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12. CYPRUS
            Deep recession to prevail over the forecast horizon

                                                            demand. Exports are expected to fall moderately in
     Rapid deterioration in economic activity
                                                            2012, while the projected economic performance
     The weakness of economic activity seen in the          of Cyprus' major trade partners suggests a gradual
     second half of 2011 is expected to intensify in        increase in exports of both goods and services in
     2012, when the Cypriot economy is projected to         2013 and 2014. In services, both tourism and
     contract by 2.3% against the background of             business services continued to perform well in
     unwinding imbalances and widespread loss of            2012 and this trend is expected to continue in the
     confidence among economic agents. The fiscal           coming years. In particular, revenues from tourism
     consolidation effort that has been pursued, the        are expected to continue to rise. This reflects a
     rapid deterioration in labour market conditions,       projected increased flow of arrivals from Russia
     and the high degree of economic uncertainty have       and new destinations helped by government
     together weighed heavily on private consumption.       policies promoting tourism, and from tourists'
     In addition, the tightening of credit conditions has   concern over stability in competing Mediterranean
     aggravated       the    unfavourable      economic     tourist destinations. Exports of transport services
     environment while weak confidence has amplified        are expected to shrink, while financial and other
     the drag on investment activity. Adverse               business services will stagnate over the forecast
     developments in the external environment,              horizon in view of worsen business confidence.
     particularly in Greece, and the sustained volatility   Overall, the current-account deficit is expected to
     in European financial markets have affected            narrow gradually over the forecast horizon in spite
     Cyprus predominately via developments in the           of a deterioration of the income balance.
     financial sector.                                             Graph II.12.1:Cyprus - GDP growth and contributions

                                                             12                                                          6
     The economy is projected to contract by 1.7% in               pps.                              % of pot. GDP
     2013, due to further declines in domestic                9
                                                                                                                         4
     consumption, as well as in government and private        6
                                                                                                                         2
     investments. Economic activity is expected to            3

     contract further by 0.7% in 2014 with domestic           0                                                          0

     demand shrinking further and net exports still          -3
                                                                                                                         -2
     marginally supporting growth. Traditionally the         -6
                                                                                                                         -4
     main driver of growth, domestic demand is set to        -9                                           forecast
     contract over the forecast horizon driven by           -12                                                          -6
                                                                  01 02 03 04 05 06 07 08 09 10 11 12 13 14
     markedly weaker consumer confidence and lower                   Output gap (rhs)               Net exports
     household disposable income, which stem in turn                 Inventories                    Dom. demand, excl. inv.
                                                                     GDP (y-o-y%)
     from the effects of fiscal consolidation and the
     worsening labour market outlook. Investment is         Worsening labour market conditions
     projected to decline in view of the difficulties in
                                                            Employment is expected to worsen in 2012 and
     accessing credit and the high level of corporate
                                                            subsequent years, reflecting the slowdown in
     indebtedness. In spite of the reconstruction work at
                                                            economic activity. Job losses are particularly
     the electricity power plan and the private
                                                            prominent in labour-intensive sectors such as
     investment in a new oil storage facility,
                                                            construction and trade. The unemployment rate
     construction activity is expected to continue to
                                                            would remain on a strong upward trend, rising
     shrink strongly in 2012 and 2013. Although
                                                            from 7.9% in 2011 to 12.1% in 2012, and is likely
     construction indicators suggest that the correction
                                                            continue to increase further in 2013 and to be close
     should persist in 2014, this is expected to be at a
                                                            to 14% in 2014. Given the unfavourable labour
     milder pace reflecting the general level of
                                                            market conditions and the effects of fiscal
     economic activity in the economy as a whole.
                                                            consolidation, wage growth is expected to be
                                                            negative. In particular, the freezing of public sector
     On the other hand, the external sector is expected
                                                            wages until 2014 should affect wages in the
     to provide a positive contribution to growth for the
                                                            economy as a whole.
     whole forecast period. In particular, imports of
     both goods and services are set to decline
     considerably against a backdrop of weak domestic



