A lot has been written about the dangers of excessive private sector debt (interpreted as the debt owed by households and private businesses) and the overriding need to actively manage it.
All crises, like the one we are going through right now with COVID-19, always bring this issue to the forefront; only to be forgotten when each crisis goes away.
Cyprus has traditionally exhibited one of the highest private debt to GDP ratios over the last few decades. Although a lot has improved in the local economy over the past few years, not much has been achieved insofar as private debt is concerned. Yes, the ratio has come down in recent years, although it is still one of the highest in Europe and the world, but this has come about mostly through passive deleveraging; that is, it has resulted mostly on the back of economic growth and expansion (denominator effect) rather than because of a substantial reduction and management of the nominal level of private debt (numerator effect).
Excessive private sector debt is one of the major macroeconomic imbalances around the world. The Troika has been advising Cyprus that active measures must be taken to manage and reduce private sector debt. Any unexpected turn of events such as an increase in interest rates or a slow-down in economic growth is enough to create the spark for another major private debt (and banking) crisis; let alone an unprecedent economic shock, such as the COVID-19 pandemic, with its uncertain severity and visibility.
The residual high private debt in the economy, the excessive levels of NPLs, with Cyprus’ ratio still around 30%, or 50% in the real economy if we consider the loans which have gone outside the banking sector compared to the European average of around 3%, and the recent pandemic crisis which may put the economy on hold for an unknown period of time, are an explosive recipe for disaster.
Small and medium enterprises (SMEs) are the steam engine of our local economy, contributing 55% to value added and 62% to total employment. At the same time, the SME sector still has around 50% of NPLs (taking into account loans which have gone out of the banking system).
A similar NPL ratio holds true for local households, which, in addition, maintain the highest ratio of household expenditure as a proportion of GDP in the EU (77,2% vs 54,6% respectively – this means that Cypriot households are spending more, relative to their income) and a negative savings rate since 2013 (this means that local households are running down their cumulative savings, presumably to maintain their standards of living), as compared to a positive EU average rate of around 10%. Not surprisingly, local households exhibit the highest monthly debt service burden (in terms of the percentage of disposable household income which must be used for the monthly servicing of loans) in the EU.
The still excessively high level of private debt leaves the local economy extremely vulnerable to outside and largely uncontrollable factors: economic, geopolitical, social or even health events.
Crises have happened in the past and will definitely continue to happen in the future. The recent coronavirus pandemic is a timely reminder that Cyprus is ‘obliged’ to undertake an active and strategic management of the excessive debt in the private sector.
Key economic stakeholders, in the form of government, related institutions and the business community must at last take a holistic view of the situation. A national strategy and plan of actively managing private debt will act as a strong risk-mitigating factor, safeguarding the resilience of the local business community and the robustness of the local economy with every subsequent crisis that comes our way.
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Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.