IN APRIL 2010 asset manager Toscafund issued a discussion paper carrying the title “Storm clouds darkening over Cyprus“. This was not a meteorological warning, but an economic one.
The piece argued that two forces in combination threatened to send the Republic’s economy into a recession as challenging as anything it had faced since the devastation of the 1974 Turkish invasion.
On the one hand we cautioned the Republic of Cyprus (RoC) was vulnerable through its varied banking channels to the extremely unpleasant economic events unfolding in Greece. Added to this we warned that frenetic building had led to a significant over-hang of property stock across large swathes of the RoC. We argued the timing of events could not have been worse, with demand sliding precisely when new supply was still increasing.
Our conclusion was as clear as it was stark. We wrote “real estate across the RoC faces further downward price adjustments, possibly a halving in certain areas [and] those who view recent weakness in prices as an opportunity to pick up value will find no shortage of sellers. The market is far from its bottom.”
It is true the RoC’s property market has failed to record the weakness we had warned it would suffer through 2010 and 2011. The fiction of robust pricing can be put down to low transaction volumes.
property owners have delayed selling
Specifically, we are convinced that over much of the period since penning our research, property owners have delayed selling, for fear of what prices they would have to trade at. Low volumes and the resulting lack of pricing visibility has helped banks avoid having to recognise what otherwise would have been severe mark-to-market loan write-downs.
In short, the foreclosure activity we feared would be a feature of 2010 and 2011 has simply been delayed. Indeed, the evidence from the pricing data now being collated by the Central Bank of Cyprus suggests prices are falling gently.
prices could halve in certain tourist areas
As for where the market may bottom, the answer is that peak-to-trough prices could easily halve in certain over-built tourist areas, with property in Nicosia also cheapening by more than owners would feel comfortable believing possible.
In our previous report we visited the issue of where the economy of the RoC was heading. In our assessment we made clear that we saw no chance of any nation departing the eurozone. In the intervening period we have been steadfast in this view and continue to hold it even against the barrage of poorly informed arguments that suggest otherwise.
For all nations across the eurozone, the mechanism through which competitiveness will be re-established will be re-pricing. The simple truth is that wages will fall and asset prices with them, including property.
prices are falling at a quickening pace
Even now with irrefutable evidence that property prices are falling at a quickening pace across the Republic of Cyprus, one senses a sanguine mood that something will soon interrupt the decline.
Some optimists have argued ‘Russian money’ will provide the elixir for RoC’s property market ills. These and others have pointed enthusiastically to the “discovery” of “considerable” gas reserves deep in the RoC’s territorial waters. Still others expect a concerted government fiscal programme to revive the RoC’s economic fortunes.
Indeed, confidence that Moscow will provide assistance has been boosted by news that Cyprus has received the second tranche of a €2.5bn four-and-a-half year, 4.5 per cent loan pledged by Russia, a considerable injection when put alongside the RoC’s fiscal deficit in 2011 of €1.6bn and overall gross debt of close to €10bn.
Should we see Russia as the RoC’s salvation? We believe that even though further “friendly” loans “with no strings attached” from Moscow (to quote from the Cypriot finance minster) are likely to be forthcoming, this will at best ease the economic pain rather than avoid pain altogether.
It is notable that the figure the RoC was hoping for was four times greater than that which was ultimately forthcoming. It should also be remembered Russia extended a loan not a gift, albeit at a rate less onerous than the RoC would have faced in the open sovereign debt market. Why are we so sceptical of a “Russian rescue”?
Cyprus is Russia’s closest ally
There is little doubt that Cyprus is Russia’s closest ally of those countries within the eurozone and amongst its closest of those in the EU. There is also little doubt that economically Russia promises a far stronger outlook than does the EU in aggregate.
However, those expecting Russia or rather Russians to generously bail out Cyprus might like to consider this point. Opportunities exist widely for enriched Russians to spread their wealth, and many of these options are in economies whose currencies are more “affordable” than the euro. Opportunities also exist in markets that offer better value since they never enjoyed the asset price growth seen across the RoC.
asset prices will have to fall significantly
The reality then is that before the RoC can hope to attract further tranches of Russian rescue capital, all asset prices will have to fall significantly as an inducement. In essence, additional Russian rescue capital will arrive into the RoC, but only after the painful correction in asset prices we warn looks certain.
Even if further capital were forthcoming there is the issue of precisely where it might and might not be welcomed across the RoC, and on what terms?
As much as Cypriot property will fall into Russian ownership, one has to question whether it will be allowed to enter as freely into the Cypriot banking sector, neither as deposits nor into their ownership. Much like the hope that oil and gas will prove some magical cure for the RoC’s worsening economic problems, so those expecting a Russian remedy will be disappointed.
It is widely believed Cyprus can “extract” itself from its problems if only it can extract the considerable oil and gas reserves amassed around it. Those rallying around this hope might like to consider two issues. First, the logistical challenges in extracting from contested waters. The second is the time it will take to arrive at a point where the RoC’s sovereign oil and gas extraction is commercially viable.
Let us close this short reprise with lines we ended in our far more extensive piece two years ago.
“The picture we have painted will be seen by enthusiasts for Cyprus as bearing poor resemblance to the robust economy they recognise. They may well defend their case by arguing our negative outlook relies on a number of correlated shocks whose likelihood is far from certain.
“Notable here is a Greek banking crisis; currency collapses across Southern and Eastern Europe and further weakness in the Spanish coastal property market. It is true that were these not to detonate the RoC would avoid the worst of what we have suggested awaits it.
“Economic enthusiasts for the Republic of Cyprus will also be frustrated by our insistence there is little than can be done to forestall events. All this is true. We are wishing no ills on the island, and genuinely hope the dark clouds passing over do not unleash the severe storm they threaten. We are however not confident they will simply pass.”
From the vantage point of May 2012 few can deny that the storm we claimed threatened Cyprus has broken.
About the author
Dr Savvas Savouri is partner, chief economist, and chief investment officer of Toscafund, an established asset manager based in London and Dubai. The firm was founded in 2000 by Martin Hughes and is part of Old Oak Group, a large, well capitalised, financial services business. This includes Cheviot, a private client asset manager and Penta, a private equity business.