76
Member States, Cyprus




Inflation declining                                                    conditions, and lower productivity. Furthermore,
                                                                       any worsening of the economic situation in Greece
HICP inflation is projected to decline to 3.2% in
                                                                       remains a significant downside risk for Cyprus as
2012 on the back of weaker domestic demand and
                                                                       well as any further needs of recapitalisation for the
the fading-out of the base effect of the electricity
                                                                       domestic banks.
prices increases in 2011 despite increasing oil and
commodity prices and of VAT standard rate by
2 pps. With domestic demand remaining subdued,                         Fiscal and financing imbalances prevail
the effect of the VAT increase and the projected
                                                                       The general government deficit is set to narrow to
decline of oil and commodity prices, headline
                                                                       5.3% of GDP in 2012. Should no further measures
inflation is projected to ease further to 1.5% in
                                                                       be adopted, the deficit will rise further to 5.7%
2013 and to 1.3% in 2014.
                                                                       GDP in 2013 and to 6% in 2014. The downgrading
                                                                       of the government sovereign to non-investment
Significant downside risks exist                                       grade raised yield spreads to prohibitive levels,
                                                                       with the government covering its financing needs
Cyprus requested external financial assistance
                                                                       through short-term borrowing from the domestic
from the EFSF/ESM in view of the challenges
                                                                       market. The government's participation in the
facing the economy. Under the no-policy-change
                                                                       recapitalisation of a commercial bank (which was
assumption (the draft 2013 Budget not yet
                                                                       unsuccessful in implementing its capital
available), significant downside risks are present
                                                                       enhancement plan) is expected to increase the
for the current account, public finances, and the
                                                                       general government debt significantly from 71.1%
financial    sector,    testing    the    economy's
                                                                       in 2011 to about 90% of GDP in 2012. In view of
sustainability. Failure to raise the required capital
                                                                       shrinking economic activity, the government debt-
and to put policies back on a sustainable path
                                                                       to-GDP ratio is projected to reach 96.7% in 2013
could dramatically worsen the outlook and
                                                                       and 102.7% in 2014. The fiscal imbalances are set
reinforce the negative loop of lower liquidity,
                                                                       to persist despite the significant consolidation
higher indebtedness, worsening labour market
                                                                       effort pursued in 2012.


Table II.12.1:
Main features of country forecast - CYPRUS
                                                      2011                           Annual percentage change
                                   mio EUR Curr. prices      % GDP       92-08    2009     2010     2011     2012    2013    2014
GDP                                                17979,3     100,0        4,3     -1,9     1,3      0,5     -2,3    -1,7    -0,7
Private consumption                                11899,2      66,2          -     -7,5     1,5      0,2     -3,4    -3,6    -0,9
Public consumption                                  3584,2      19,9          -      6,8     1,0      -0,2    -1,7    -2,4    -1,5
Gross fixed capital formation                       2941,8      16,4          -     -9,7     -4,9    -13,1   -22,0   -12,0    -5,3
 of which : equipment                                828,0       4,6          -     -0,3     -5,9    -23,1   -26,0   -11,0    -3,7
Exports (goods and services)                        7699,0      42,8          -    -10,7     3,8      3,3     -0,9     0,8     1,3
Imports (goods and services)                        8251,7      45,9          -    -18,6     4,8      -4,1    -9,3    -5,5    -0,4
GNI (GDP deflator)                                 16481,6      91,7        4,4     -4,9     2,4      3,6     -2,4    -1,7    -0,7
Contribution to GDP growth :                 Domestic demand                  -     -6,3     0,2      -2,4    -6,2    -4,4    -1,5
                                             Inventories                      -     -1,6     1,8      -0,5     0,0     0,0     0,0
                                             Net exports                      -      5,7     -0,7     3,4      3,9     2,8     0,7
Employment                                                                    -     -0,5     0,0      0,5     -4,0    -0,6    -0,3
Unemployment rate (a)                                                         -      5,5     6,4      7,9     12,1    13,1    13,9
Compensation of employees/head                                                -      2,5     2,7      3,3     -0,9    -0,3     0,5
Unit labour costs whole economy                                               -      3,9     1,4      3,3     -2,6     0,8     0,9
Real unit labour costs                                                        -      3,8     -0,5     0,5     -4,2    -0,7    -0,4
Saving rate of households (b)                                                 -     11,4    11,6      4,1      5,2     7,3     7,5
GDP deflator                                                                3,4      0,1     1,9      2,7      1,6     1,5     1,2
Harmonised index of consumer prices                                           -      0,2     2,6      3,5      3,2     1,5     1,3
Terms of trade of goods                                                       -      2,7     -0,9     -0,6    -1,7    -0,1    -0,9
Merchandise trade balance (c)                                                 -    -25,5    -26,8    -24,2   -21,9   -20,6   -20,7
Current-account balance (c)                                                   -    -10,7     -9,2     -4,2    -6,3    -3,5    -3,0
Net lending(+) or borrowing(-) vis-à-vis ROW (c)                              -    -10,6     -9,0     -4,0    -5,5    -2,7    -2,4
General government balance (c)                                                -     -6,1     -5,3     -6,3    -5,3    -5,7    -6,0
Cyclically-adjusted budget balance (c)                                        -     -6,2     -5,3     -6,1    -4,4    -4,8    -5,3
Structural budget balance (c)                                                 -     -6,2     -5,3     -5,9    -4,6    -4,8    -5,3
General government gross debt (c)                                             -     58,5    61,3     71,1     89,7    96,7   102,7
(a) Eurostat definition. (b) gross saving divided by gross disposable income. (c) as a percentage of GDP.




