government will need the support of all Cypriots – taxpayers, businessmen and, if possible, of people across the entire political spectrum.
Measures to support the most severely hit must be taken swiftly. The Government’s funds are limited, so if society wishes to sail through the rough seas it must be understood that a transfer of funds among the various segments of society must take place. Subsidies must be directed to the unemployed and the really needy – and nobody else! The healthcare and education systems must be protected.
Gold: What about privatisation?
G.P.: The government must have a crystal-clear policy on privatisation and defend it at any cost. If privatisations do not proceed as scheduled, more measures will be taken with severe consequences on employment and everyone’s income. The real challenge for the government is the development of a long-term plan for the restructuring of the economy. Many jobs that have already been lost (and quite a few of those that will be lost in the next few months) will not be there when Cyprus recovers. New activities need to replace the obsolete ones. The Government’s limited funds must be directed, fairly and transparently, to activities that will allow people’s productive potential to surface and be part of the recovery process.
Gold: The Boards and management of the three main state-owned organisations (Electricity Authority of Cyprus, Cyta and the Cyprus Port Authority) are strongly opposed to privatisation, claiming that there are other ways to generate income for the state. What is your view on the future of these organisations and the need for privatisation?
G.P.: First things first: the Boards should be fired immediately! They have failed to generate enough income for the state for many years. Pure incompetence! If this goldmine is there, they should be held accountable for not distributing this wealth over the past years. I bet they offer the familiar line of defence: it was partisan politics that forced us to have many more employees that are actually needed, to offer unheard of benefits, to give contracts to this or that company, to advertise in obscure publications, etc., etc. Let me state the obvious: if a company operates as it should, the only difference between public and private ownership is in the dividend. It is up to the state to establish the regulating mechanisms to ensure that these companies do not operate against the public interest, regardless of ownership. One thing must be made clear: unless the state-owned companies generate some €1.5 billion by 2018, over and above all state revenues from taxation, levies and social security, measures of an equal amount will be imposed on the Cypriots. This is the subject of the debate – not the prospects of these companies under their current management. Let us not forget that Cyprus was ready to trade most of the nation’s future gains from its hydrocarbons, it was ready to contribute the reserves of the pension funds and, at the same time, there is concern about the outlets through which partisan clientele politics pass! Where is the concern about the pensioners, the unemployed, the future generations?
Gold: Some of the main political parties, as well as some local businessmen and international analysts argue that Cyprus should abandon the Memorandum with the Troika and find a solution to its financial problems outside the context of the euro. What is your view?
G.P.:. Leaving the euro before Cyprus has fully recovered and grown prosperous would, in my view, be catastrophic. Moreover, the stance of the international community during the critical two weeks of March, showed that, with the island still divided, the very existence of the nation is in jeopardy outside a supra-national organisation. The cost to the Cypriot people of a euro exit would be insupportable. I hope the champions of the euro exit have a plan for coping with the geopolitical issues, as well. I will refrain from getting into a discussion about how the new currency would perform (devaluation), how imports would be supported, where the values of all assets would end up in the case of an exit from the eurozone. We only need to take a look at the books, as an accountant would. If Cyprus wishes to leave the association of which it is a member, its books need to be balance. They contain €15.5 billion of public debt, €11.2 billion of ELA and €2 billion of state guarantees. A total of over €28 billion compared to a GDP of €17 billion. This figure is with no provision for the banks, which will be hit further. How on earth would this settlement be financed? In my view, a euro exit would be suicide unless the financing of such an exit is secured.
Gold: What would the political cost be if Cyprus were to exit the eurozone?
G.P.: I’m afraid that, any discussion about Cyprus leaving the eurozone brings with it a hasty and forced decision about the national problem of the divided island. Politically, I cannot see how the cost could be any less than catastrophic, as long as the 39-year old national problem remains unsolved. The Cypriot people must have realised all these years that morality and geopolitics are often mutually exclusive.
Gold: Are there practical steps that can be followed in order for Cyprus to exit the Memorandum? Is it possible?
G.P.: The Memorandum per se is a mutually agreed upon set of measures and actions that need to be implemented to ensure that Cyprus is in a position to finance its economy by itself by 2018 – either by its own means or by securing financing from lenders other than the Troika. In that sense, a roadmap that achieves the same goals with measures and actions that have a more bearable impact on society would be more than welcome. The key is not the Memorandum itself – it is the achievement of the goals. The €10 billion loan agreement simply does not exist in the absence of a credible plan, no matter who the father of such a plan is. An alternative Memorandum is possible but I doubt whether it would be much different from the agreed one. Besides, Cyprus had nearly two years to develop such an alternative plan and came up with next to nothing when it was really needed. If your question means “with no Memorandum at all”, we come back to the underlying issue of who will finance Cyprus.
Gold: What conditions need to be met before Cyprus can be optimistic about its future?
G.P.: The major risk for Cyprus is not economic – it is moral and political. The Government needs to be candid with the people and present the real alternatives and their consequences, regardless of the infamous “political cost”. The widest possible consent needs to be gathered on the recovery policies for as long as the crisis lasts. The recession and austerity are unavoidable. The Eurogroup’s decision, no matter how harsh, has cleared the picture, along with the mess. It is up to an “alliance of the willing” from within Cyprus to secure a better future for the country. It is a crime against future generations to engage in populist debates about magic solutions and the white knight who will solve all the problems overnight.
The next few weeks are critical – we can talk forever about all kinds of policies. However, the litmus test will be the moment of the “full return to the euro”, that is, when all capital movement restrictions are lifted. If this transition is made smoothly, we all can be optimistic about the future – the next day will be in the hands of the Cypriots.
A euro exit would be suicide unless the financing of such an exit is secured.
The Cypriot people must have realised all these years that morality and geopolitics are often mutually exclusive
It is up to an “alliance of the willing” from within Cyprus to secure a better future for the country
The Government needs to be candid with the people and present the real alternatives and their consequences, regardless of the infamous “political cost”