Cyprus: Risk Assessment
Country Risk Rating
Business Climate Rating
- Centric geographical location between Europe, Asia and Africa favors transshipment industry
- Offshore finance hub
- Rich, unexploited offshore natural gas deposits
- Skilled, English-speaking workforce
- High-quality transport and telecommunication infrastructure
- Island divided since 1974, tense relations with Turkey
- Highly dependent on Russia and the UK as export markets and sources of financing
- Slow legal process, poor enforcement of contracts
- Oversized banking sector with poor asset quality, very high public and private leverage
- Weak industrial diversification (tourism, construction, natural gas, finance)
Construction, tourism and natural gas continue to sustain the economy
Growth will slow down slightly in 2020 but will remain firmly around the 3% mark. At 65% of GDP, private consumption is the main driver of demand and will decelerate slightly to 2.5% annual growth from 3% in 2019; owing to lower tourism revenues. Construction and professional services are becoming important contributors to growth. Construction in particular has benefited from a surge in private investment, which will grow at a slower pace in 2020 (6%, compared to 10% in 2019) but will remain adequate at 20% of GDP. The surge in FDI is explained by a citizen investment scheme encouraging foreigners to invest in property, and is accelerating prices of preferential real estate. Due to recently discovered maritime reserves (Aphrodite, Calypso and Glaucus-1 fields), we expect important investments in natural gas exploitation. Nonetheless, a disorderly Brexit would substantially depress FDI and tourist arrivals, as roughly a third of visitors hail from the UK. Moreover, the trans-shipping industry is exposed to global trade tensions.
Banking health improves but remains fragile
Thanks to the successful resolution of the Cyprus Cooperative Bank (CCB), progress has continued in cleaning the banking sector balance sheet. Non-performing loans (NPLs) have been reduced from 30% of total loans (50% of GDP) in Q1 2018 to 20% (33% of GDP) in Q1 2019. Furthermore, legal reforms have been instituted to encourage debt restructuring. The new law streamlines the procedure for seizing collateral assets, thus incentivizing borrowers to initiate restructuring negotiations. €3.5 billion worth of loans will benefit from a 1/3 state subsidy under the Estia scheme. Nonetheless, the banking sector remains vulnerable. With domestic bank assets at 200% of GDP, Cyprus remains one of Europe’s most overbanked economies, and low interest rates will harm profitability. Along with Greece, it remains the only Eurozone country with a double-digit NPL ratio (20%). The processing of bad loans remains hampered by pervasive uncertainties regarding the ownership of deeds, resulting in weak repayment discipline.
Fiscal consolidation continues its progress
Thanks to low interest rates and its newly regained investment-grade credit status, debt service costs have been substantially curtailed. Unemployment will continue to decrease (7%), providing stronger social security contributions and, along with better tax collection, compensate the rolling back of public sector wage freezes. Hence, a healthy primary surplus of 4.5% of GDP will help bring down the debt ratio below the 90% mark. With a poorly developed domestic manufacturing industry (cheese, medicine, electronics), the country is heavily reliant on imports and posts a substantial trade deficit of 20% of GDP, only partially covered by the surpluses in tourism and offshore financial services. The current account deficit will remain large (7% of GDP) and financed by FDI flowing into real estate, tourism and natural gas. With a still convalescing domestic banking sector, capital inflows must fund the growth necessary for reducing the debt of households (90% of GDP) and firms (120% of GDP, excluding special purpose entities). However, given an external financing requirement of 147% of GDP, this leaves the country vulnerable to a sudden tightening of global financial conditions. External debt remains at an extraordinary 460% of GDP, with the largest part corresponding to the private non-financial sector (around 200% of GDP).
Rising tensions over maritime gas reserves
President Nicos Anastasiades fronts a coalition government between his center-right Democratic Rally and the centrist Democratic Party, which should hold into the 2021 parliamentary elections. As in recent years, the main geopolitical issue in Cyprus will continue to be the relationship between the Republic of Cyprus (RC), 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. Since reunification talks broke down in 2017, tensions have escalated over contested waters with potential gas reserves. In response to Turkish ships penetrating into southern waters without authorization, the EU has threatened sanctions with an immediate cost close to €150 million. The island’s geopolitical stability will therefore depend on Turkey’s willingness to assert its interests despite the risk of confrontation.