Cyprus is back on a growth track and has been ranked as one of the fastest growing EU economies. The country exceeded international expectations by turning its economy around in just three years following a devastating financial crisis. But far from resting on its laurels, the island is determined to maintain a steady pace in boosting efficiency and investor confidence.
Cyprus has shown remarkable resilience following the financial crisis of 2013 and has implemented tough austerity measures to restructure and diversify its economy. The country surpassed all expectations exiting recession in 2015 – a year earlier than first projected – and continuing to grow in 2016. Despite a challenging period for one of the smallest EU member states, the economic adjustment remained on track and progress has been made in all key objectives set out by the country’s international lenders, allowing Cyprus to reclaim its status as a self-determining and thriving economy.
Cyprus gained independence from the UK in 1960, became a member of the EU in 2004, adopted the euro as its national currency in 2008 and was listed by the IMF as one of the 31 advanced economies in the world in 2011. Throughout its history the Cyprus economy has experienced external shocks that have been followed by astonishing revival. The Greek-backed coup d’état and subsequent Turkish invasion in 1974 of the northern part of the island led to a sharp real GDP contraction of 16.9% in 1974 and 19% in 1975. But hard work and collective focus led to a rapid bounce back, with growth of 18.2% in 1976 and 15.8% in 1977, followed by an uninterrupted period of strong growth lasting more than 30 years. Since independence, the economy has gone through several transformations: from an exporter of minerals and agricultural products in 1961-73, an exporter of manufactured goods from the late 1970s to the early 1980s, to transforming into an international tourism, business and services centre in the 1980-1990s.
Classified by the World Bank as a high-income country, today the economy is mainly built upon the services sector, including tourism, financial services and real estate, which accounts for over 80% of the island’s total GDP and around 75% of employment. The island went through yet another transformation in 2013, when at the height of the eurozone sovereign debt crisis Cyprus became the fifth EU member state to request a financial assistance package from the European Commission (EC), the European Central Bank (ECB) and the International Monetary Fund (IMF) – collectively known as the Troika. The Cyprus 2013 bailout captured the attention of the world, as it was the first and only bailout worldwide with a condition to impose a bail-in of bank deposits – a measure considered inconceivable until then. Following the country’s €10-billion bailout deal and the controversial bail-in decision by the Eurogroup, restructuring the economy and restoration of credibility in Cyprus’ banks has been a top priority – and true to form, the country’s economic recovery has been faster than many first projected.
Cyprus’ speedy return to international markets was a positive step towards restoring confidence and credibility in the eyes of the international business community. Successful bond issues raising over €3 billion, successive upgrades by international rating agencies and positive bank results have all contributed to stronger investor interest. Cyprus returned to growth from 2015, posting a growth rate of 1.7% in that year, and 2.8% in 2016 according to the Statistical Service. The Cypriot Ministry of Finance predicts a growth rate of 2.5% to 3% for 2017.
A successfully recapitalised banking sector passed rigorous ECB stress tests and found a stable footing after the turmoil of the 2013 bail-in. Liquidity and solvency in the banking system have improved significantly, and deposits grew by more than €3 billion in 2016. In addition, the insolvency and foreclosure legislation led to a reduction of more than €4.3 billion in loans past due more than 90 days between October 2015 and October 2016. Despite the harsh terms of Cyprus’ international lenders, the country has taken full advantage of the tough supervision and reform programme to correct fundamental weaknesses in its financial system.
Driven by a strong private demand and supported by the euro’s depreciation and low energy prices, the Cyprus economy once again beat estimates and contrary to expectations returned to growth in the first half of 2015 and officially exited recession in the second. Growth is set to gain momentum and reach 2.5% to 3% in 2017 while public finances are expected to remain stable.
Unemployment is set to continue its decline, although tackling youth unemployment continues to be a significant challenge. The unemployment rate started to fall in the first half of 2015, averaging 14.9% in that year and dropped to 13.3% in 2016. The European Commission expects it to fall to 12% in 2017 and to 11% in 2018.
From 2015, investment growth turned positive in Cyprus, driven by new ship registrations and an upturn in housing investment in 2016. More than half of Cyprus’ trade in goods is done with the European Union. After a large rise of more than 20% in 2015, exports declined from a high base by 0.9% in 2016. Cyprus’ main export partners for goods are Greece and the United Kingdom, while Israel has recently started to vie with other countries for third place. The main domestic export commodities are pharmaceutical products, raw and manufactured food products, and scrap products. The three leading import partners are Greece, the United Kingdom and Italy. The island mainly imports hydrocarbons, machinery, chemicals, vehicles, and iron and steel. As a small open economy that is currently dependent on energy imports, Cyprus’ trade balance is traditionally in deficit, while its services balance is normally in surplus. After a recession-driven divestment in 2013-14, foreign direct investment (FDI) liabilities (reflecting investment into the country) turned positive in 2015, reaching €7 billion, while net FDI (net of assets, or outward investment) was €8.5 billion. In the first three quarters of 2016, net FDI was €1.4 billion. A range of new initiatives underway are attracting more investment and there is renewed investor interest in large scale developments.
Recently approved tax measures have further improved the long-established comprehensive and transparent character of the Cypriot tax framework. The new measures, which are fully aligned with EU directives, support the promotion of economic development by encouraging the introduction of new equity capital as an alternative to excessive debt financing – notional interest deduction (NID) regime on equity – and encourage the creation of business substance by offering compelling advantages to individuals from a personal tax perspective. Tax incentives for intellectual property, innovative small and medium-sized enterprises (SMEs) and start-ups were also introduced in late 2016 and early 2017. These incentives will further improve Cyprus’ international competitiveness as a location of choice for multinationals seeking to do business in the EMEA region.
