Cyprus: Risk Assessment
Country Risk Rating
Business Climate Rating
- At the crossroads of Europe, Africa and Asia
- Eurozone membership
- Tertiary sector: tourism, business and international finance hub, maritime transport and transhipment
- Skilled, English-speaking workforce
- Good quality transport and telecommunications infrastructure
- Offshore gas potential
- Island divided (since 1974) and tense relations with Turkey
- Small domestic market, isolated, remote and outside the center of Europe
- Poor economic diversification (tourism, property, finance) and limited foreign customer base, with the United Kingdom and Russia providing 36% and 24% of visitors (2016)
- Regional geopolitical instability
- High levels of debt of all economic actors and dependent on external finance
- Huge banking sector, hyper-concentrated and burdened by non-performing loans
- Slow legal process
Growth Driven by Internal Demand and Tourism
Private consumption (69% of GDP) will contribute strongly to growth, encouraged by lower unemployment, more jobs and higher wages, low inflation as well as the recovery in house prices (after a 30% slump since 2010). It will also be sustained by spending by three million tourist visitors to the Island, namely three times the local population. The construction of tourism facilities (marina, golf courses, ports and luxury residences) and offices will remain buoyant, thanks to external finance encouraged by the Citizenship-by-Investment scheme. National investment will remain hesitant because of household and corporate debt levels equivalent to 123% and 150% of GDP respectively (excluding Special Purpose Vehicles engaged in offshore activity) which does not encourage the banks to get credit flowing again. Against this, public investment will return thanks to the relaxation of budgetary constraints. Meanwhile, despite good performances by tourism, maritime transport, financial services and other sectors, trade’s contribution to growth will remain negative due to robust imports associated with internal demand.
A Convalescent Banking Sector
Following Cyprus’s EU accession in 2004, the Cypriot banking sector swelled to six times GDP. The contraction in the local property market in late 2008 and the collapse of the Greek economy in early 2010, in which was heavily invested, were fatal resulting in the insolvency of its main players. Incapable of rescuing the sector alone, given the severe degradation of the public and external accounts and under pressure from the European Commission, the ECB and the IMF whose financial assistance was on condition that the sector is restructured, the authorities carried out a restructuring mainly paid for by creditors and depositors whom the authorities are planning to indemnify. Despite the bankruptcy of one of the largest banks, the sector, currently highly concentrated with three major institutions, is still very large (3.5 times GDP in June 2017, excluding offshore banks). With the gradual implementation of insolvency and foreclosure legislation approved in 2015, the scale of non-performing loans ratio is declining but still represents 46% of bank portfolios (60% in large institutions) and 135% of GDP (June 2017). Dealing with these is made arduous by poor registering, immunity for the main residence and the difficulty in valuing assets. Given this mess, neither households nor developers have an incentive to repay their loans, while banks are reluctant to commit to long procedures in respect of households and SMEs who are liable for 4/5 of these loans, preferring to wait until property prices rise. However, the increase in deposits recorded since 2016, the growth in new credit and the ending of recourse to central bank liquidity assistance are positive signs.
High Levels of Public and External Debt
The public accounts surplus could increase with royalties on gas exploration. The primary surplus (i.e. excluding interest) and growth will ease the heavy burden, with 50% due to public-sector creditors (EU, Russia, etc.) mainly in euro and with medium to long-term maturities. The improvement derives to a great extent from good economic conditions, which is confirmed by the narrow equilibrium in the structural balance. However, the reduced influence of European institutions and the IMF since the end of the assistance program in 2016 could lead to a relaxation of efforts in what is a long-haul struggle. So, while administrative reform (promotion, wage structure, mobility) is progressing, that of the management of public-sector entities and local authorities, as well as privatizations (telecommunications, electricity) is falling behind.
Poor manufacturing diversification (cheese, medications and electronics) explains the trade deficit (20% of GDP). Despite the services surplus (22%), the current account balance is negative because of outgoing dividends and interest payments. The current account is financed by FDIs in property and tourism and through bond issues. Meanwhile, significant sums come in from abroad (especially from Russia), but in the main only transit the country. Gross external debt represents seven times GDP. 89% is held by the private sector, of which 60% corresponds to commitments from the special purpose vehicles intended to finance ship-owners or businesses without any real local activity. Nonetheless, the share owed by local borrowers still accounts for more than three times the GDP.
A Minority Government
The May 2016 parliamentary elections confirmed the President’s conservative Democratic Rally Party (Disy) as the largest party in parliament with 18 seats out of 56. With sixteen MPs from the Progressive Party of Working People (Akel, left-wing) on the opposition benches, President Anastasiades and his government need to find circumstantial majorities with the nine centrist members of the Democratic Party (Diko) and members of the five small parties by combining fiscal restructuring measures, with social measures such as the introduction of a national health system in 2019. Despite the failure of negotiations between the governments of the Island’s Greek and Turkish communities aimed at ending the division of the country, the economic recovery should be enough to ensure the President’s re-election in February 2018.