20 February 2015 Are out of date troika forecasts a Grexit risk for Cyprus?

Are out of date official forecasts a Grexit risk for Cyprus?

On 13 February der Spiegel reported (in German) that during the Eurogroup meeting of 11 February there were suggestions that if Greece left the eurozone, Cyprus would have to go as well.

These were quickly described (in Greek) as “nonsense” by the Cyprus finance minister, Harris Georgiades. One can imagine that either Cyprus was not privy to these conversations or that the notion was leaked in order to pressurise Cyprus into going along with the majority of eurozone members.

Either way, as noted to subscribers in my January report, it looks as though Cyprus is already suffering from the risk I had identified as “reputation contagion” – a risk that has more to do with perceptions than fundamentals but which can have very serious consequences.

Let me explain in a bit more detail how this risk would play out.


Cyprus rarely studied in-depth by financial houses

Because of the economy’s small size, the lack of a local bond market, the near absence of a stock market and the small amount of internationally traded bonds,  Cyprus does not figure highly in financial houses and research organizations.

When it is studied, I have good reason to believe that Cyprus is normally given to the last one in, with the least experience.

This was evident in the literature produced during the run-up to the financial crisis. With the notable exception of Morgan Stanley, much of the research was thin or derivative. Another example was a conference call in March 2013 in which one of the participants did not believe my assessment that there would be no social unrest in Cyprus.

It was a perfectly reasonable to expect social unrest in Cyprus if you knew absolutely nothing about the country. But if you happen to live here, you would know that the Cypriots make a lot of noise but in practice are nowhere near as volatile as the Greeks. There has been no social unrest in Cyprus despite the unique terms of the bailout/bail-in.


Imagine a scenario

So imagine the scenario. It’s late Friday afternoon, things are going badly with Greece and the boss asks the team to draw up a “first out of the eurozone after Greece” list.

You know that Cyprus is a Greek-speaking, junk-rated, bailout country. You also know that, like Greece, (but in this case thanks to parliament, not the government), it is not on track with its bailout programme.

And you are in a hurry. Your partner is still waiting for that Valentine’s dinner you missed last week because of Greece.

You pull up your firm’s forecasts and they have not been touched for over a year.

So you go looking for the next best thing: the latest official forecasts from the International Monetary Fund (IMF), the European Commission (EC) or the European Bank for Reconstruction and Development (EBRD).

The EBRD’s latest forecast dates from September (just the growth rate was updated in January), the IMF’s from October, and the EC’s from December 2014. The IMF and EC are more comprehensive than the EBRD so you prefer those.

The IMF is the oldest (a by-product of Cyprus not having passed the review) but it is far easier to find in a simple Google search than the elusive EC one. So you go with the IMF.

Whichever one you look at, you will find that the latest reports of all three institutions report a debt/GDP ratio of around 112% of GDP in 2013. The IMF and EC expected that debt/GDP ratio to rise to around 118% of GDP in 2014.

You will also find budget deficits in the range of 4.4% (IMF) to 4.7% (EC) in 2014 and primary deficits  ranging from 1.0% (IMF) to 1.3% (EC).

With a debt/GDP ratio approaching 120%, a large budget deficit and a primary deficit too, you conclude that Cyprus is vulnerable.

You have not read my January report analyzing the economic linkages between Greece and Cyprus, so you go with your gut feeling and assume that the two economies are closely connected.

You throw Cyprus in the “next after Greece” category and you head off for your postponed Valentine’s dinner.

Meanwhile in Cyprus, we find ourselves back in the days of March 2013, when capital controls were a lot stricter than they are now, when it was difficult for exporters to obtain credits, and when no one wanted to do financial business with Cyprus.


Official forecasts versus actual data

What you will not know while supping that night is that the statistics upon which you made your judgement are out of date and thereby give a very wrong impression of the macroeconomic fundamentals of Cyprus.

There are two main reasons for this: GDP revisions and the recent strong fiscal performance.

The revisions to nominal GDP in late October 2014 as a result of applying the adopting the revised European System of Accounts (ESA 2010) made a substantial difference to GDP as you can see below.

The European Commission (the only one to publish the nominal GDP) had not caught onto this in its December report.

We do not yet have an official figure for nominal GDP in 2014. But we already have the flash estimate for the four quarters of 2014 (published in February), which imply a real GDP decline of 2.4% for the whole year.

We also have the actual inflation figures for 2014. So from that we can make a reasonable estimate that nominal GDP in 2014 was €17.6bn.

Table 1


Changes to GDP make a difference to debt/GDP ratios of course. So even though the official institutions expected pretty much the same debt level for 2013 ad 2014, their debt/GDP ratios differ substantially from the actual outcome once you apply the revised GDP numbers.

The PDMO figures below are official statistics from the Public Debt Management office. Although the office reported a deficit/GDP ratio (see below) it did not, for some reason, report a debt/GDP ratio. However, using inferring from the GDP figure above, we can assume that the debt/GDP ratio in 2014 was around 106% of GDP.

This is substantially lower than the 117%-118% of GDP given in the most recent troika forecasts. Since 106% of GDP is closer to 100% level—the threshold below which debt is considered to be sustainable—it is rather important to get this figure right.

Table 2


Finally, let’s take a look at forecasts for the general government budget and the primary balance (budget balance minus interest payments).

Here, the differences for 2014 are also very large, not helped by the fact that there are different ways of measuring fiscal balances. My own forecasts are based on the Eurostat general government accounts under the “excessive deficit procedure and methodology”.

Whichever measure you use, it was clear from November 2014, once three quarters of general government accounts had been published, that Cyprus was heading for a large primary surplus and an overall balance close to zero for 2014.

According to the PDMO statistics published in February, that was indeed the case. The general government budget is reported as just €7m or 0%, while the primary balance is reported as a surplus of €488m or 2.8% of GDP.

Yet the EC, which published in early December, was still expecting a large budget and primary deficits for 2014. Doubtless the forecast was probably prepared several weeks before it went through all the institutional hierarchy, so missed the third-quarter results that made all the difference.

Table 3


In sum, the fiscal performance in Cyprus is far better than anything you will find in official reports. That is not to say these reports are not good. The IMF, EBRD and EC reports each have really excellent analysis of key structural issues.

But when it comes to forecasts, they are pre-determined to be out of date as soon as they are published.

If you are beginning to suspect that this article is a long-winded way of saying you need to be subscribing to my monthly reports if you want to keep up with Cyprus, you are absolutely right.

But I am also writing this because it is important.

In crises people make knee-jerk decisions with big consequences based on the most easily available information. If that information is out of date, then there is a real risk that Cyprus gets thrown in the bin for no good reason. I hope that by making the information available to the general public, this article has prevented that from happening.

That would leave only one major risk for Cyprus, namely parliament and its refusal to pass the foreclosure legislation. I shall return to that topic another day.

For independent monthly analysis on the Cyprus macroeconomy, fiscal performance, banking sector, natural gas and political stability visit https://sapientaeconomics.com/country-analysis-cyprus/