What next for Cyprus and its economy? A downwards wage-price spiral….?

Sometimes events in a single country can illustrate a multiple number of the themes of this blog even if the country is as small as Cyprus. Back in the spring of this year it was “rescued” by its partners in the Euro area and since then it has received one of the worst economic harbingers that a country can receive. From the European Commission and the emphasis is mine.

Staff concluded that Cyprus’ economic adjustment programme is on track

I take that as confirmation of my initial forecast that the outlook for the economy of Cyprus is simply horrible. It may even exceed the declines seen in its near neighbour Greece.


The next theme is that such countries find themselves mired in an enormous amount of debt which in spite of its size turns out never to be quite enough. For example more and more officials and politicians are talking openly about yet another bailout for Greece. The current state of play for Cyprus is summarised here.

Cyprus has now received a total of €4.5 billion in ESM (European Stability Mechanism) financial assistance out of a total committed amount of approximately €9 billion.

So such a small island is being increasingly weighed down by a heavy debt burden, and there will be another 1 billion Euros to be added from the International Monetary Fund too. The catch, as you can see, is that it is going rather fast which has the implication that more will likely be called for. But even now, it is an enormous extra burden as at the end of the first quarter of this year the national debt of Cyprus was 15.34 billion Euros so the rescue has added around 30% to this already. Before the crisis Cyprus had a relatively good national debt to economic output ratio but it had already risen to 86.9% and is currently moving as the Billboard charts would put it with a bullet.

Creating another credit crunch

You might think that having seen the effects of the 2007/08 credit crunch echo destructively around the world for the past five or six years that the authorities would move heaven and earth to avoid replicating that. However you would be wrong as this is exactly what has been applied to Cyprus.

At the end of 2012 total deposits at Cypriot banks were 70.16 billion Euros and at the end of September they were 48.3 billion for a fall of 31% in nine months. I think we can call that a credit crunch! What would Milton Friedman say about prospects for Cyprus if he was still alive?

Tucked away in this, deposits by Cypriots have fallen heavily too such that the lending so far by the ESM (4.5 billion Euros) represents over 13% of their total of 33.58 billion Euros. The former will continue to surge whilst the latter has already fallen by 22% so far in 2013.

We also have another feature of a credit crunch which is that in spite of the official intervention mentioned above and the fact the official ECB interest rate is 0.5%, ordinary people and companies face much higher ones. This was my first theme on this blog if I recall correctly.

This is in full force in Cyprus where a mortgage in August according to its central bank had a typical interest rate of 5.86%. Also these have been rising which you might not expect when you look at all the centrally planned intervention, but you would if you simply googled the words credit and crunch. There was an initial dip but then they moved higher.

You do not need to take my name for it as the Governor of the central bank the conveniently named Panicos Demetriades met the banks on the 27th of September and this was part of the agenda.

The discussions were conducted in a climate of mutual understanding and all credit institutions recognised the need for a gradual reduction in lending rates and for applying other relevant measures aiming at reducing the cost of loan restructuring in the immediate future, especially during the current difficult economic situation.

The Bank of Cyprus responded with a new lower mortgage rate offer. However it may not turn out to be as good as promised.

Interest rate from 4.75% (APR 4.85%*). Pricing shall vary according to each client’s contribution.

I think we know about descriptions of prices or interest-rates beginning from!

Oh the new conservative finance era in Cyprus seems to be having something of a false start.

we reward repayment consistency by providing a discount for every 13th instalment, if 12 monthly instalments have been paid without delay.

But how can you get a reward if you also want to take advantage of the grace period? Sorry for the capitals which come from the documentation.


Still I guess it will help with the non-performing loans numbers…….

The Labour Market


We were told by Eurostat earlier this week that unemployment in Cyprus had risen at the fastest rate in the Euro area in the year to August with the unemployment rate rising from 12.3% to 16.9%. Sadly I expect it to go much higher, a belief which has been reinforced by this morning’s registered unemployment numbers.

Based on the seasonally adjusted data that shows the trend of unemployment, the number of registered unemployed for September 2013 increased to 52.112 persons in comparison to 51.275 in the previous month…..In comparison with September 2012, an increase of 13.151 persons or 38,8% was recorded

Just for clarity registered unemployment means you register at the jobs or dole office.

What about wages?

They too have taken a downwards turn according to the latest data.

In comparison with the second quarter of 2012, a decrease of 1,6% was recorded in the average monthly earnings of employees

This was also a fall in real wages as inflation was pretty much flat at the end of the quarter.

So on the definition applied by Pavlaki in a comment earlier in the week  “it is very painful to go backwards” (in living-standards) then more than a few people are currently in pain in Cyprus.

