FORMER CENTRAL Bank Governor Athanasios Orphanides yesterday accused his successor and the previous government of launching an assault on the banking system to win votes in the presidential elections at the cost of the destruction of the economy.
In a live link-up from America with a conference on the euro organised by the Tassos Papadopoulos Centre for Studies yesterday in Nicosia, Orphanides was scathing about the responsibility of the Demetris Christofias government and current central bank governor Panicos Demetriades for today’s economic mess.
He argued that the economic consequences of the past five years were so severe that during that time, real GDP per person fell cumulatively by more than 10 per cent. Following the latest damage to the economy, the decline in GDP is projected to continue.
“In five-short years, Cyprus had become a case study on how destructive economic populism can be,” said Orphanides.
He quoted German economist Rudi Dornbusch who said: “Populism always ends in tears.”
Despite being at the helm of the central bank from May 2007 to May 2012, Orphanides maintained the bulk of the blame for today’s crisis rests mostly with the Christofias government, though he also had a dig at his successor for allegedly undermining the independence of the central bank by following the AKEL party line.
In his live address to the conference, the former governor noted that when Cyprus joined the eurozone in 2008, it had the respect of its peers.
“Five years later, the economy is in shambles. For two whole years, Cyprus has a government with no access to markets. Euro deposits in Cyprus are unequal to euro deposits elsewhere. How could this happen?” he asked.
Orphanides, who now teaches at MIT in the US, noted that unlike other southern European countries that ran into trouble and applied for a bailout in recent years, when the Cypriot government ran into problems in May 2011 when it was shut out of international markets, it refused to follow the rules.
Instead of seeking help immediately, it waited a full year to request a bailout, on the same day in fact that Spain asked for financial assistance.
However, unlike other EU countries in trouble, the Cyprus government “refused to finalise an MoU”.
In contrast, Spain completed its agreement on July 20, 2012, three weeks after it had asked for help.
“The inaction by the government had severe economic consequences,” said the former governor.
When financial markets raised red flags, the government had a choice to fix the problem, regain credibility and restore sustainability or make the problem worse.
“Faced with this choice, the government assaulted the banking sector that was already weakened by the global crisis. By the time the five-year term of this government had ended, it had also succeeded in destroying the economic model of the country,” he said.
Orphanides presented in a slide show a letter dated May 18, 2010, from the central bank when he was at the helm to the government, warning of the looming economic and banking crisis.
The central bank warned “that unless there is a change in direction with meaningful fiscal consolidation, primarily on the expenditure side, the consequences for the Cypriot economy will be catastrophic”.
By the end of 2010, the presidential palace received another “emphatic” warning, this time from the European Central Bank (ECB) on the “disastrous” possibility of experiencing “negative feedback loops between the financial sector and public debt”.
The letter stressed the need for prompt corrective action, said Orphanides.
“Unfortunately for the Cypriot public, the government dismissed all these warnings. Not heeding the ECB warnings was particularly costly,” he said, noting that the ECB had shown a willingness to support ailing European economies through the purchasing of Greek, Irish, Portuguese, Italian and Spanish debt.
“Cyprus had the government that chose to dismiss all warnings. Unsurprisingly, the ECB made no purchases of Cypriot bonds.”
The former governor argued that in 2011 while everyone else was taking note of the widening fiscal problems and credit downgrades in Cyprus along with the deteriorating situation in Greece, the government imposed a levy on banks to raise more revenue and continue spending.
“By May, the situation had deteriorated but the Ministry of Finance denied it. There was a reason for the denials. The ministry of finance was trying to avoid disclosing the deterioration of the country's finances prior to the parliamentary elections in late May.”
He added: “The government's plan was successful. The communist party gained one seat on the 22 May 2011 parliamentary elections. However, the country was to pay a huge cost. The government had lost control of its financing.”
Orphanides argued that anyone with access to market data “could see the tsunami coming”.
