Cyprus: Risk Assessment
Country Risk Rating
Business Climate Rating
- At the crossroads of Europe, Africa and Asia; eurozone member
- Services sector: tourism, international business and financial hub, maritime transport and transhipment
- Skilled, English-speaking workforce
- High-quality transport and telecommunication infrastructure
- Offshore gas potential
- Island divided (since 1974); strained relations with Turkey
- Small domestic market, isolated, remote and outside the center of Europe
- Poor economic diversification (tourism, real estate, finance) and limited foreign customer base (United Kingdom and Russia)
- High levels of debt among all economic actors; dependent on external financing
- Massive and highly concentrated banking sector burdened by non-performing loans
- Slow legal process, poor enforcement of contracts
Growth remains strong but is slowing
Private consumption (69% of GDP) is contributing strongly to growth, driven by falling unemployment, more jobs, low inflation, higher wages, and the recovery in housing prices, which fell by 35% after 2010. Growth will likewise be supported by spending by the island’s three million foreign visitors (more than three times the size of the local population). The construction of tourist facilities (marinas, golf courses, ports, and luxury residences) and offices will remain on track, thanks to foreign investment encouraged by the Citizenship-by-Investment scheme. Despite sustained public investment in infrastructure, particularly for health and education, national investment will remain weak because – with household and corporate debt levels equivalent to 100% and 120% of GDP respectively (excluding offshore special purpose entities) – banks will be inclined to exercise caution. However, households, given their creditor position, will be able to draw on their savings. In addition, the export performances of tourism, shipping, and financial services could lose some of their luster amid increased competition from alternative destinations, a decline in the number of Russian and British visitors, and a downturn in international trade. Meanwhile, imports will remain strong, in line with domestic demand. As a result, trade should again make a negative contribution to growth.
A convalescent banking sector
Efforts to restructure the Bank of Cyprus and liquidate Laiki (the number-one and number-two banks respectively) in 2013 proved insufficient, and Cyprus Co-operative Bank (CCB), the replacement number-two, was liquidated in turn in 2018, with its good assets and deposits being transferred to Hellenic Bank, now the new number-two. This time, the rescue was done at the expense of the state, which owned 77% of CCB following its bailout in 2013. The sector, which has become even more concentrated, is still a huge presence, representing 350% of GDP at the end of 2017, excluding offshore banks. Non-performing loans (NPLs) continued to make up 30% of outstanding loans and 80% of GDP at the end of September 2018. A full 90% of these loans are to households and SMEs, and one third of them have already been restructured. The authorities are hoping that 2018 amendments to insolvency and foreclosure legislation, and the 2019 launch of the ESTIA programme, through which the state will provide financial assistance for household debt restructuring, will help to process bad loans faster. Dealing with NPLs is made harder by an inaccurate land register and difficulties in valuing assets. Neither households nor developers have any incentive to repay their loans, while banks are reluctant to engage in lengthy procedures, preferring to wait for house prices to rise.
High levels of public and private debt
Vigorous economic activity will keep budgetary revenues high (40% of GDP in 2018). Moreover, despite the gradual loosening of curbs on wages, the cost of launching ESTIA and the National Health Programme, fiscal policy will remain restrictive and the budget surplus will persist. The primary surplus, i.e. excluding interest (5.5% of GDP), combined with growth and the decline in interest rates after credit rating agencies re-rated Cyprus “investment grade”, should lead to a reduction in debt, of which 73% is due to non-residents (65% public). This debt, which is still very high, has temporarily increased following the CCB rescue.
Although competitiveness remains good, the current account deficit could widen slightly, in line with the decline in the services surplus (21% of GDP in 2017) related to tourism and financial services. Poor manufacturing diversification (cheese, medicines, and electronics) generates a goods deficit (24%), while outgoing dividend and interest payments, as well as transfers from foreign workers, show a negative balance (5%). FDI in real estate, tourism, and gas exploration make it possible to finance the current account deficit, while allowing the country (especially banks) to deleverage. Gross external debt still represents five times GDP, with 45% owed by non-financial companies, 16% by banks, and 15% by the state, while 24% corresponds to intra-group FDI commitments. A full 60% of the private sector's debts correspond to commitments of Special Purpose Vehicles (SPVs) intended to finance ship-owners or companies with no real local activity. A quarter of the total is short-term, contributing to an external financing requirement equivalent to 150% of GDP.
A minority government
Although talks between the governments of the island’s Greek and Turkish communities failed to end the country's division, the economic recovery was enough for President Nicos Anastasiades of the conservative Democratic Rally Party (Disy) to be re-elected in February 2018 with 56% of the vote, beating the representative of the left-wing Progressive Workers' Party (Akel). Since the May 2016 parliamentary elections, Disy has held just 18 of the 56 seats. Given that Akel has 16 seats, the President and his government need to build majorities by working with the nine MPs of the centrist Democratic Party (Diko) and the members of five smaller parties.