The Rise and Fall of the Cypriot Economy (Part 2) 

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Part 2 – Decline & Deleveraging

onestopbrokers-logo1Stage 4

In the fourth stage people start to become poorer but still think of themselves as rich. The decline is gradual and at first people didn’t realise it and in cases where they did their defence mechanisms i.e. denial, took over to block these unwanted thoughts. This stage was characterised predominantly by the leveraging up of the state, businesses and households.

Debts typically rise relative to incomes until something gives. In Cyprus this period was ushered in by the stock market bubble which collapsed in 2000 when virtually overnight a small sleepy stock market became a hobby and past time of all economic classes irrespective of age, knowledge, education or expertise. By this stage the people who worked hard during the early stages of the economic miracle had become irrelevant and those in control had little fear of debt or financial insecurity.

The result of previous positive economic winds had increased the net worth’s of households, businesses and the subsequent entry into the European Union brought with it a property boom and foreign direct investment like Cyprus had never seen before. The moochers are now joined by the looters and eventually outnumber the producers who are by now in decline.

The 2000’s in Cyprus saw a series of bubbles in consumption and asset classes which encouraged unconstrained spending, an increase in debt levels and careless investment and capital allocation practices in all sectors of the economy. The euphoria of entering the EU and elevated importance of the island on the global map for business and financial services primarily from Russia and post-Soviet states brought a sense of invincibility and overconfidence.

People mistakenly believed that investments that had increased in value were great investments instead of just expensive. They borrowed more to buy even more investments. The feedback loop became self-reinforcing and carried on until the bubbles burst. The financial losses materialised as a result of the bubbles bursting and the mishandling of the financial distress signals from the state and Central Bank contribute to the country’s economic decline. Cyprus at this stage was a later stage developing economy.

Stage 5

The last stage and the one Cyprus is currently in, is the deleveraging and decline stage. During this stage people are getting poorer and are no longer in denial about it. They initially struggle to accept it but slowly come to terms with this.

After the real estate bubble burst and the era of unprecedented debt growth came to a halt also as a result of the Global Financial Crisis, private debt growth, private and public spending and asset values start to decline at an increasingly rapid rate. Household net worth’s deteriorate, the highly leveraged hit the hardest.

The government remaining without any surplus borrowed first from the markets and then from anybody willing to lend to it. It then sought a bailout from the Troika as had no ability to print its own money or devalue its currency having foregone the Cyprus pound for the Euro in 2008. As an extension to its economic and financial malaise Cyprus loses its credibility with its European partners and was forced to apply unpalatable haircuts to depositors in two of its largest banks which collapsed following gross mishandling of negotiations with Troika.

The government and the banking sector now have serious challenges to face namely on-going large deficits, vast public and private debts, weak productivity and the enactment of entirely necessary but largely unpopular legislation in order to enable a clear up of the mess.

What Next?

Boom and bust cycles like the one Cyprus has been through are not new and have been occurring as long as history books go back. Cycles vary according to each country’s size, culture and the period they occur.

The fundamentals however remain the same through the ages and are predominantly a result of human nature. Times change, technology changes, innovations come and go but humans remain the same at the core. Emotions such as greed, fear, hope and despair dominate economic behaviour more than we like to think and humans have a natural tendency to resist change.

In the case of Cyprus large scale change has only been effected by external forces three times since Cyprus got independence. The first was initiated by the Turkish invasion in 1974, the second by accession into the EU in 2004 and lastly the changes that have been imposed by the Troika of lenders in 2013.

Perhaps the people of Cyprus might get lucky this third time and one day come to praise the Troika for forcing change and modernisation of the economy and finally bringing it up to speed with the rest of the world. That remains to be seen…

 

By OneStopBrokers

Part 1: The Rise and Fall of the Cypriot Economy


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