- Cyprus Property News Magazine - https://www.news.cyprus-property-buyers.com -

Without Devaluation will Property Prices Collapse?

The President and Central Bank have ruled out devaluation ahead of joining the euro zone. What else could they say? Every devaluation in history has been preceded by such denials. The more denials necessary, the more likely the event.

Your correspondent Roger Greenwood has admirably stated the pros and cons of devaluation in your columns. It is a very difficult and unenviable decision, given the scale of the property bubble and the very real dilemma this presents to the Central Bank. If the Central Bank curbs property appreciation using interest rates, it could boost an already overvalued currency; but if it does nothing it runs the risk of a catastrophic property bubble collapsing, which would make the recent stock market collapse seem like a non event. It could even collapse the indigenous banks as an equivalent bubble did in Thailand in 1998.

Over the last eight years, there has been a worldwide property boom. This happens cyclically whenever there is excess liquidity within the banking system. Worldwide, the cycle is now heading downwards fast. In parts of the USA, house and real estate prices are down by between 30 and 40 per cent; with very few exceptions worldwide, property prices are heading downwards fast. Is it realistic to expect that Cyprus will somehow, magically, buck the worldwide trend? It might if property sellers become more realistic in their expectations and voluntarily revise their prices downwards to create a soft landing.

The real estate boom has been much more spectacular in Cyprus than elsewhere – worldwide only backward economies such as Lesotho and lesser developed ones such as Bulgaria have seen percentage house price appreciation greater than Cyprus. Not a good sign if you think about it as it means that Cyprus is relatively massively overpriced. Economists compare relative housing costs in different countries by means of the purchasing power parity equivalent (PPPE) which measures what like homes and local amenities cost in different parts of the world.

In 1999, in comparison with most of the Mediterranean, Cyprus was already overpriced on the back of an influx of Middle Eastern and Russian money. Since then, prices have bubbled to the point where not only is housing unaffordable to the local population but also to the point where any foreigner can get better bargains elsewhere in Europe and the Mediterranean.

The greater the bubble, the greater the subsequent collapse.

Cypriot central bankers will be particularly mindful of what happened in Thailand in that the local economy mirrors to some extent Thailand before the stock market plunged by 80 per cent, property by 70 per cent, the currency by 40 per cent and the indigenous banks collapsed. The economic similarities are frightening, particularly in the proportion of fixed capital investment as a percentage of GDP devoted to non-productive assets, such as property. Having watched a banking system irresponsibly fuel a stock market bubble, landing itself with many non-performing loans, the Central Bank can be only too well aware that a property collapse on any great scale could collapse the indigenous banks. If Cyprus can enter the euro next year, saving the local banks will become a problem for the much larger European Central Bank.

The government has very real difficulties to address. If it enters the euro at its present value, the country will be uncompetitive and local wages and the standard of living of the majority will have to pay the price to restore competitiveness. The alternative of devaluation is not sure fire, even if the tourist and export opportunities it presents are seized.

There is never an ideal time for devaluation, but now with the US dollar and oil prices falling is as good as it gets.

Fifteen per cent devaluation – a brave government would contemplate 30 per cent – as well as aiding competitiveness will reduce the scale of any property price collapse from the really frightening to the more manageable. If you believe that Cyprus will not buck the worldwide property collapse, one of the most powerful political arguments in favour of devaluation is that it could contribute significantly to safeguarding against a banking crisis.

F.Hunter
Limassol

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