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Cyprus: Lack of adjustment of household sector

Posted by (Guest Contributor) on May 16th, 2017 - 5 Comments

An analysis of the results of the Eurosystem’s Household Finance and Consumption Surveys (HFCS) reveals how Cyprus households and their counterparts in certain other financially distressed Euro area countries have been affected by and responded to their financial crises.

According to the first wave results of the HFCS centered on 2009/2010 Cyprus households entered the crisis years of 2012 and 2013 with relatively high levels of real and financial assets, well in excess of the Euro area averages. At the same time Cyprus households were burdened with very high large amounts of debt, with the ratio of debt to income for indebted households estimated at 157% in 2010, far above the euro area average of 63%.

As a result of the financial crisis of 2012/2013 and its aftermath Cyprus households experienced huge falls in their net wealth of 36% and income of 30% between 2009/10 and 2013/14. However, Cyprus households largely maintained their consumption over these years running down their saving balances and increasing their indebtedness. The household saving rate fell to minus 7.9% in 2014 and the debt to income ratio for indebted households rose spectacularly to 251%.  And the ratio of debt service to income for indebted households climbed to above 35% in 2014, with the ratio for the poorest 20% sky-rocketing to 64%.

The failure of Cyprus households to repair their balance sheets and adjust their spending behavior to their falling incomes contrasts with that of households in Spain, Portugal and Ireland which kept their consumption below incomes and generated saving to repay debt and reduce their debt service to income ratios to more manageable levels of 18.6%, 15.1%, and 12.9%, respectively.

With the very large falls in incomes, households previously categorised as being in the middle class descended into the lower ranks and along with the bottom 20% classified by net wealth became exposed to the risk of poverty as well as experiencing greater difficulties in honoring debt repayments. Indeed, there has been a large shrinking in the incomes and number of middle-class households (down by at least 20 percentage points) that has seriously reduced investments in education and healthcare, as well as outlays by the self-employed in business assets of SMEs.

Beyond 2014 limited data on the behavior of Cyprus households indicate that the steep declines in their net wealth and incomes have been halted, with a small rise in real household incomes occurring in 2015 and 2016.Notwithstanding these latest developments, the financial position of households remains precarious as many households have continued to consume beyond their income and delay their servicing of debt, hence keeping non-performing household loans above €12 billion  and over 57% of their gross loans. Indeed, the NPLs of households were reduced by only €709 million or 5.5% between end-2014 and end-2016, a disturbing figure indicating the inability of many households to repay their debts.

Thus, there is an urgent need for policy-makers to deal more effectively with the severe debt problem of households. Specific taxation measures and reforms should be introduced to support sustained economic growth and to redistribute the proceeds of such growth more equally. These policies would help raise the disposable incomes of lower and middle level income households giving them among other things the increased capacity to service their loans.

Action, backed politically, has to be taken to induce/enforce wealthier households including so-called strategic defaulters which have the capacity to punctually repay loans to do so. But given the huge amount of household debt estimated to be around 124% of GDP, with a considerable proportion of it held by households with very limited capacity to pay, the above proposals are unlikely to contribute enough to reducing household indebtedness and in removing it as an important constraint on economic growth.

Accordingly, it is proposed that banks institute a household debt relief program over a period of 24 months whereby certain loan principals of households, essentially mortgages for main home residences and business loans for self-employed persons are partly written-off. To incentivize the banks to participate in the program and for their capital not to be the victim of shattering losses from the write-offs, these losses should be allowed to be spread over a long period of say 15 years, supplemented by tax credits.

Policy-makers should be aware that successful efforts and arrangements that result in large reductions in private debt involving higher savings by households and business enterprises will inevitably reduce private domestic demand over the medium-term and contribute to lower economic growth.(See “Neglect Private Debt at the Economy’s Peril” id=2886345). This puts a premium on assigning even greater policy orientation toward boosting net exports as the prime source of economic growth, especially through exploiting the enormous potential of the Cyprus tourism sector.

Last but not least, policy-makers cannot afford to neglect the private debt problem which is impairing the foundations needed for the future growth of the Cyprus economy. Furthermore, with bank loans to the private sector, amounting to around 287% of GDP, of which around 47% are non-performing, there are serious concerns for financial stability as such huge debt weighs heavily on banks’ profitability and restricts their ability to raise capital and extend credit to support economic growth.