He further noted that the regulatory authority under his leadership had been providing information to stakeholders on the worsening situation. Instead of taking urgent action, the government and ruling party focused on “winning an extra seat in parliament”.
And unlike, Greece, Ireland and Portugal who when in a similar situation had requested financial assistance from the EU and the IMF, and despite the catastrophic consequences of the Mari explosion, Cyprus waited another year to seek help.
When the economy was in a critical condition comparable to that in 1974, and action was imperative to avoid the worst, the government did nothing again, he said.
In a likely dig at his successor, Orphanides added: “Advisers, including academics based abroad, were drafted to criticise those calling for action and argue that what was needed was more spending. The country was falling apart.”
Orphanides further argued that the island’s two biggest banks were capable of handling a haircut of Greek bonds of up to 21 per cent but the Eurogroup’s decision to revise that amount upwards was “a huge blow to the banking system in Europe” and cost Cypriot banks the equivalent of 25 per cent of Cypriot GDP.
“Remarkably, the government agreed to this decision while the exposure of Cypriot banks and associated cost to them were public information,” he said.
“With the economy tanking and no access to markets the sovereign faced default,” but instead of requesting EU/IMF assistance, Christofias sought a bilateral loan from Russia worth about 15 per cent of Cypriot GDP.
“Once again, the government chose to delay taking corrective measures and make the problem worse.”
Orphanides accused the previous government of attempting to delay everything beyond the February 2013 elections. A plan which might have worked, had it kept its sovereign ratings at investment-grade or at least, its credibility.
One last chance to save the country presented itself in April 2012 when Orphanides arranged for then finance minister Vassos Shiarly to hold talks with the ECB in Frankfurt about adopting measures similar to what an MoU would have demanded and in this manner avoid a formal support mechanism.
“Unfortunately, his plan was deemed too politically costly for the communist party and resoundingly rejected. The president's public dismissal on June 1, 2012 pushed Cyprus over the cliff. Shortly after, government bonds no longer met the ECB eligibility criteria.
“Cyprus became the first country in history whose central bank refused to accept its bonds for monetary policy purposes for many months.”
When the government finally asked for help on June 25, 2012, “it chose not to complete the MoU” while “simultaneously, it intensified its assault on the banking system as a platform for the (presidential) election”.
Orphanides then charged AKEL with effectively securing control of the central bank by replacing him with Demetriades, so that “the government and central bank could engage in a coordinated campaign against the banks as part of the February 2013 presidential election campaign”.
He proceeded to list the ways in which his successor contributed to this process, noting the removal of chairmen and CEOs from the two largest banks; launching investigations against banks “with selective defamatory leaks to press”; characterising banking in Cyprus as “casino banking”, and exaggerating the capital needs of the banking system.
On the latter, he said: “For every euro that these numbers were exaggerated meant that a depositor lost money.”
“The goal was to create a negative image that could be used to claim that the only reason the government had to seek EU/IMF assistance was problems with the banks,” he said.
The campaign was so successful that it created the image the only way to recapitalise the banks without burdening the public debt was through a ‘bail-in’, he argued.
Also speaking at the event, University of Cyprus (UCY) professor Stavros Zenios said it was difficult to find who holds most of the blame in Cyprus; the banks or the government.
In Greece, it was clearly the state. In Ireland and Iceland, it was the banks. But in Cyprus, “it seems to be 50/50 between the two”.
Another UCY academic Alexander Michaelides said the methodology of PIMCO’s assessment of the recapitalisation needs of Cypriot banks will become a focus of study among doctorate students, particularly when compared to what Blackrock, another firm, did when carrying out the same exercise in Greece and Ireland.
Michaelides highlighted the need for better corporate governance in Cyprus.
Former finance minister Michalis Sarris, who was equally scathing of the previous government during his testimony before the committee of inquiry set up to look into the economic disaster, warned that unemployment was going to be a big challenge for a long time to come.
He said Cyprus needed to avoid having “underskilled but overqualified” workers.
Former central bank boss Athanasios Orphanides