Cyprus: Risk Assessment
Country Risk Rating
Business Climate Rating
- Central geographical location between Europe, Asia and Africa favours the transhipment industry
- Offshore finance hub
- Rich, unexploited offshore natural gas deposits
- Skilled, English-speaking workforce
- Relatively successful pandemic management
- Divided territory, increasingly tense geopolitical neighborhood
- Small domestic market, isolated from the rest of Europe
- Highly dependent on Russia and the UK as export markets and sources of financing (Brexit risk)
- Slow legal process, poor enforcement of contracts
- Heavy debt load for the state, banks, companies, and households
- Weak industrial diversification (tourism, construction, natural gas, finance)
A massive contraction, despite a relatively controlled outbreak
The management of the pandemic has been comparatively successful, as protracted lockdown measures were sufficient to put the spread of the virus under control. Therefore, private consumption (65% of GDP) suffered a relatively modest 4% contraction, most of which will be made up for by the 2021 rebound. Employment has been largely insulated from the economic shock thanks to the temporary work suspension scheme, in which up to 65% of eligible employees have participated at some point. Given this protection of employment and accumulation of savings, we can expect important positive pent-up demand effects in 2021. Private investment, set to contract by 11% in 2020, will take longer to recover as uncertainty in the tourism sector will take longer to dissipate and the corporate sector debt burden will increase. Furthermore, the end of the citizenship-by-investment scheme will create a durable negative demand shock for the construction sector, although partially offset in 2021 by continued public infrastructure investment. Two-thirds of the GDP contraction were accounted for by negative net exports, and more specifically the tourism sector (15% of GDP), whose revenues contracted by between 80 and 90% in 2020 The external sector’s recovery, however, will be more protracted, given that a full normalization of air travel is not expected until late 2021 at best. Brexit is another (more) structural factor weighing on the external recovery. The weaker pound will make traveling to Cyprus more expensive (the UK is the country’s main source of visitors, accounting for a third of the total). A return to vigorous growth will therefore depend on the successful development of a natural gas industry, which, despite its potential, faces important geopolitical and environmental challenges.
FDI and tax revenue will suffer from the loss of the citizenship-by-investment scheme
Tarnished by money-laundering accusations, the Citizenship Investment Program (CIP) scheme was abolished in October 2020. The program is estimated to have generated around EUR 10 million in revenue and investment since 2013, which means an average of 1.4% of GDP per year. This adds to the fiscal toll of responding to the pandemic, the total of which amounts to 4.5% of 2019 GDP. Overall, expenditures grew by 12% in 2020 and should start stabilizing in 2021, while revenues contracted by 5% and will rebound vigorously by 10%. Furthermore, the end of the CIP program will imply a smaller flow of reliable FDI (14% of GDP). With a modest exporting goods sector (recreational boats, refined oil, food products), the tourism-driven services surplus is not enough to avoid chronic deficits. Therefore, in the absence of investment-friendly reforms (gas exploitation has been slowed down by bureaucracy), a larger share of the current account deficit will be funded by less dependable capital flows. This is worrying given the country’s large negative international investment position (-40% of GDP) and external debt (230% of GDP). The level of Non-Performing Loans in bank portfolios remains high (22%) and should deteriorate further as the damage to the corporate sector materializes, Despite the record-level public debt, yields have dropped to historical lows. This is because, despite the degradation of fundamentals, European fiscal and monetary stimuli have reassured investors.
Tensions over maritime gas reserves escalate
The island of Cyprus is divided between the Greece-aligned Republic of Cyprus (RC), the Eurozone member state controlling the southern half of the island, and the Turkish Republic of Northern Cyprus (TNRC), which controls the north and is recognized only by Turkey. While a peaceful stalemate has been maintained since the 1970s, rising geopolitical tensions between Greece, Cyprus, and the EU on one side and Turkey on the other have further strained this relationship. The RC is governed by a coalition between the center-right Democratic Rally and the centrist Democratic Party, which should hold until the 2021 parliamentary elections. President Nicos Anastasiades faces the challenge of navigating the escalating confrontation with Turkey and the TRNC over maritime claims with potential gas deposits. The RC has auctioned exploration rights to European energy firms within its internationally recognized maritime borders, some in areas that Turkey and the TNRC claim as theirs. Since 2018, Turkey has repeatedly sent exploration vessels escorted by military ships into contested waters. This has been condemned as illegal by the EU, which has threatened economic sanctions, while France has deployed naval vessels in the region. Cyprus remains a key member of the EastMed Gas Forum, an alliance with Egypt, Greece, Israel, Italy, Jordan, and Palestine, aimed at fostering a regional gas industry. However, in the wake of the EU’s green agenda, critical doubts have emerged concerning the economic and environmental viability of the EastMed pipeline project, which is set to reduce Cypriot influence in the group.