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Cyprus International Instituteof Management

CIIM

The International Financial Crisis and its possible effects

on the Cypriot Economy

Charilaos StavrakisMinister of Finance

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International Financial Crisis The first phase

Crisis in the US housing market :April August 2007: sub-prime contagion

prices fallingdefault rates on sub-prime loans rise to recordlevels

The US banking system is exposed to too many defaulting mortgages

Effect on UK market: August 2007 sub primelenders begin to withdraw mortgages

September 2007: Northern Rock crisis

Oct. 2007: Major losses begin to emerge frommajor banks.

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International Financial Crisis Policy reaction

US government outlines plans to help more than amillion owners facing disclosure

Central Banks intervene, making more fundingavailable

US Fed takes an aggressive stance and cutsinterest rates in an attempt to prevent recessionand ease strain on financial market

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International Financial Crisis Second WaveMarch 08: Bear Stearns is acquired by JP MorganChase

July 08: US mortgage lender IndyMac collapses

Aug 08: UK house prices show their biggestdecline in 20 yrs (10,1%)

Sept 08:Mortgage Lenders Fannie Mae and Freddie Mac which account for about half of US mortgages

are rescued by US government.Collapse of Lehman Brothers BankMerill Lynch taken over by Bank of AmericaGovernment Bail out of AIG

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International Financial Crisis Main Features

Volatility of Exchange Rates

Strains on Capital markets: major financialinstitutions severely undercapitalised hard toraise capital

Securitization of paper amplified crisis

Effects on real economy

Credit default swaps at record level

Increased spreads on Debt Capital

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International Financial Crisis Is it over?

Recent US treasury bail out plan , supportingmarkets

Doubts on long term impact

US Dollar under attack ?

Crisis is by no means over second round effects?EU banks may come under strain?

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International Financial Crisis - Effects on realeconomy

Stagflation :

Increasing inflation :Oil pricesFood and other commodity prices

Slowing economic growth

= Worst possible economic scenario

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The Cyprus Economy Key Indicators

-11,0

4,8

49,0

1,0

3,9

2008(est.)

2007(real)

2009(est)

Growth rate (%) 4,4 3,7

Budget surplus (% GDP) 3,3 0,7

Public Debt (% GDP) 59,8 45,0

Inflation (harmonised index )(%) 2,2 2,5-3,0

Current Account Balance (%GDP) -9,7 -10,0

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The Cyprus Economy Good performance

continuesSatisfactory growth rate

Full employment conditions

Improvement of living standards

Increase of social spending

Healthy public finances

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The Cypriot Economy - Challenges

Increased inflation, mainly due to exogenousfactorsPressure on competitiveness and worsening ofbalance of paymentsHigh Indebtedness businesses and households

Consumption still at high levels but on a decliningtrendReal estate market show first signs of slowdown,but activity still at high levelsOver-dependency on Russian market, effectsfrom political crisis in Russia.

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The Cyprus Economy Direct Effects from

International CrisisDirect Effects to the Financial system so far

limited:

Cypriot banks engaged in more traditionalproducts lending and savings, thus no shock

effectsRepercussions due to falling asset pricesinternationally and domesticallyUncertainty might create problems in raisingcapital

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The Cyprus Economy Direct Effects from

International CrisisDirect Effects to Financial system so far limited:

So far, exposure of Banks to Lehman Bros and USbonds minimal:

Cypriot Banks (around 15 mil)subsidiaries of EU banks small ( 35 mil)

branches of third country banks is less than 1 mil

Cooperatives : No Exposure to Lehman Bros

Insurance:Insurance companies have low exposure to equityProblems of AIG subsidiaries in Cyprus limited.

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The Cyprus Economy Direct Effects from

International CrisisDirect Effects to Financial system :

Securities market / Investment firms:2 Investment firms have little exposure theirviability is by no means at stakeThe Securities and Exchange Commission isexamining the potential effects from other by productsDifficulty in identifying sales of products in theCypriot market from abroad

Stock exchange : index fell by 15% in Sept ( 40%fall since beginning of the year)

Provident Funds : limited exposure

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The Cyprus Economy Direct Effects from

International Crisis

Solid Supervisory Framework : The RegulatoryAuthorities are vigilant, monitoring the situation,

and coordinating amongst them.

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The Cyprus Economy Indirect Effects fromInternational Crisis

Indirect effects :

EU economies, (especially the UK) will experiencesubstantial slow down in economic growth:

Potential fall in tourism

Potential decrease in investmentsSome decrease in real estate and constructionsector

The Russian effect:Impact on real economy in Russia ?Impact on Cyprus ?

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Indirect effects :

Higher cost of credit :Decrease of loans, slowdown in consumption?Some strain on Bank profits?

= Some slow down in economic activity in Cyprusmight be inevitable, but no dramatic effects

The Cyprus Economy Indirect Effects fromInternational Crisis