How do we max­imise the Cyprus peace

The key eco­nomic chal­lenges need to be front­loaded if we are to reach a set­tle­ment

Financial Mirror (Cyprus) - - FRONT PAGE -

One of the rea­sons for our rec­om­men­da­tions is that cir­cum­stances have changed rad­i­cally in the past ten years.

The econ­omy of the Greek Cypriot com­mu­nity (GCC econ­omy) is con­sid­er­ably weaker than it was ten years ago, while the econ­omy of the Turk­ish Cypriot com­mu­nity (TCC econ­omy) also has sig­nif­i­cant struc­tural prob­lems.

EU in­sti­tu­tions have much more ex­ten­sive pow­ers over eu­ro­zone mem­ber state bud­gets than in the past, while larger banks will soon come un­der the di­rect su­per­vi­sion of the Euro­pean Cen­tral Bank.

The GCC econ­omy’s bor­row­ing from the Euro­pean Sup­port Mech­a­nism (ESM) and IMF could com­pli­cate some pre­vi­ous un­der­stand­ings reached to date, such as on debt­ser­vice obli­ga­tions.

In a weaker property en­vi­ron­ment, the property and ter­ri­tory set­tle­ment will also bring new chal­lenges.

Last week, Alexan­der Apos­tolides, Mustafa Besim and I pre­sented our co-au­thored “The Cyprus Peace Div­i­dend Re­vis­ited”, pub­lished by the Peace Re­search In­sti­tute Oslo (PRIO). Copies of the re­port can be down­loaded from the events sec­tion of the PRIO Cyprus Cen­tre web­site http://cyprus.prio.org .

We found that a so­lu­tion to the long­stand­ing Cyprus prob­lem could raise per capita in­comes by ap­prox­i­mately EUR 12,000, ex­pand the size of the econ­omy by around EUR 20 bln and add on aver­age 2.8 per­cent­age points to real GDP growth ev­ery year for 20 years.

How­ever, as we note in the re­port, it would be naïve to sug­gest that such growth rates are guar­an­teed. Im­por­tant prepara­tory work needs to be done to en­sure that these growth rates are pos­si­ble.

The fol­low­ing are edited high­lights from sec­tion 9 of our re­port, en­ti­tled “Max­imis­ing the growth po­ten­tial: key chal­lenges.” Here, we iden­tify key ar­eas of tech­ni­cal as­sis­tance needed. The econ­omy is there­fore the new ele­phant in the room. In the past, eco­nomic is­sues were treated as if they could be dealt with af­ter all the po­lit­i­cal de­tails had been ironed out. To­day, I be­lieve that the re­verse is true.

If the ne­go­tia­tors have econ­omy wor­ries in the back of their minds while ne­go­ti­at­ing gov­er­nance, property, ter­ri­tory or tran­si­tional is­sues, I fear they will never be able to reach an agree­ment.

But they need tech­ni­cal as­sis­tance to do so. In our re­port,

we iden­tify the key re­quire­ments as fol­lows:

1. Tech­ni­cal com­pe­tences

as­sis­tance

on match­ing

re­source

to

Fed­er­a­tions typ­i­cally in­volve com­plex dis­tri­bu­tion mech­a­nisms from one level of govern­ment to the other. Nat­u­rally, since the is­sue in­volves tax­pay­ers’ money, these mech­a­nisms are also the sub­ject of in­tense de­bate in all fed­er­a­tions. They are likely to be more so in Cyprus.

Whether the dis­tri­bu­tion is from federal to state (con­stituent state) govern­ment or the other way round will de­pend a great deal on how tax-rais­ing pow­ers are dis­trib­uted.

If it is de­cided, for ex­am­ple, that big budget ser­vices such as ed­u­ca­tion, health­care and so­cial se­cu­rity are com­pe­tences of the con­stituent states, then the con­stituent states will need enough re­sources to be able to pro­vide those ser­vices at least to the same level of qual­ity that they have pro­vided to date.

This will ei­ther mean suf­fi­cient tax-rais­ing pow­ers at con­stituent state level or a dis­tri­bu­tion mech­a­nism from the federal govern­ment rev­enues to the con­stituent states.

At the same time, con­trol­ling ex­pen­di­ture of big budget items such as health­care is one of the great­est chal­lenges fac­ing de­vel­oped economies to­day. Wher­ever the com­pe­tence of health­care is placed, and what­ever the mech­a­nism for fund­ing it, sig­nif­i­cant con­trols need to be in place to en­sure that spend­ing does not spi­ral out of con­trol.

