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Banks Admit Cyprus Property Bubble

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New action needed on building boom

By Stelios Orphanides

AUTHORITIES need to take prudent new measures to tame a construction boom that threatens the soundness of the country's banking system just as it is about to adopt the euro, economists warned yesterday.

Despite a newly reduced ceiling on lending for holiday home buyers, bank credit grew in August by an annual 25 per cent, as investors sought to beat the introduction of value-added tax to land sales from the end of this year.

The availability of cheap loans that has been stoking the construction boom could even increase when Cyprus joins the euro zone in January since the bloc's interest rates are currently half a percentage point lower than those of Cyprus.

"There is currently a bubble [in the real estate market], comparable to what we had at the stock exchange between 1999 and 2000," said Yiannis Telonis from Hellenic Bank.

However, Telonis cautioned that construction was the economy's locomotive at present, and there would be negative consequences if it were slowed down too abruptly.

"It is not up to the Central Bank to fix this problem. It is an issue of the [government's] general economic, development and social policy," he said.

Economist Marios Mavrides said imposing a property tax could go some way to addressing the problem, as could halving the island's capital gains tax to 10 per cent to make alternative investments more attractive.

"[but] if they take too drastic action, property prices will suffer and so will mortgages," he added.

Central Bank governor Athanasios Orphanides warned on Monday of probable risks for the banking system, should credit expansion persist as a result of local banks competing intensely to boost profits and market share.

According to price tracker BuySell Home Price Index, house prices increased 9.7 per cent in July year-on-year and 1.8 per cent compared to June.

The average lending rate for housing loans has fallen since Cyprus' EU accession in May 2004 from 7.3 per cent to 5.94 per cent in July this year.

Economist Mavrides said he could not rule out a scenario similar to that of the US subprime loans mess, and a repetition of 2002 and 2003, when Cypriot bank results were battered by exposure to a poorly-performing stock market.

Mavrides said a speculative bubble behind property inflation was mainly rooted in VAT introduction. It was introduced on buildings in 2004, and is will apply to land sales from 2008.

Once the VAT target date was passed, Mavrides said demand for real estate was likely to decrease as investors took more account of price-to-income ratios in assessing the value of real estate deals.

Mavrides said there was a danger that in two or three years, clients would experience difficulties in paying back their debts.

"The expected decrease in interest rates as a result of euro adoption will not be able to offset the decrease in demand," he said.

Mavrides' views on the effect of lending on the banks' profitability are not shared by bankers.

"We are not concerned that the quality of our asset portfolio will be affected as we have not relaxed the criteria for the approval of new loans we introduced years ago," Yiannis Kypri from Bank of Cyprus, said. The Bank of Cyprus policy followed Central Bank guidelines and offered the bank a protective "cushion" to offset risks of a probable decline in property price, Kypri added.

In 2006, the direct contribution of the construction sector to the island's GDP was 7.5 per cent. One in 10 Cypriots worked in the construction industry in 2004.

Copyright © Cyprus Mail 2007

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