Population 0.876 million
GDP 22.446 US$ billion
@rating
country
Business climate
assessment
| 2010 | 2011 | 2012(e) | 2013(f) | |
|---|---|---|---|---|
|
GDP growth (%)
|
1.1 |
0.5 |
-2.4 |
-4.5 |
|
Inflation (yearly average) (%)
|
2.6 |
3.5 |
3.1 |
2.2 |
|
Budget balance (% GDP)
|
-5.3 |
-6.3 |
-4.8 |
-5.6 |
|
Current account balance (% GDP)
|
-9.9 |
-10.4 |
-9.2 |
-8.3 |
|
Public debt (% GDP)
|
61.5 |
71.6 |
87.3 |
92.6 |
| (e) Estimate (f) Forecast | ||||
STRENGTHS
- Attractive business environment
- Bilateral relations with Russia
- Significant tourism potential
WEAKNESSES
- Very high public and private debt
- Disproportionate banking sector and heavily exposed to Greek crisis
- Uncertain outlook for reunification of the island
Risk assessment
Domestic demand limited by private sector debt deleveraging
Household consumption usually drives growth, but it will remain in the doldrums in 2013. With construction remaining sluggish long term, following the bursting of the property bubble, unemployment exceeded the eurozone average in 2012, climbing to over 12% of the economically active population. The number of job seekers has tripled since 2009 and the number of long-term job seekers doubled in 2012. Civil service salary cuts (of between 6.5% to 15.5%) and still high household debt will adversely affect growth. Likewise, private investment will continue to be hampered by corporate deleveraging and the sharp drop in credit supply resulting from the extreme weakness of the banking sector. Fiscal efforts, subject to aid from the Troika (ECB, IMF and European Commission) will limit public investment, although foreign direct investments from Russia are likely to rebound in 2013. Ratification of the Protocol to the Russia-Cyprus Double Tax Treaty allows the abolition of the tax collection on dividends received by Russian companies from their Cypriot subsidiaries. Meanwhile, the country’s growing attractiveness for CIS nationals is likely to boost tourism and accordingly offset some of the fall in exports to Greece.
Public finances exposed to banking sector recapitalisation requirements
The banking sector remains highly exposed to the Greek risk because of its size (750% of GDP). Besides, the credit to GDP is at 280%. Over half of bank assets are concentrated in the Bank of Cyprus and Laiki Bank, while a hundred of cooperative societies share the remainder of the market. The main banks are no longer in compliance with prudential capitalisation ratios following the Greek debt discount. So in July 2012, Laiki Bank had to be nationalised with the €1.8bn recapitalisation mostly subscribed by the State, while a rapid increase in non-performing loans means there is significant need for recapitalisation combined with a concentration of the co-operatives.
After raising VAT from 15 to 17% in March 2012, the government will continue its fiscal adjustment efforts through spending cuts. However, the government will not achieve compliance with the 3% budget-deficit limit, established as one of the Maastricht criteria, given the drop in fiscal revenue resulting from the slowdown in activity. Meanwhile, the government is unlikely to increase corporation tax (10%, making it the lowest in the EU) as this could undermine the country’s position as a regional platform for services to businesses. Against this backdrop, public debt is likely to carry on rising. The island has not been able to access the financial markets since May 2011 so to cover its financing needs it obtained a €2.5bn loan from Russia in October 2011. Despite this, Cyprus presents a major default risk. According to the government, it needs about €17bn, of which €10bn are for the banking sector. Subject to agreement with the Troika and acceptance of fiscal austerity terms, the first tranche of aid could be disbursed in the first quarter of 2013. Finally, the current account deficit is likely to shrink, given the fall in imports due to the downturn in domestic demand. However, the current account balance will remain broadly in deficit, affected by electricity and fuel imports. This deficit is financed mainly by short-term capital, most of it from Russia and the Gulf countries, which should however prove stable.
Long, drawn-out reunification negotiations
The delay in the reunification talks, with international financial support and President Christofias’ call for new support from Russia, is explained in part by the forthcoming presidential elections in February 2013. As for the reunification talks, despite the efforts made to date, there is still a long way to go on settling differences. Turkey, in particular, is still vetoing OECD membership for Cyprus and prohibiting access to Turkish ports and airports by all vessels transiting the island. With the first sounding announced for mid-2013, potential offshore natural gas reserves are aggravating the conflict, and Turkey has already signalled its opposition to any drilling.