Inflation or rather disinflation

When the crunch really hits, we have now entered a phase where inflation goes negative and Cyprus is in that club.

The rate of inflation for September 2013 decreased by -1,0% compared to -0,9% in August 2013 and 2,5% in September 2012. The rate of inflation is negative for the fifth time in 2013.

Whilst this will be welcomed by the embattled consumers of Cyprus there are other implications which are not so hopeful.

Industrial Production

I mentioned these numbers yesterday but they deserve their own billing. On a glass half-full basis they were the best so far in 2013 but that neatly side-steps this issue.

The Index of Industrial Production for July 2013 reached 86,1 units (base 2005=100), recording a decrease of 12,8% compared to July 2012.

For Manufacturing, the index for July 2013 reached 75,9 units, recording a decrease of 12,5% compared to July 2012.

So another theme of these times hits us, as one more time we see declines in industrial and manufacturing production. Compared to the average for 2005 they are at 86.1% and 75.9% respectively.


So many of the themes of this blog come together in what might be called a perfect storm for Cyprus. Except of course the results are a doppelganger of perfection. In essence the Euro area cried “save the banks” adding a new bail-in phase for larger depositors. The catch is that the credit crunch reverberates around the economy with wages, prices, production and unemployment all adversely affected amongst others. What never seems to be officially admitted is that this then weakens the banks further so the cry actually is “save the banks for now”. This was even spotted yesterday by a credit ratings agency.

Moody’s estimates that problem loans increased to around 26% of gross loans as of December 2012, six months before the bail-in, and will increase to over 35% by year-end 2013.

Of course there is one more theme to bring in which is Euro area austerity which like a dog chasing its tail will further weaken the economy and lead to a perceived need for more austerity and repeat. At least dogs are bright enough to tire of this game and move on!

Should wages and prices continue their current downward moves and turn into a spiral Cyprus will have the dubious privilege of being in a race with Greece to fully replicate the Great Depression of the 1920s and 30s. As the Kaiser Chiefs so aptly put it.

And oh my god I can’t believe it
I’ve never been this far away from home

Of course there is another way involving both default and devaluation which would give a good chance of doing this.

Knock me down I’ll get right back up again
I’ll come back stronger than a powered up Pac-Man





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  • Mike from Enfield

    Hi Shaun,

    You present a picture where all aspects of the Cypriot economy are in harmony, all pushing with increasing momentum in the same direction – unfortunately it is a very bad direction and with far too much momentum to stop or turn. All the indicators you cite appear destined to get worse. Pick any one of them – e.g. falling wages – then follow through the consequences and you always end up with the initial problem causing itself to deteriorate via a nasty sort of bootstrapping process.

    So the question should be, how to break out of the loop?

    For the 99.9% of Cypriots, I just don’t see any rational argument to staying in the Euro; although I’d agree there are many irrational ones that may seem appealing at first. Humiliating as it may be to the political class, leaving the Euro followed by some form of default surely involves less pain than just carrying on racking up more and more debt as its citizens (surely) feel more and more helpless and hopeless.

  • Rods

    Hi Shaun,

    Another excellent but grim blog.

    I’m sure Merkel is quite happy to have sacrificed Cyprus for her greater good of reelection. When it comes to saving her political skin she is a ruthless operator as former colleagues and coalition partners have found to their cost.

    This, the Euro and the previous communist Cypriot president all seem to have inflicted much damage on the country. As much as I don’t like seeing people suffering there is also an element of self infliction here.

    The bailin of depositors is going to have long term bad consequences for the Cypriot banking sector where it was the off-shore haven of choice for Russian and Ukrainian entrepreneurs who for many valid reasons don’t want to keep vast amounts of money on-shore and I’m sure there was also an element of dubious people and their sources of wealth, This money will now go elsewhere in the world.

  • Justathought

    “Nothing will change unless;at least 50 to 60 % of the population will bath into poverty”. This was a statement overheard which I reproduced few weeks ago on this blog.
    Looking at the present state of affair within the PIIGS (including Cyprus,)’s population “wellbeing” and supported by the “Pavlaski’statement”: “It’s painful to go backwards”… I am seriously asking question…How to wake up populace which does not want to wake up but the proverbial horse brought at the river is the answer. A regular commenter will say: Enjoy the show and have some popcorn…

  • Walt Kowalski

    Unfortunately for European stability, the best bet Cyprus has is to essentially become Putin’s new aircraft carrier with a new currency not handcuffed to the wants of economically illiterate European politicians. Will this happen ? i say 50-50, with the chances increasing as deflation begins to bite down hard.

