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Private debt is the problem

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Το ιδιωτικχ ρΕος εΙναι το πρoβληµα

By Alexia Kafetzis

Private debt (debt of households and non-financial companies) in Cyprus stood at 206% of GDP at the end of the third quarter of 2023, according to the quarterly financial accounts published by the Central Bank of Cyprus. Household debt amounted to 19.9 billion euros at the end of September 2023, with the relative debt ratio standing at 68% of Gross Domestic Product (GDP), showing a marginal decrease compared to the previous quarter mainly due to the increase in GDP . The corresponding debt of non-financial companies at the end of September 2023 amounted to 40.2 billion euros, with the debt ratio standing at 138% of GDP, marking a slight decrease compared to the previous quarter mainly due to the increase in GDP.

By Savvakis K. Savvidis*

Sweeping the excessive private debt that plagues the country under the carpet does not solve the enormous problem it can cause us. The clumsy manipulations lead the country to a deep and long economic recession. I summarize it in the diagram below from one of my presentations. It's called “Balance Sheet Recession”. A term that the Economist Richard Koo has developed in several of his books from his long experience in Japan.

The perfect storm of the Balance Sheet Recession in Cyprus

The chart shows private debt as a percentage of Gross Domestic Product (GDP) in Cyprus for 20 years (from 1997 to 2016). Although private debt in Cyprus was high throughout the twenty-year period, it fluctuated in line with GDP ups and downs until 2004. In fact, in 2004 private debt in Cyprus had reached its lowest point and was just under 250% of GDP.

From 2005 onwards, however, we notice that the private debt stopped changing in parallel with the GDP, but escaped and constantly climbed higher. It begins a sharp upward trajectory thus creating a gap between lending and productivity in the economy. This continued with lending rising rapidly through 2013 and beyond. The result was that the ability to repay loans was significantly constrained.

Richard Vague (2014) identified an important empirical regularity that has manifested itself in every financial crisis of the last 150 years. This occurs when the combination of private debt to GDP is 150% or more and additionally there is an increase in private debt to GDP within a five-year period to 17% or more (Vague, 2014).

The figures for Cyprus, as can be seen in the chart, should ring bells in the five-year period from 2008 to 2012, which had not only exceeded the 17% mark, but, as can be seen from the chart, the increase in private debt to GDP had reached 62.5%!

When private debt to GDP takes such a course, it destroys the infrastructure needed for an economic growth that will add to the prosperity of the world and the companies in the country. The conditions for a healthy growth are basically two and when the private debt escapes to such an extent from the GDP, the country enters a downward path with no easy solution to overcome.

The sustainable investments require demand and purchasing power

Sustainable investments assume that there is demand and purchasing power to acquire the products or services of a new project. When the economic agents are in debt to the extent that they can hardly service the loans that are already burdening them, the purchasing power of the country is reduced. This is also pointed out by Richard Koo (2015).

In short what it says is that when you bankrupt the world and businesses by giving out a lot of bad loans without the ability to repay (as happened in Cyprus), you reduce the purchasing power of the world and there will no longer be good conditions for new viable projects. Furthermore, with the balance sheets of the country's economic factors “crushed” the banks will not find them worthy of lending. These two are leading the country slowly but surely, as it happened in Japan for about two decades, into a long-term recession. This is exactly what is happening in Cyprus now. And the only role left for our banks is to become -in Cyprus under the protection of the state- “zombie” banks.

“Save the economy so that the banks have a role” and not the opposite

Iceland did exactly the opposite of what we do! They said “save the economy so that the banks have a role”. They nationalized their troubled banks and wrote off bad loans. In three years they came out of the crisis. In other words, they did the opposite of what the majority of our politicians in Cyprus serve us, that “we must save the banks in order to have an economy”.

We have repeatedly analyzed and warned about the dangers posed by the uncontrolled private debt problem (Manison and Savvides 2017). In Cyprus we are world champions in private debt. And the worst thing is not that these concerns debts only between us, but that they are collected by foreigners outside Cyprus with complete opacity and without substantial supervisory control through the collateral of the loans with the help of our political leadership and with willing accomplices inside and outside banks. But our politicians prefer to ignore it and rely on their own wishful thinking. However, their clumsy and myopic manipulations lead us with mathematical precision to the deterioration of the balance sheets of the country's economic factors and slowly but surely to a deep and long-term recession through bankruptcy.

The conclusion from the analysis in the article is that in the period 2004-2012, those who were supposed to protect the economy and the well-being of the world, let Cyprus become an open vine to the appetites of astute people inside and outside Cyprus whose only meaning was their own enrichment. The supervisory authority that was supposed to be the guardian of economic and financial stability during the 2004-2012 disaster period opened the gates wide to those who were comfortable serving foreign ulterior interests. They flooded our banks with inflows of tens of billions of “suspicious” money in deposits from third countries. The banks in turn were obliged to give loans in order to have income. However, it was not possible for them to achieve this with a proper assessment of the ability to repay, as is their duty, and they offered them in abbreviated procedures with the only criterion being the collateral.

I should add that the banks had completely irresponsibly wasted a lot of this liquidity by recklessly buying Greek bonds and also to expand abroad without viable prospects. The result is what we live in today. The enormous wear and tear on the balance sheets of households and businesses with the consequent impending recession of the balance sheets.

Source: 24h.com.cy

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