[PIO] Proposal to reduce excess liquidity in the Cypriot banking system

The Ministry of Finance wishes to comment on an article by Professors Stavros Zenios and Andreas Milidoni, published today 01/9/2023 in Stockwatch, which proposes to reduce excess liquidity in the banking system by issuing government bonds.

The Ministry of Finance welcomes any ideas or proposals for managing the economy.

In the same context, the Ministry of Finance should participate in the public debate by expressing its views, thus contributing to the formation of a more comprehensive information to citizens.

In summary, the Treasury's views in principle on the above-mentioned proposal are as follows.

More specifically, the use of fiscal and public debt management policy tools to absorb a significant part of the liquidity may lead to a deconstruction of the fiscal targets and a derailment of the public debt management strategy from its main mission, without even achieving the intended purpose for which the liquidity absorption is attempted. In particular, even if EUR 2.5 billion of liquidity is absorbed (which we consider unrealistic to achieve for the reasons set out below), the excess liquidity that will remain in the system will be of such magnitude that no impact on deposit rates is expected to occur, while at the same time, public debt will be inflated by 10 p.p. In addition, the public debt management strategy will be led down dangerous paths since, on the one hand, Cyprus will run the risk of failing to issue bonds with all that this implies for the financing of its needs, for its credit ratings by the rating agencies and for the future pricing of its bonds at higher levels and, on the other hand, the international government bond market of the Republic of Cyprus will be deconstructed in the absence of any new European bond issuance.

It is worth noting that the above is of more theoretical importance since, as already mentioned, issuing such a large amount of bonds in the domestic market and focusing them exclusively on domestic investors is practically impossible. First of all, it should be stressed that a bond issue is not allowed to exclude international investors. International investors can only be excluded by their own decision, which is the case when the bonds in question or the market in which they are issued is a disincentive for them. It is well known that the domestic secondary market - at present - does not function in an efficient manner. Consequently, the degree of liquidity of domestic bonds is significantly limited. This, however, has a similar impact on the investment decisions of domestic investors. For this reason, in the current period, the main source of funding for the Cyprus Government is the international European Medium Term Bond (EMTN) market in which both international and local investors invest. A relevant question is how will such a domestic bond be priced and how will its price compare to a European EMTN bond?

The article mentioned also refers to a commission to be paid to organisations that will undertake the promotion of the issuance of the bonds. It should be noted that the bonds of the Republic of Cyprus can be issued by 3 alternative methods depending on the market conditions and the degree of the State's financing needs: (a) by auction, (b) by syndication as in the case of the European EMTN bonds of the Republic of Cyprus, and (c) by private placement. The payment of a commission by the issuer to intermediaries is normally made in the case of syndicated issuance for which an extensive infrastructure must be in place. In the case of EMTN bonds, syndicated issuance is carried out by appointing international investment banks, a paying bank, international legal firms and credit rating agencies. Private placement is only carried out under specific circumstances and pressing needs. Therefore, the only option offered is the auction method for which the government does not pay a commission.

Today, the Republic of Cyprus enjoys comfortable financing conditions, with fiscal convergence, with liquid assets sufficient to cover the financing needs for this year and the whole of next year (2023-2024) and with steadily improving credit ratings, which allows it to focus on managing the cost of borrowing due to high interest rates, with the flexibility to choose the most appropriate timing of bond issuance without time pressure, and to rationally decide on the maturity and other features of the new bonds, always in line with the objectives of the medium-term public debt management strategy.

This strategy, which, combined with prudent fiscal policy, has enabled Cyprus to manage today the economic consequences of an unprecedented geopolitical crisis - which even followed the pandemic crisis - must be preserved and remain fully committed to its mission.

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