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Next Previous How will the increase in interest rates affect households and the state HOME • INSIDER • CYPRUS • How will the increase in interest rates affect households and the state
& nbsp & nbspΘεανώς Theiopoulou & nbsp; & nbsp;
After a decade, the ECB appears ready for the first interest rate hike early in the summer and this event opens the debate on what the new decision will mean, what are the fears about private debt and especially for low-income households , which are mostly over-indebted. This decision, when formally taken, is expected to affect government borrowing in terms of the cost of raising funds and refinancing debt. The focus is now on the ECB's Governing Council meeting in early June. Most anticipate that the ECB & nbsp; will decide to raise interest rates, and many analysts predict that the year will end with at least three consecutive increases in key interest rates.
READ ALSO: & nbsp; The weak euro and the coming monetary crisis
For the European Central Bank, this is one of the most critical periods in its recent history. It is no coincidence that the leaks of the board recorded in the foreign news agencies, show the division between the so-called “hawks”, who demand immediate reduction of the expansionist policy and the so-called “pigeons”, who fear that such a move will hit the European development. The hawks have long criticized the ECB for underestimating inflation, which averaged 7.5% in the eurozone in March.
Policy mix, not simple increase
“F” records the views of Stelios Platis, economist, non-executive chairman of the MAP S. Platis group and economist Christakis Patsalidis, on what the expected change in monetary policy from Cyprus means for Cyprus ΕΚΤ.
As a general assessment, asking what impact the ECB's intention to raise lending rates will have on the European economy and how much it will affect Cyprus in particular, Platis said: “The ECB is possibly one of the last major central banks in the West. which will intervene by raising interest rates. At least on the basis of intentions, as it seems today. And this is related to the difficult position that the ECB is in today. European economies are particularly hard hit, as a result of the ongoing Russian invasion and the sanctions imposed by the EU itself. This concerns both inflation, which is already three times the ECB target, and significant recessionary pressures, as the EU imports around 60% of its energy needs. But also through the supply shock of critical raw materials for European industry. In the extreme scenario, the eurozone economies could be called upon to face a stagnant inflation shock. And the role of the ECB is very important in the process of avoiding such a scenario. I think we will see a policy mix, rather than a simple rate hike, with an expansionary fiscal policy consisting of support measures as well as development measures. Thus, the effects of interest rate hikes cannot be analyzed on their own at Union level. In Cyprus, of course, we have not yet seen substantial support measures, but I believe that they are imposed and should be expected, as part of a pan-European strategy. Especially to the low and middle income classes. But also in the direction of supporting development “.
Normalization of expectations
For his part, Mr. Patsalidis points out that “the ECB has announced that before any increase in its key interest rates, it intends to complete the asset purchase program in the third quarter of the year. International markets, however, are anticipating rising interest rates faster, given the significant rise in inflation across the eurozone due to rising energy and commodity prices. When and if the ECB raises interest rates, and if it is judged that the rise in interest rates is in line with the stated goal of stabilizing inflation at 2% in the medium term, then such an increase will lead to the normalization of expectations and the removal from negative/zero interest rates. which are not normal and cause other side effects in all Eurozone countries, including Cyprus “.
Problem with over-indebted
But what about public and private debt if the ECB starts raising money costs? Mr. Platis points out that “unfortunately, non-performing loans remain one of the main problems of our economy. At the same time, the private lending of Cypriot households remains among the highest in the EU. Conversely, the increase in key interest rates raises the cost of money. Which in turn will increase the cost of lending services. Disproportionately affecting lower-income households, most of which are over-indebted. Added to this is the fact that strong inflationary pressures are expected to make it more difficult for lower, lower and even middle-income households. Since they are required to spend much more on electricity, fuel, heating and food, in relation to their income. Negatively affecting their ability to service their existing borrowing.
At the level of public debt “, adds Mr. Platis,” we must note that the risk of bankruptcy has risen internationally. Especially in cases of greater relative risk. That is, developing countries and countries in the region, such as Cyprus. Something that raises the risk premium and usually leads to an increase in borrowing costs in the next phase of raising money, through government bonds. This means that overdue loans for 2022 and 2023 (around 3.5 billion euros) may be refinanced at a higher cost (although it appears that the amount of cash available will cover the financing needs at least for 2022).