  • forbin

    indeed :-)

    I remember both comments . The problem is that the EU is a political construct and not an economic one. The top politicos can see the largess in Brussels and all want a slice of the pie and when your trying to convince anyone of anything that means he/she looses his wage packet …….

    combined with media that are little more than copy and paste artists / scribblers , or at worst in bed with TPTB, then no one cannot counter the argument to stay in.

    Like the BoE over QE come the cries of ” it will be / would have been worse if we ,etc,etc,

    And without intellectual vigour in media and all parties on the same side – well sit back and eat the popcorn…..

    talking heads – we’re on the road to nowhere


  • forbin

    hello Mike

    seems everyone forgets the Icelandic option these days.

    A small country like Cyprus should bounce back in a few years but then again , look at my reply to Justathought.

    common sense doesnt come into it


  • Anonymous

    Hi Shaun,

    As a comparison, Bulgarian GDP was 13.07B USD in 1995, 8.89B USD in 1996, 10.05B in 1997 and 13.06 in 1998. (Google says sources include world bank)

    This suggests the hyperinflationary collapse reduced GDP by 32% in 1996, and default, devaluation and an enforced balanced budget bought GDP back up within 2 years. A bigger sample shows communist era GDP of around 20B USD, then falling below 9B – let us hope neither Cyprus or Greece suffer similar falls in GDP.

    While default & devaluation worked very well for Bulgarian GDP, pensioners and savers were big losers – they did not receive any share of increasing GDP. The rich got richer and the poor got poorer

  • pavlaki

    I wonder what would have happened if Cyprus had not joined the Euro? Would the imbalances still have caused it’s demise or would it have been nimble enough to survive?

  • Anonymous

    Iceland could not afford to rescue it’s banks. I’d suggest that the Greek private sector haircut would have put an independent Cyprus in a similar position.

  • pavlaki

    They may not have been quite so intertwined with Greece if they had stayed out. It’s all speculation and we can discuss ‘what ifs’ forever but I wondered at the time if Cyprus was doing the right thing.

  • Anonymous

    Hi Mike

    I think there is a clear case for Cyprus to in effect go “Bye and thanks for all the fish!” . However as you point out her political class do not see that as being in their interests so they will need to be pushed/forced. So far the Greek politicians have found a away to avoid that partly via the “Grecovery” claims I discuss here.


  • Anonymous

    Hi Rods

    The old business model of being an offshore banking system was ruined by the bail in and in case there was any doubt the weekly reconfirmation of capital controls finishes the job! So a new model is needed which of course is exactly the time to default and devalue and take a fresh start…

  • Anonymous

    Hi Forbin and Justathought

    The “Nothing will change unless;at least 50 to 60 % of the population will bath into poverty” is an interesting one as something which is a surprise (as in the old definition of an expected event as opposed to the modern one of a predictable inconvenient one…) is that the threshold has turned out to be so high.

    As to songs maybe “Up the hill backwards” is the new model….

  • Anonymous

    Hi Mr.K

    Rather ironically it is the RAF that has been using it as an unsinkable aircraft carrier when it sent 6 Typhoons to our base there when tensions heightened with Syria. Presumably they were there as air cover for the US and NATO ships in the area although of course in a subplot the UK found itself also providing support for the Euro/Ruble battle going on……

    But yes President Putin is on the march and so far he has gained ground…

  • Anonymous

    Hi ExpatInBG

    You are reminding me of something that has come up in the debate from time to time albeit to a different purpose which is GDP warrants. One route forwards might be to give GDP based warrants to savers and pensioners as a way of allowing them to gain some benefit from any recovery…..

  • Anonymous

    Hi pavlaki

    The then President of the ECB Jean Claude Trichet welcomed Cyprus to the Euro thus.

    ” Furthermore, for a small open economy such as Cyprus, the euro adoption provides protection against international financial turmoil, which often has a disproportionate effect on smaller economies.”

    Has anybody asked him how that protection against international financial turmoil has worked out?

  • Noo 2 Economics

    Hi Shaun, an interesting piece on qfinance but do you have the numbers for the discrete months of July and August?

  • Justathought

    Perhaps, Incremental changes over time might not have been factored into equation leading into lower treshold???

  • Anonymous

    That scheme adds complexity, admin costs. There is a question of affordability. Warrants issued by a government in default, what could go wrong ?

  • Anonymous

    I think all this analysis is not relevant as far as the decision for Cyprus to stay or not in the Euro. There is an elephant in the room in Cyprus (literally and metaphorically) and because of this elephant Cyprus will never go out of Euro by its own device, unless the EZ is dismantled by more countries. Economics is irrelevant. Completely and utterly.

  • David Lilley

    I couldn’t be without your daily bogs. Or those of Simon Ward.

  • James Brown

    David, I wish everyone would proofread before posting!