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All the recent hubbub over Cyprus, the controversial Eurogroup bailout, and wealthy tax-phobic Russian oligarchs seems to have overshadowed the economic troubles plaguing Cyprus' much larger Eurozone partner to the northwest: Greece (NYSEARCA:GREK). However, there is much Cyprus can learn from Greece, since Greece's fortunes provide a snapshot into what Cyprus could well become in the near future.

Cyprus's economy is expected to contract 9 percent this year by the IMF but could easily contract more due to the nationwide liquidity crunch, widespread bankruptcies, and the complete implosion of Cyprus' banking sector. Considering the troika's austerity prescription of significant increases in taxes and cuts to pensions and welfare benefits, Cyprus' economy could slip into a freefall. Moreover, the IMF's target goal of bringing Cyprus' budget to surplus by 2018 is extremely optimistic. The economic decline brought on by the initial austerity conditions could very well result in Cyprus missing deficit goals, leading the troika to demand tighter austerity measures to catch Cyprus up with fiscal targets. This aid-for-austerity approach would be exactly the same as the one Greece is going through, one which is failing spectacularly.

Greece's troubles are, for the most part, just as significant as Cyprus' as it struggles with a self-defeating austerity death spiral. In fact, the severe economic contraction in Greece was actually a major catalyst for the Cyprus crisis: Cyprus has significant economic ties with Greece and many Cypriot banks were heavily exposed to the Greek debt crisis, crumbling in lockstep with the Greek economy.

Things look anything but rosy for the Greek economy, one which has been depleted of spending and social safety nets due in part to austerity. Although its GDP is not expected to shrink 9 percent this year, as is Cyprus', Greece still faces significant challenges, namely a 26.8% unemployment rate, significant social unrest, and a misguided Troika-forced austerity program that continues to cut into the economy.

Recently, the Athens-based Foundation for Economic and Industrial Research warned that the economic situation in Greece may be worse than originally forecasted. That's pretty bad, considering that the forecast was horrible to begin with. Angelos Tsakanikas, the IOBE research director, estimates that the economic contraction in 2013 may be greater than the 4.6 percent level previously forecasted. In fact, Greece's economic situation has gotten so bleak that the only positive spin that Tsakanikas could put on it was that it "is a small difference when one considers the slide in the country's output since 2007, which stands at 23.3 percent." Moreover, unemployment is expected to increase this year from 26.8% to 30%.

So what about the fiscal side of Greece? Ironically, even after the implementation of austerity measures as directed by the troika, Greece's fiscal situation shows no signs of improvement. Greece recently reported that its fiscal deficit for 2012 amounted to 9.5 percent of GDP and is expected to soar to 15.2 percent of GDP this year according to official figures. These figures vastly exceed previous projections, which estimated Greece's 2012 fiscal deficit at 7 percent and its 2013 fiscal deficit at 5.5 percent.

Although this significant miss was brushed off as a one-time anomaly attributed to Greece's recapitalization of its banks, Greece has a broader pattern of constantly missing deficit-reduction goals even though its austerity march has not slowed down. In countries such as Greece, austerity has actually proven to be ineffective in significantly improving the country's fiscal situation because the economic contractions caused by these austerity measures are actually lessening the government's ability to collect revenue more than the rate the government is able to cut its spending. Recently, the Greek Finance Ministry announced that it expected monthly budget revenue data to show yet another shortfall, on top of reports of double-digit decreases in tax revenue reported earlier this year (even with significant tax hikes).

Yet austerity measures are projected to continue well into Greece's future. By the end of 2014, Greece's fiscal consolidation will be equivalent to 30 percent of its GDP, at least three times greater than the relative fiscal consolidation of Portugal, Spain, and Cyprus. There is no end in sight to Greece's economic decline and its harsh austerity measures. Thus, Greeks have grown increasingly disenchanted with the measures and have staged large, nationwide protests; the most recent one was a 24-hour general strike involving 40,000 Greeks that brought public transportation to a halt. It's gotten so bad that the government has twice had to invoke emergency laws to force strikes to end in 2013.

Hopefully, Cyprus will learn from the lessons of its larger northwest neighbor and not succumb to this Greek state of mind, which basically involves seemingly endless cycles of austerity and economic decline. One way would be for Cyprus to leave the Eurozone and adopt its own currency. The significant devaluation of its currency would also provide its export market with a much-needed boost. Whatever path it chooses, Cyprus must not cut until there is nothing left to cut.

Source: The Greek State Of Mind