Economic Crisis In Cyprus - Dissertation Example

Economic Crisis In Cyprus Chapter 1: Introduction One provisional aim: Competition and increased public and private debt contributed to the Cypriot financial crisis. (a) Background area of study: The European economic crisis is an ongoing economic crisis that has made it hard or impossible for some nations in the euro region to re-finance or repay their government debt devoid of the help from third parties. Clerides and Stephanou (2009) noted that Cyprus was considered as a tax haven, thus becoming an epicenter for corruption and money laundering. This made the banking sector to be larger than the nation’s economy. Therefore, when there was an increase in public and private debt, the country went into recession with the economy shrinking by 1.67 % in 2009 (Blundell-Wignall, 2013). This marked the beginning of the Cypriot economic crisis. (b) Focal area of study: The study is going to discuss how competition and increased public and private debt contributed to the Cypriot financial crisis. (c) Researchable Context: The study is going to examine how competition and increased public and private debt contributed to the Cypriot financial crisis. It would also examine the rescue model that was used in Cyprus in the economic crisis, bail-in of the Cypriot banks imposed by Euro group, and what it could have be done by the government and banks to avoid this situation. It would also provide recommendations to avert the financial crisis. Rationale for the study: Over the last decade, the Greek government has borrowed greatly from international markets in order to pay for its trade deficits and budget. Investors became nervous that the public debt was soaring high, which drove up Greece’s borrowing costs. With the banking systems in Cyprus were experiencing intense pressure; they amassed €22 billion of Greek private sector debt. This increase in public and private debt reduced economic growth plunging the country into a crisis (Faustman and Kaymak, 2013). This market concerns is what initiated the study to examine how public and private debt contributed to the Cypriot Eurozone crisis. Chapter 2: Literature Review Background literature Although Cyprus had been experiencing rising living standards before the commencement of the economic crisis in 2012, serious problems surfaced in the Cypriot banking sector as early as 2011. Cyprus borrowing costs slowly increased due to its exposure to the Greek debt (Theophanous, 2013). Furthermore, the public debt that was owed by the foreigners increased thus making the economy unsustainable thus creating the crisis. High public debt is very detrimental to economic growth. The easy credit conditions during the 2002–2008 period encouraged high-risk lending and borrowing practices. This later resulted to increased bad debts from the private and public sector. Although high private debt is more detrimental to growth than high public debt (Puri, 2013), excessive sovereign debt reduces growth only when the corporate and household sectors are heavily indebted too. The damaging effect of high private debt becomes evident in the busts that follow credit-driven booms. Those households that have borrowed too much in connection to their income reduce their spending. The overleveraged firms shun investing and concentrate on shrinking their balance-sheets. As bad debts wear down their capital, banks become more hesitant to give somebody a loan. These unfavourable trends reinforce each other, increasing the overall drag on economic growth. The other sub-topics include: what triggered the immediate crisis, how the financial crisis would have global implications, and justification of the rescue plan for Cyprus. Focal Literature My investigation mechanism would be based on a theoretical framework. The paper outlines the results of the factors that contributed to the Cypriot economic crisis; sliding competitiveness and increased private and public debt. The paper then goes ahead to propose an analytical framework of how the crisis could be avoided drawing on the economic theories; prospect theory and the revenue based finance theory. Applying the revenue based finance theory; one will be able to ascertain how competition and increased public and private debt contributed to the Cypriot economic crisis. It outlines that a fixed-rate national debt can actually be replaced by a revenue-based financial instrument. Basing on the theory, most investors are always willing to agree to lower returns in the short-term in exchange for the prospect of a higher payout later (Faustman and Kaymak, 2013). Moreover, the study will use the prospect theory. It takes into consideration the alternatives that come with uncertain outcomes. This model is actually descriptive by nature and tries to represent real-life choices other than not optimal decisions. The prospect theory would outline the decisions that were arrived at during the crisis. Context The study would be based on banking sector which