                                                                                                                                           77

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Cyprus Economic Forecast 2012-2014

  • 1. 12. CYPRUS Deep recession to prevail over the forecast horizon demand. Exports are expected to fall moderately in Rapid deterioration in economic activity 2012, while the projected economic performance The weakness of economic activity seen in the of Cyprus' major trade partners suggests a gradual second half of 2011 is expected to intensify in increase in exports of both goods and services in 2012, when the Cypriot economy is projected to 2013 and 2014. In services, both tourism and contract by 2.3% against the background of business services continued to perform well in unwinding imbalances and widespread loss of 2012 and this trend is expected to continue in the confidence among economic agents. The fiscal coming years. In particular, revenues from tourism consolidation effort that has been pursued, the are expected to continue to rise. This reflects a rapid deterioration in labour market conditions, projected increased flow of arrivals from Russia and the high degree of economic uncertainty have and new destinations helped by government together weighed heavily on private consumption. policies promoting tourism, and from tourists' In addition, the tightening of credit conditions has concern over stability in competing Mediterranean aggravated the unfavourable economic tourist destinations. Exports of transport services environment while weak confidence has amplified are expected to shrink, while financial and other the drag on investment activity. Adverse business services will stagnate over the forecast developments in the external environment, horizon in view of worsen business confidence. particularly in Greece, and the sustained volatility Overall, the current-account deficit is expected to in European financial markets have affected narrow gradually over the forecast horizon in spite Cyprus predominately via developments in the of a deterioration of the income balance. financial sector. Graph II.12.1:Cyprus - GDP growth and contributions 12 6 The economy is projected to contract by 1.7% in pps. % of pot. GDP 2013, due to further declines in domestic 9 4 consumption, as well as in government and private 6 2 investments. Economic activity is expected to 3 contract further by 0.7% in 2014 with domestic 0 0 demand shrinking further and net exports still -3 -2 marginally supporting growth. Traditionally the -6 -4 main driver of growth, domestic demand is set to -9 forecast contract over the forecast horizon driven by -12 -6 01 02 03 04 05 06 07 08 09 10 11 12 13 14 markedly weaker consumer confidence and lower Output gap (rhs) Net exports household disposable income, which stem in turn Inventories Dom. demand, excl. inv. GDP (y-o-y%) from the effects of fiscal consolidation and the worsening labour market outlook. Investment is Worsening labour market conditions projected to decline in view of the difficulties in Employment is expected to worsen in 2012 and accessing credit and the high level of corporate subsequent years, reflecting the slowdown in indebtedness. In spite of the reconstruction work at economic activity. Job losses are particularly the electricity power plan and the private prominent in labour-intensive sectors such as investment in a new oil storage facility, construction and trade. The unemployment rate construction activity is expected to continue to would remain on a strong upward trend, rising shrink strongly in 2012 and 2013. Although from 7.9% in 2011 to 12.1% in 2012, and is likely construction indicators suggest that the correction continue to increase further in 2013 and to be close should persist in 2014, this is expected to be at a to 14% in 2014. Given the unfavourable labour milder pace reflecting the general level of market conditions and the effects of fiscal economic activity in the economy as a whole. consolidation, wage growth is expected to be negative. In particular, the freezing of public sector On the other hand, the external sector is expected wages until 2014 should affect wages in the to provide a positive contribution to growth for the economy as a whole. whole forecast period. In particular, imports of both goods and services are set to decline considerably against a backdrop of weak domestic 76
