Cyprus recovery set to continue this year and next

By Axel  Reiserer

Cyprus recovery set to continue this year and next

Growth exceeded forecasts in 2016; challenges remain

The recovery of the economy in Cyprus is set to continue this year and next, says the European Bank for Reconstruction and Development (EBRD) in its latest set of economic forecasts.

The EBRD’s most recent Regional Economic Prospects report, issued during the Bank's Annual Meeting in Cyprus on 9-11 May, said the Cypriot economy had performed well again in 2016 after a return to growth in 2015. Expansion of 2.8 per cent last year was higher than originally forecast.

Tourism is one of the main drivers of the economy, with arrivals last year up by around 20 per cent and virtually all hotels at full occupancy. Other sectors such as construction and professional services are also contributing to the ongoing recovery. Levels of consumer confidence in Cyprus are currently higher than the EU average.

Overall growth is likely to continue in 2017 and 2018 at between 2 and 2.5 per cent, but significant headwinds remain, including the very high levels of indebtedness in the economy, and the large legacy of non-performing loans which still account for nearly half of all loans in the country.

Peter Sanfey, the EBRD’s Deputy Director for Country Economics and Policy, is optimistic about the long-term outlook for the Cypriot economy. “It’s a very open economy,” he says. “The people are well educated, public administration functions well and some sectors are quite robust – tourism, obviously, and accounting services too, as well as some of the other high-value service sectors, which have come through quite well.”

But he also points to the challenges.

“There is still a huge overhang of non-performing loans and non-performing exposures. This is a challenge,” says Mr Sanfey. He points to steps being taken to address the issue, including changes to the country’s insolvency laws. “But that’s a process that’s going to take some time, working through bad debt.”

The EBRD’s report notes that the long-term sovereign debt rating for Cyprus was raised by S&P in March 2017 from BB to BB+. The government is maintaining a prudent fiscal stance and delivered an overall budget surplus for 2016.

“The challenge now, in light of the still high levels of public debt (exceeding 100 per cent of GDP), will be to maintain strong fiscal discipline in the run-up to elections in 2018,” the report on Cyprus concludes.

Regional overview

The report also says economic growth is expected to pick up across the EBRD regions this year and next, supported by higher oil prices and Russia’s recovery from recession.

On the back of developments in Russia and on the commodity markets, growth in eastern Europe and the Caucasus is also forecast to accelerate and activity in Central Asia is likely to stabilise at slightly higher levels.

Turkey, however, is expected to see a slowdown in growth during 2017, partly reflecting security and geopolitical risks that have also led to a downward revision in EBRD forecasts for countries in the southern and eastern Mediterranean.

On average, economic growth in the 36 EBRD countries of operations is expected to rise to 2.4 per cent in 2017 and to 2.8 per cent in 2018, compared with expansion of 1.8 per cent last year.

The latest forecasts reveal a narrowing of an east-west growth gap that has characterised the economies of the EBRD regions in recent years following a stronger upturn of growth in the east.

Countries further east had previously suffered from weak commodity prices and the Russian downturn and countries to the west had benefited from the softer oil price and accommodative monetary policies in the eurozone.

In those western regions, growth in central Europe and the Baltic states is now expected to accelerate slightly in 2017 to around 3 per cent following an investment-driven dip in 2016. It is projected to remain at the same level in 2018.

In south-eastern Europe, average growth is also forecast to reach the 3 per cent mark. Greece is expected to return to growth as reforms advance further and business confidence gradually improves.

The report says the latest forecasts are subject to major risks related to geopolitical tensions in and around the region, set against a backdrop of increased political uncertainty. “The economic outlook for the region remains materially affected by terrorism, geopolitical tensions and the refugee crisis. Over the last six months Egypt, Jordan, Russia and Turkey saw several terrorist attacks while Syria remains in a humanitarian crisis,” the report notes.

The outlook for China is also cited as a risk as the country seeks to rebalance its economy and any reversal of the recent oil price recovery would be a major source of risk to Russia and to the countries which with it has close economic links.

The report also notes that capital flows to the EBRD regions were stronger than expected in the first months of 2017 despite the gradual tightening of monetary policy in the United States of America. This reflects the fact that the pace of monetary tightening is now slower than previously anticipated.

As a result, the post-US election depreciation of the regions’ currencies against the US dollar has been fully reversed in most countries, with the notable exception of Turkey where domestic factors have played an important role.

Levels of non-performing loans remain elevated across many of the EBRD regions despite some improvements in south-eastern Europe.