Cyprus: Risk Assessment
Country Risk Rating
|C||A very uncertain political and economic outlook and a business environment with many troublesome weaknesses can have a significant impact on corporate payment behavior. Corporate default probability is high.|
Business Climate Rating
|A3||The business environment is relatively good. Although not always available, corporate financial information is usually reliable. Debt collection and the institutional framework may have some shortcomings. Intercompany transactions may run into occasional difficulties in the otherwise secure environments rated A3.|
Confirmation of a slow recovery
The recovery is expected to broaden in 2016. Tourism, shipping and non-financial services, the island's three traditional export sectors, are benefiting from increased competitiveness prompted by the euro's depreciation and lower wages. Surpluses in these sectors to a great extent offset the trade deficit (17%) associated with the weak diversification of local manufacturing output (medicines, cheese and electronics). The drop in visits and spending by Russian tourists (26% of visitors in 2014) is balanced by the strong increase in those by British (39%) and other nationals. The numerous Russian businesses registered in Cyprus are still important clients for service companies. Local demand will grow very modestly and households are still increasing their spending only slightly, in the face of a collapse in house prices of over 30% since 2010 - prices are only just beginning to stabilize - high unemployment (16%, but 40% youth unemployment) and debt equivalent to 124% of GDP. Moreover, wages in the public sector are frozen until 2016 and those in the private sector have barely stopped declining. Meanwhile, public investment remains constrained by fiscal consolidation. Finally, businesses will be faced with debt levels equivalent to 134% of GDP. In this context, the construction of tourist and office facilities, the other key sector, will stage a timid recovery.
A banking sector in convalescence
Following the country's EU accession in 2004, the Cypriot banking sector expanded to seven times the size of the GDP. The downturn in the local property market at the end of 2008 and the collapse of the Greek economy at the start of 2010, in which it had made substantial investments, were fatal for the sector, triggering the insolvency of its main players. Unable to rescue the sector on their own, given the sharp deterioration of the public and external accounts, under pressure from the European Commission, the ECB and the IMF, who made a restoration of soundness a condition of their financial aid, the authorities restructured the sector largely at the expense of creditors and depositors. Despite the liquidation of one of the leading banks, the sector - currently extremely concentrated - still accounts for 315% of GDP, excluding foreign banks (160%). Dependence on non-resident deposits (40% of total, or 130% of GDP) and on liquidity from the central bank remains high. Non-performing loans represent over 50% of the portfolio and only a third are funded. Despite the adoption of modernized property foreclosure and insolvency legislation, the process is made difficult due to the difficulty of estimating the value of assets offered as collateral, the frequent lack of registry identification of apartments and the slow transfer by the administration of property from developers to buyers. In this tangled state of affairs, neither households nor developers have an incentive to repay their loans. Progress has, nonetheless, been made, such as the creation of a credit register and the transfer of supervision to the European authorities.
Fiscal consolidation needed for debt reduction
Spending cuts representing 7.5% of GDP over 2013 and 2014 succeeded in eliminating the deficit. However, in order to accelerate the reduction in public debt, excluding the bank loan guarantees (20% of GDP), an additional fiscal effort estimated at 4% of GDP needs to be made in 2016. This is likely to include higher taxes on investment income and on corporate profits. Although civil service reform (promotion, salary scale, mobility) is under way, reform of the management of state-owned enterprises and privatizations (Cyprus Telecom, Port of Limassol) are delayed. There is a risk that the political class will not persist with these reforms, which are likely to take a long time given the scale of the debt. The influence of the European institutions and the IMF could lessen after March 2016, once they have disbursed the full amount of their financial aid (€10 billion or 57% of GDP, of which 72% had been disbursed at the end of October 2015).
A minority government involved in talks about reunifying the island
While waiting for the next parliamentary elections in May 2016, Nicos Anastasiades, elected to the presidency in 2013 for 5 years, leads a minority conservative government with his party, the Democratic Rally (Disy). He needs to obtain a majority in parliament together with the centralist Democratic Party (Diko) over the Progressive Party of Working People (Akel), by including social measures (implementation of a national health system and a minimum wage) as part of the fiscal consolidation package. Nicos Anastasiades and Mustafa Akinci, the respective leaders of the island's Greek Cypriot and Turkish communities have met several times since May 2015 under the auspices of the Americans with a view to ending the division of the country. This will benefit the economy and, in particular, future offshore gas exploitation. The outcome will depend, among other things, on the attitude of Turkey, which has a military presence in the north of the island.