Rather than leave these ques­tions to those who have no ex­pe­ri­ence of fed­er­a­tions, and thus risk the eco­nomic vi­a­bil­ity of a set­tle­ment, we rec­om­mend that ex­pert tech­ni­cal as­sis­tance be sought on these is­sues well in ad­vance. Both the IMF and the World Bank have con­sid­er­able ex­per­tise in this area (see, for ex­am­ple the list of au­thors in the Hand­book of Fis­cal Fed­er­al­ism by Ah­mad et al).

2. Min­imis­ing debt ter­ri­tory set­tle­ment

fi­nance

for

the

property

and

On the as­sump­tion that the property and ter­ri­tory set­tle­ment will in­volve a cer­tain amount of com­pen­sa­tion, ex­change and re­in­state­ment that will lead to the dis­place­ment of those cur­rently us­ing the property, work needs to be done on: - iden­ti­fy­ing non-debt forms of fi­nanc­ing; - en­sur­ing that dis­placed com­mu­ni­ties are moved in ways that al­low them to sus­tain a liveli­hood; - en­sur­ing that the property mar­ket is not ham­pered

for decades by un­re­solved claims.

As re­gards fi­nanc­ing, given the high in­debt­ed­ness of most de­vel­oped coun­tries these days, and grow­ing un­will­ing­ness among EU vot­ers to fi­nance other coun­tries’ debt, as wit­nessed in the “bail-in” of March 2013 in the GCC econ­omy, it would be too easy to as­sume that re­set­tle­ment and property com­pen­sa­tion costs will be fi­nanced by for­eign donors, es­pe­cially given the sums in­volved.

It would be wiser to seek so­lu­tions that pro­vide in­cen­tives for pri­vate (do­mes­tic and for­eign) in­vest­ment to take an ac­tive role in tak­ing on such projects. In such a way one can avoid bur­den­ing the state with fur­ther debt in the be­gin­ning of the post-so­lu­tion pe­riod.

Pri­vate sec­tor so­lu­tions for tack­ling these is­sues have al­ready been sug­gested. These in­clude as­sess­ing op­tions for max­imis­ing the cur­rently de­pressed val­ues of Greek Cypriot property in the north and the Turk­ish Cypriot property in the south.

For ex­am­ple, Greek Cypriot prop­er­ties cur­rently at­tract a lower price than orig­i­nal Turk­ish Cypriot property with the same fea­tures. This is be­cause the mar­ket recog­nises that there is an en­cum­brance on the ti­tle, or in layper­son’s terms, there is a risk of law­suits from the Greek Cypriot dis­pos­sessed owner.

In the south, the value of Turk­ish Cypriot property is de­pressed be­cause of lack of liq­uid­ity (it is barely traded at all), and some Turk­ish Cypriot land lacks ba­sic in­fra­struc­ture such as wa­ter and elec­tric­ity. Care­fully planned de­vel­op­ment of this property could have con­sid­er­able upside po­ten­tial for an in­crease in price.

How best to lever­age the value of prop­er­ties in ways that might raise funds for com­pen­sa­tion needs to be fleshed out in more de­tail with ex­perts in as­set-backed fi­nanc­ing and real es­tate de­vel­op­ment who have ex­pe­ri­ence of these kinds of large-scale projects.

One sug­ges­tion for com­pen­sa­tion is that, in cases where the “cur­rent user” gets to keep the property, he/she will be taxed over time on the in­crease in value that he/she en­joys as a re­sult of ob­tain­ing an un­en­cum­bered ti­tle. This debt would be legally bind­ing, would come with a state guar­an­tee (per­haps from Turkey) and could act as a lien on the property.

As for the property in the south, as­sum­ing that there is not a mass de­sire by Turk­ish Cypri­ots to move back to the south, a not-for-profit real es­tate in­vest­ment trust, with strict guide­lines about phased, en­vi­ron­men­tally re­spon­si­ble de­vel­op­ment could de­velop these prop­er­ties over time, which in turn could sup­port the over­all property set­tle­ment and help fi­nance com­pen­sa­tion.

In or­der to pre­vent an in­fla­tion­ary gush of liq­uid­ity into the econ­omy that might come about if com­pen­sa­tion were paid in lump-sums, there are also ways in which one might cre­ate in­cen­tives for those own­ers who are com­pen­sated to opt for money over time, or com­pen­sa­tion in kind (such as ed­u­ca­tion vouch­ers), rather than im­me­di­ate cash.

Fi­nally, there are prece­dents from class ac­tion suits from abroad to give guid­ance on how to re­solve the claims as quickly as pos­si­ble. If a con­sid­er­able por­tion of the property mar­ket is locked in le­gal dis­putes, this can only dam­age property val­ues in the short term and the econ­omy as a whole in the long term.

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