  • 2. Member States, Cyprus Inflation declining conditions, and lower productivity. Furthermore, any worsening of the economic situation in Greece HICP inflation is projected to decline to 3.2% in remains a significant downside risk for Cyprus as 2012 on the back of weaker domestic demand and well as any further needs of recapitalisation for the the fading-out of the base effect of the electricity domestic banks. prices increases in 2011 despite increasing oil and commodity prices and of VAT standard rate by 2 pps. With domestic demand remaining subdued, Fiscal and financing imbalances prevail the effect of the VAT increase and the projected The general government deficit is set to narrow to decline of oil and commodity prices, headline 5.3% of GDP in 2012. Should no further measures inflation is projected to ease further to 1.5% in be adopted, the deficit will rise further to 5.7% 2013 and to 1.3% in 2014. GDP in 2013 and to 6% in 2014. The downgrading of the government sovereign to non-investment Significant downside risks exist grade raised yield spreads to prohibitive levels, with the government covering its financing needs Cyprus requested external financial assistance through short-term borrowing from the domestic from the EFSF/ESM in view of the challenges market. The government's participation in the facing the economy. Under the no-policy-change recapitalisation of a commercial bank (which was assumption (the draft 2013 Budget not yet unsuccessful in implementing its capital available), significant downside risks are present enhancement plan) is expected to increase the for the current account, public finances, and the general government debt significantly from 71.1% financial sector, testing the economy's in 2011 to about 90% of GDP in 2012. In view of sustainability. Failure to raise the required capital shrinking economic activity, the government debt- and to put policies back on a sustainable path to-GDP ratio is projected to reach 96.7% in 2013 could dramatically worsen the outlook and and 102.7% in 2014. The fiscal imbalances are set reinforce the negative loop of lower liquidity, to persist despite the significant consolidation higher indebtedness, worsening labour market effort pursued in 2012. Table II.12.1: Main features of country forecast - CYPRUS 2011 Annual percentage change mio EUR Curr. prices % GDP 92-08 2009 2010 2011 2012 2013 2014 GDP 17979,3 100,0 4,3 -1,9 1,3 0,5 -2,3 -1,7 -0,7 Private consumption 11899,2 66,2 - -7,5 1,5 0,2 -3,4 -3,6 -0,9 Public consumption 3584,2 19,9 - 6,8 1,0 -0,2 -1,7 -2,4 -1,5 Gross fixed capital formation 2941,8 16,4 - -9,7 -4,9 -13,1 -22,0 -12,0 -5,3 of which : equipment 828,0 4,6 - -0,3 -5,9 -23,1 -26,0 -11,0 -3,7 Exports (goods and services) 7699,0 42,8 - -10,7 3,8 3,3 -0,9 0,8 1,3 Imports (goods and services) 8251,7 45,9 - -18,6 4,8 -4,1 -9,3 -5,5 -0,4 GNI (GDP deflator) 16481,6 91,7 4,4 -4,9 2,4 3,6 -2,4 -1,7 -0,7 Contribution to GDP growth : Domestic demand - -6,3 0,2 -2,4 -6,2 -4,4 -1,5 Inventories - -1,6 1,8 -0,5 0,0 0,0 0,0 Net exports - 5,7 -0,7 3,4 3,9 2,8 0,7 Employment - -0,5 0,0 0,5 -4,0 -0,6 -0,3 Unemployment rate (a) - 5,5 6,4 7,9 12,1 13,1 13,9 Compensation of employees/head - 2,5 2,7 3,3 -0,9 -0,3 0,5 Unit labour costs whole economy - 3,9 1,4 3,3 -2,6 0,8 0,9 Real unit labour costs - 3,8 -0,5 0,5 -4,2 -0,7 -0,4 Saving rate of households (b) - 11,4 11,6 4,1 5,2 7,3 7,5 GDP deflator 3,4 0,1 1,9 2,7 1,6 1,5 1,2 Harmonised index of consumer prices - 0,2 2,6 3,5 3,2 1,5 1,3 Terms of trade of goods - 2,7 -0,9 -0,6 -1,7 -0,1 -0,9 Merchandise trade balance (c) - -25,5 -26,8 -24,2 -21,9 -20,6 -20,7 Current-account balance (c) - -10,7 -9,2 -4,2 -6,3 -3,5 -3,0 Net lending(+) or borrowing(-) vis-à-vis ROW (c) - -10,6 -9,0 -4,0 -5,5 -2,7 -2,4 General government balance (c) - -6,1 -5,3 -6,3 -5,3 -5,7 -6,0 Cyclically-adjusted budget balance (c) - -6,2 -5,3 -6,1 -4,4 -4,8 -5,3 Structural budget balance (c) - -6,2 -5,3 -5,9 -4,6 -4,8 -5,3 General government gross debt (c) - 58,5 61,3 71,1 89,7 96,7 102,7 (a) Eurostat definition. (b) gross saving divided by gross disposable income. (c) as a percentage of GDP. 77