was the focal point of the factors that led to the economic crisis; competition and increased public and private debt. Laiki Bank and Bank of Cyprus, the two largest banks of a country held 37.9% of all Cypriot deposits (Zenios, 2013). So when thay experienced an increase in debt levels both private and public, they could not sustain the economy plunging the country into an economic crisis. All the bank deposits were to be levied in Cyprus in order to recapitalize the Bank of Cyprus and Laiki Bank. According to Blundell-Wignall (2013), sliding competitiveness was a significant factor that led to the Cypriot financial crisis. The banking sector was too big with regard to the total economy, and with the two big banks attracting foreign deposits, this created sliding competition posing a risk to the economy if the banks collapsed. The bailout was from European Central Bank, IMF and European Commission; organisations which saved the Cyprus’ banking system from collapse by giving them a €10 billion loan. Faustmann and Kaymak (2013) noted that of the €10billion bailout, €4.1billion was to be spent on debt liabilities. 3 Provisional Research Questions What effect did sliding competitiveness have on the Cypriot financial crisis? What effect did increased public and private debt have on the Cypriot financial crisis? What economic rescue model was used in Cyprus? Chapter 3: Methodology Design approach, stance & why The research uses qualitative research methodology with a descriptive design (Nenty, 2009). The methods used to gather qualitative data included open-ended questions, observation, reviewing documents, personal interviews, the use of surveys, filling of questionnaires, and focus groups. These were the main primary data collection tools. The secondary data would be collected by reviewing the Cyprian financial reports from the government and other financial institutions. Focus groups were used because they are designed to elicit-depth insights and comprehension of the participant’s motivations and perceptions. The open-ended questions collected information on how a reducing public debt and competition made Cyprus to succumb to the effects of the Eurozone crisis. The administration of questionnaires would take at least 30 minutes to fill and it targeted persons who directly affected by the crisis and the ability to critically analyze the situation. Data collection/analysis methods The analysis draws out patterns from insights and concepts since sampling is theoretical. A descriptive analysis on how competition led to the Cypriot economic crisis, as well as how public and private debt contributed to the Cypriot economic crisis will be done. The descriptive component reported what was found, using diagrams, maps,charts, tables, graphs or other illustrations where appropriate. The research project will use logical analysis since it provides an outline of generalized causation and logical reasoning process. This analysis uses flow charts and diagrams to pictorially represent these, in addition to written descriptions. For instance, data on labour market and competition levels between Cyprus and other EU nations. Therefore, this analysis component will interpret the findings and consider the implications for the research question addressed. Bibliography Besim, M., and Mullen, F. 2009. Cyprus in the Global Financial Crisis: How Lack of Banking Sophistication Proved an Advantage. South European Society and Politics , 14 (1), 87-101. Blundell-Wignall, A. 2013. The banking crisis: Lessons from Cyprus. Organisation for Economic Cooperation and Development (295), 32-60. Clerides, Sofronis. 2012. "Competition, Productivity and Competitiveness: Theory, Evidence, and an Agenda for Cyprus." Cyprus Economic Policy Review, 6 (2): 8 Clerides, M., and Stephanou, C. 2009. Financial crisis and the banking system in Cyprus. Journal of Economic Perspectives: Cyprus Economic Policy Review , 3 (1), 27-50. Faustman, H., and Kaymak, E. 2013. Cyprus. European Journal of Political Research Political Data Yearbook , 52 (1), 42-49. Genay, H., and Mei, M. 2013. The Cyprus crisis through the lens of bank investors. Chicago Federal Letter (315), 1-. Grönvold, H., and Arnbjörnsson, G. 2009. The financial crisis in Iceland. Transfer , 15 (1), 153-158. Lane, P. R.,and Milesi-Ferretti, G. M. 2010. The cross-country incidence of the global crisis. IMF Economic Review (1), 1-35. Nenty, H. Johnson. 2009. "Writing a Quantitative Research Thesis." International Journal of Educational Science 1: 19-32; Kennesaw State University. Pasarides, O. 2012. Cyprus: The Financial Crisis and the Way Forward. Journal of Finance and Management (1), 34-40. Puri, I. 2013. A financial hub's future: can Cyprus retain its banking sector? Harvard International Review , 35 (2), 9-11. Theophanous, A. (2013). The Way Out of the Cyprus Economic Crisis. Policy Paper , 1, 1-22. Zenios, S. 2013. The Cyprus Debt: Perfect Crisis and Way Forward. Cyprus Economic Reviews Policy , 7 (1), 3-45. Read More