Investment inhibitor
To what extent could rising money costs affect growth and investment? Mr. Platis answers that “in general, the increase in the cost of money has a deterrent effect on development initiatives and investments. Since in most cases it raises the required amount in return on an investment – & nbsp; higher cost of money requires higher returns. And this limits the range of investments. At the moment, however, we are also experiencing a shock of supply of important raw materials, which makes even more difficult the development and investment initiatives. I repeat, however, that my assessment is in the direction of an economic policy mix, rather than a simple increase in interest rates. That is, state support and investment, supported by the state, with potentially increased budget deficits. In this case, we may see less, under the circumstances, less impact on development. Of course, this policy mix requires careful moves and is easy to move in the opposite direction. “
Mr. Patsalidis explains the same question (growth impact) that “the goal of increasing money costs is to slow down economic activity and growth & nbsp; – less lending/investment, more savings – & nbsp; in order to avoid the risk of overheating , as high inflation erodes long-term growth. The risk of a restrictive policy is an excessive slowdown in economic activity, without achieving the goal of reducing inflation. In extreme cases, however, which are still observed today (such as shortages of materials and raw materials), the risk of stagnation-inflation is not completely out of the picture. But if we accept the ECB's estimates that price escalation due to shortages is temporary, then the possibility of stagnant inflation is completely ruled out. In such a case, we lead to lower growth, without inflationary pressures. Cyprus, as a small and open economy, is expected to be affected. On the other hand, there are so many other dynamics that affect the economy, both positively (eg the recovery & resilience program) and negatively (eg sanctions against Russia). It is the total of the indirect effects from the developments in the international economy and the most direct ones that concern in particular our economy, that will finally determine the course of development of the economy “.
Delay in development b>
Asked how long it will take for the rate hike mechanism to work in the direction of reducing prices and prove to be a weapon against inflation, Mr. Patsalidis states that “history has shown that higher interest rates lead to lower inflation, provided that the remaining data is stable. Today, the debate is over whether central banks have delayed pushing up interest rates and whether inflation has escaped. In such a case, the duration of the higher interest rate regime should be extended in order to achieve the target, causing a delay in the growth of the economy.
By itself, “adds Mr. Platis,” the ECB can not control and direct inflation to the desired target. It is important that all macroeconomic policies, and in particular fiscal policies, are aligned with this goal. The ECB is targeting the Eurozone average and not a country-specific indicator. Today, Lithuania and Estonia have inflation of 15%, with the Eurozone average averaging 7.5%. Cyprus is at 6.2%. It is therefore important that Cyprus continues its efforts for fiscal consolidation, so that in the medium term it can enjoy interest rates that are in line with its own economy. “
Platis: Things are complicated enough
“Unfortunately, things are much more complicated today than a normal effect of an (under normal circumstances) interest rate relationship and a reduction in inflation,” notes Stelios Platis. “The prices of energy, commodities and raw materials have already skyrocketed. And this, at a time when there is a significant problem in the supply chain, with a shock of supply of important raw materials, but also energy. With this in mind, the nature and type of inflation today, but also the related structural causes that led to and kept prices up, seem to support the maintenance of strong inflationary pressures for the rest of 2022, despite the increase in interest rates. Beyond that, the policy mix, the fiscal manipulations of the major EU economies and the ECB's further actions, I believe, will be constantly monitored, reviewed and updated. “The bet is to avoid stagnant inflation scenarios,” he concludes.
Patsalidis: Cyprus will be most affected
Mr. Patsalidis answers the question “what will happen to the public and private debt in the event that the ECB increases the cost of money?” that “a continuous increase in interest rates will tend to bear the cost of servicing public and private debt. In the case of floating rate loans, the charge will be more immediate, while debt invoiced at fixed rates (usually government bonds) will be affected only during refinancing. Cyprus is more affected than the Eurozone average. First, solvency ratios are lower and therefore we bear higher borrowing costs, which reflects the country's higher credit risk. In general, the higher the interest rates, the higher the credit risk margin (which is part of the interest rate). “Secondly, the business sector in Cyprus relies more on lending than the average company in the Eurozone, and therefore an increase in interest rates will disproportionately burden the Cypriot business.”
