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Cyprus Economic & Financial Review
- Real economic situation in Cyprus.
The budget deficit in Cyprus is expected to rise from 5.3% of GDP in 2010 to 7.6% of GDP in 2011 and 2012, reflecting investment in a new power plant, but to decline to 3.5% of GDP in 2016. The main focus of economic policy will be to rein in the public deficit, to resolve the country's energy problems and the challenges being faced by potential effects of a Greek sovereign debt restructuring.Pre-financial downturn, the economy in Cyprus enjoyed incredible prosperity, with a Compound Annual Growth Rate (CAGR) in GDP of 6.1% between 1995 and 2010, rising from 7,087 million euro to over 17,333 million euro. Momentum in growth was particularly enjoyed at the turn of the century, and again later when the country entered the EU and Eurozone. Real GDP growth has also consistently performed better than its fellow EU and Eurozone countries and was more resilient during the downturn. Recent global events have slowed all indicators considerable, as they have in the rest of the developed world. However, Cyprus is taking swift measure to reinforce conditions. These will be well supported by significant developments in natural resources, which are expected to first stabilise, and then boost the economy.
After growing by 1.1% in 2010, the Cypriot economy is expected grew by 0.5% in 2011. After a stronger first half year, when GDP rose by 1.5% y-o-y thanks to an exceptionally good tourist season, economic activity was badly affected by the accident in July 2011 that destroyed the Vassilikos power station which accounted for half of the island's total electricity generation capacity. Domestic demand also decreased considerably in 2011, as tightening bank lending conditions, along with a worsening labour market outlook and weakening confidence, weighed on private consumption, as did of course pay cutbacks to the public sector. Subdued foreign demand for housing and the restructuring of corporate balance sheets kept investment on a correction path for the fourth year in a row.
The external sector did make a positive contribution to growth. Revenues from tourism increased by 13%, driven by political instability in competing Middle Eastern and North African tourist destinations, and as European holidaymakers yet again chose to travel closer to home and stay within the region. This was supported by much better accessibility to the island via new low cost airline flights, as well as traditional full fledge and charter flights. Cyprus tourism figures were further boosted by an increased flow of arrivals from emerging markets such as Russia.
In addition, import growth decelerated, in line with the contraction in domestic demand. Nevertheless, with a current-account deficit above 10% of GDP, the external imbalance remained sizeable. GDP in Cyprus is projected to contract by 0.8% in 2012 due to a fall in domestic demand and weaker external environment, including persistent financial market uncertainty. Private consumption in Cyprus will continue to be restrained by pressure on disposable income, mainly among public sector employees who were forced to take pay cuts, as well as by the rise in unemployment levels. The financial sector's exposure to Greece and the banks' need of recapitalisation will most likely raise the cost of financing and limit private-sector access. Meanwhile, demand for housing is expected to remain slow. Better growth should not come until the second half of 2012, as consumer and business confidence improves in line with a better external environment.
While slowing global trade and worsening economic prospects in Cyprus' main trading partners are likely to weigh on exports of goods, this should be partly offset by healthy performance of business services and tourism. Driven by the recent consolidation efforts, the government deficit is set to narrow to 3.4% of GDP in 2012 and 2.5% GDP in 2013. On this basis, and in view of shrinking economic activity this year, the government debt-to-GDP ratio should remain on a rising trend and reach about 76% in 2012. This could increase should the Cypriot banking system have to resort to government support for recapitalisation. Beyond this, the economy should continue to pick up, and especially boom once vast reserves of natural gas begin flowing. Inflation (national measure) is expected to rise from 2.6% in 2010 to 3.5% in 2011, then to fall slightly. The current-account deficit is expected to grow to 10% of GDP in 2011 and to shrink to about 7.7% of GDP by 2016.
These forecasts are however expected to change dramatically in the later stage of the forecasted period and in the mid to long term. The ministry of finance has moved quickly for significant cuts in public-sector pay and other measures that should improve the public-sector finances in the long term. In the short term, liquidity problems have been solved by Russia confirming its support. Further ahead, the economy should receive a massive boost via enormous natural gas and possibly petroleum reserves in the island's south basin. These are currently being extracted in only one sea block together with US based company Noble Energy. Preliminary explorations in other neighbouring Cypriot sea blocks suggest there are even greater amounts. These are to be auctioned off.
Initial expectations are that GDP growth remains below pre-crisis levels of 4%, at around 2.5% a year until the end of the decade, and slightly higher in the third decade. These should be revised considerably upwards over the next year or two, as the above mentioned events transpire.
- Economic demand by sector. Fuelled by strong exports in professional services.
Domestic demand contracted in the second quarter of 2011, largely owing to an even steeper decline in fixed investment, which has been affected mainly by weak demand for new housing and trade. Private consumption growth slowed, probably as a result of weaker bank lending growth combined with still rising unemployment, while government consumption grew only slightly. There was a net positive contribution of exports of goods and services almost reaching the level of 2007 (pre-crisis), thanks to weaker demand also depressing import growth. Tourism benefited for the second consecutive year, as economic recovery in Europe enticed greater travel spending, especially following a couple years of suppressed demand, where most opted to stay closer to home. Instability throughout North Africa and the Levant, as well as some countries in the Middle East also spurred greater demand to Southern European destinations such as Cyprus, as many travellers, packages (tour operators) and individuals alike re-routing their trips. Other better performing sectors in 2011 were mainly Mining & quarrying, Textiles, clothing & leather, and Pharmaceuticals, chemicals & refined petroleum products. Meanwhile, although others sectors are still posting negative results, the decline is slowing down.The Cypriot economy has for decades been praised for its resilience and growth, driven by its strong export sector in financial and professional services, tourism, and then later emerging in education, pharmaceuticals, as well as in real estate and construction. Indeed, a healthy inflow of foreign investments from Europe, Russia, CIS and the Middle East, as well as a more conservative approach by government and the banking sector has helped maintain economic expansion. Emerging ties with BRIC countries, especially Russia, China and India will provide extremely beneficial, as will on-going relationships with the EU, US and Middle East.
No doubt, the sector that has weathered the crisis best, namely financial and professional business services, slowed from growth of 3.6% in the first quarter to 3.1% in the second. This export-oriented sector – and an important one at that, representing the bulk of exports and GDP contribution – could be somewhat affected in short term by the general slowdown in the euro zone. It is also however quite resilient, backed by investors in Russia, CIS countries and the Middle East. Other BRIC countries are also starting to turn their eye on Cyprus as a potential financial hub, especially the two Asian giants China and India, as well as many other Central Asian economies. Professional services suppliers and financial institutions in Cyprus are eagerly venturing to these emerging markets, with on-going road-shows, establishing either a branch or representational office there and hiring the necessary resources to properly target them, i.e. Mandarin and Hindi speaking qualified staff. Early signs look promising, with Cyprus quickly positioning itself as the most suitable gateway for investors in these countries looking towards the EU, Europe and Africa.
Cypriot banks are exposed to the risk of Greek debt restructuring. If a disorderly default were to occur, public support in the banking sector would be necessary. The good news is that Cypriot banks are generally in a more comfortable situation, with excellent loan/deposit ratios, well above EU requirements.