Categories → Οικονομία

  1. avatar
    Non-indebted on May 16, 2017 - (permalink)

    So somebody (over)borrowed, continued consuming as if living in LaLaLand and now we should all assist the situation through taxation ? I don’t think so. How about their collateral.

    • avatar
      Savvakis C Savvides on May 16, 2017 - (permalink)

      So, what are you suggesting? To grab the collaterals from the Cypriot owners and give it whom? The over half of foreign depositors and the current shareholders of the Cypriot banks? It is natural for people to dissave and defend their consumption patterns in times of crisis. And it is not all that a bad thing as you suggest. Without this spending we would have been in a deep-deep recession with almost no return. LaLaLand is what the situation was prior to 2013 with bangsters, lawyers, accountants and politicians making millions and billions at the expense of the Economy.

  2. avatar
    Savvakis C Savvides on May 16, 2017 - (permalink)

    Because the comment by Non-Indebted puts the economic issue in the wrong context (i.e. Who is to blame and Who Should Pay) I restate what I said before regarding culprits. The best way to totally ruin the Economy is to base policy decisions that are necessary now on the judgement regarding who is to blame and how to make them pay.

    You are insinuating that banks are innocent and that the borrowers should pay. The banks in general, but those in Cyprus in particular, have been giving out loans without a proper assessment of repayment capability and credit risk. The Central Bank and misguided Government policy encouraged the influx of huge foreign deposits which the banks had to position in income generating assets (loans) in the local economy (and even to use it to expand abroad in hostile and unmanageable environments).

    If the banks were to do proper repayment and risk assessment (assuming they knew how) in giving out the huge surpluses of deposits they have assembled, they would in all probability be only capable to position a very small fraction of these deposits into income generating loans. This is simply because an Economy cannot grow 300% and more in a few years. There are just not enough such economically viable projects to be financed.
    So, the banks basically shoved down the throats of unsuspecting customers (households and companies) loans taking as security collaterals (fixed and floating charges), the personal guarantees of borrowers and even of those in their immediate environment and any other undertakings they could persuade the “customer” to give them in order to secure their ability to collect on the loan and interest.

    If this was the setting of a crime scene, and in a sense it was, there would be two guilty parties, the borrower for accepting such loan and terms and the lender who irresponsibly gave loans which could not be repaid. But I guess this is the weakness of our current system, where banks can demand and claim their security in full in the law of contract without having to suffer from their negligence and irresponsibility for practicing imprudent banking

  3. avatar
    Leslie G Manison on May 16, 2017 - (permalink)

    To non-indebted,You are right that debtors who over-borrowed should not be bailed-out by law-abiding taxpayers.In my blog I did not wish to create this impression.This note is an incomplete summary of a forthcoming paper on the same subject to be published by the the John Deutsch International Development Centre of Queen’s University in Canada.In this paper I argue that recommended reductions in tax rates benefitting lower and middle income households and increases in productive Government investments that would boost and sustain more equitable growth should be financed by increasing Government revenue collections from the prolific tax-evaders and strategic debt defaulters of Cyprus as well as utilising ample available EU funds.
    I would add that banks in many cases irresponsibly lumbered poorer households with loans which they did not have the capacity to service and, indeed, should bear the losses associated with this over-lending; but who is to judge and enforce the latter?
    I agree that greater efforts should be made to seize the collateral of debt delinquents, especially of those who have the ability to repay, but this will require the backing of currently unwilling politicians who are afraid also of the social consequences mass foreclosures of the properties of the less-wealthy.In addition banks would have a problem with all their seized property on their balance sheets.
    It is an issue of the financing and distribution of the losses arising from the reduction in the huge amount of NPLs, particularly of those who do not have the capacity to repay.And this is why I recommend that losses to banks from write-offs be spread over a long period so that banks and the savings of non-debtors are not wiped out.

  4. avatar
    Non-indebted on May 17, 2017 - (permalink)

    We do agree in the end. If we accept that “it takes two to tango” and both borrowers and lenders are responsible for this mess then they should both carry the losses: the banks have eroded profits through provisions/write-offs, and the borrowers may see their collateral seized. The banks would further more have trouble liquidating all the collateral. Each party should pay to the maximum extent possible. But I am in favour of actions bearing consequences and not shifting the problem to the tax payers, except of course for tax evaders.

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