Cyprus is a small and adaptable free-market economy with a positive long-term outlook. The island promotes itself as the business gateway between Europe, Asia, the Middle East and Africa, and leverages its highly educated, English-speaking population. Its EU and eurozone memberships, excellent information and communications technology (ICT) infrastructure and business-friendly environment continue to attract international companies and investment – particularly in natural gas exploitation following the discovery of significant reserves in Cyprus’ waters. Company formation, tax planning, trusts, foreign exchange trading and fund administration are all strong segments of the business services industry, encouraged by a network of double tax treaties with 60 countries and a legal system based on English Common law.
The key instrument of Cyprus holding companies has attracted hundreds of thousands of companies to set up and channel their investments into key markets through the island. Despite the challenging economic climate in 2012-14, the attraction of Cyprus has not faded and the number of applications filed for registrations of new companies has seen a solid increase since 2014. The developing funds industry, which could evolve into a multi-billion business for Cyprus, is also placing the island on the map as an exciting emerging domicile. Professional services continue to be one of the fastest growing sectors, rising by 6% in the first three quarters of 2016, building on its success in 2015 when the sector grew 4.5%, compared with 1.7% for the economy as a whole.
Cyprus hosts the largest third-party ship management centre in the EU, underlining the success of the country’s formidable maritime sector. The Cyprus Registry is classified as one of the top merchant fleets in the world and ranks as the third largest fleet in the EU. Flying its flag are some 1,100 ocean-going vessels and 767 non-convention size vessels, totalling a gross tonnage of around 22 million.
The tourism sector has shown solid growth in spite of the crisis and 2016 saw a second record year for tourist arrivals. Efforts to upgrade the product could lead to a renaissance of the industry, which currently contributes around 12% to GDP. After a long decline, construction has also started to rebound, growing by 8.7% in the first three quarters of 2016.
Although traditionally strong, primary sectors such as agriculture and manufacturing – contributing around 2% and 4.5% respectively to GDP – have faced challenges which have led both to follow a similar strategy of creating value-added products targeting niche markets willing to pay a premium for quality. Both sectors of the economy have placed strong focus on innovation and diversification, which has supported the industries’ efforts to increase productivity.
Energy will be a significant new source of growth, following the discovery of natural gas reserves in Cyprus’ EEZ. The island has ambitious plans to become a regional energy hub in the Eastern Mediterranean and the successful extraction of natural gas from its waters could allow the island to export to European and East-Asian markets. The already established involvement of major oil and gas companies in Cyprus, such as French energy giant Total, the Italian-Korean consortium Eni-Kogas, and the UK-Dutch company Royal Dutch Shell, has strengthened the development of these plans coming to fruition. The sector saw a further vote of confidence during the third licensing round in 2016, when Total, Eni and US major ExxonMobil all made bids and were awarded offshore blocks.
Cyprus has recently embarked on a privatisation programme with the commercialisation of services at Limassol port. Other potential prospects for privatisation are the State Lottery and dominant telecommunications provider Cyprus Telecommunications Authority (Cyta). Several new marinas are also planned in key coastal towns of Cyprus, with luxury marina complex Limassol Marina already attracting record sales. One of the most exciting developments is the licensing of Cyprus’ first-ever integrated luxury casino resort, which was awarded to a consortium including the globally renowned Melco and Hard Rock. Government chiefs expect the project could increase annual tourist numbers by up to 500,000 and create hundreds of job opportunities.
The primary balance for the government is estimated to have reached a surplus of 2.6% of GDP in 2016, while the headline deficit was estimated at 0.1% of GDP. The general government primary surplus is to remain high at 2.2% of GDP in 2017, according to the European Commission. Cyprus’ debt-to-GDP ratio peaked in 2015 and is projected to decline to 99.6% in 2018. Structural reforms are expected to put long-term public finances on a more sustainable path at the same time as improving competitiveness.
The inflation rate in Cyprus was recorded at -1.5% in 2015 and -1.2% in 2016, owing to oil prices and historically high unemployment. It is expected to rise to 1.2% in 2017 and to 1.1% in 2018, according to the European Commission. After four years of decline, wage developments are expected to begin warming up slowly in 2017 and 2018.
The Cyprus economy has again demonstrated its resilience with an impressive turnaround that was faster and stronger than expected. The key challenges that remain are to further reduce high levels of non-performing loans (NPLs), maintain fiscal discipline in order to bring down public debt and implement structural reforms that will increase the efficiency and effectiveness of the public sector and improve Cyprus’ attractiveness as an investment destination. The legal framework for foreclosures and insolvency, passed at the end of 2015, is already bearing fruit supporting banks with loan restructuring and reviving the economy. Although there is still work to be done before Cyprus can declare that it has put the crisis fully behind it, foreign investors are showing interest in the country. The strong tourism sector, the rapidly developing investment fund sector and the discovery of significant quantities of natural gas in Cypriot waters raise the prospect of a transformation of the Cypriot economy in the medium to long term.
Resolving the long-standing issue of the Cyprus problem – the de facto partition of the island – has been highlighted as one of the most significant priorities in attracting more foreign investment, boosting the economy and bringing unemployment figures below double digits. A solution would open up substantial opportunities, especially given the synergies available from regional cooperation on hydrocarbons. UN-led talks on resolving the Cyprus problem have been revived, and many see 2017 as a pivotal year in reaching a solution. There is some trade across the UN-monitored Green Line between Greek and Turkish Cypriots, but the narrow range and small volume underlines the fact that this trade cannot bring the same benefits as a solution.
Cyprus has an open, free-market, service-based economy with a long record of successful economic performance. Despite tackling a major fiscal and banking crisis, the strong business environment, highly educated workforce and favourable tax regime remain in place. Looking ahead, with measures to reform public spending, accelerate initiatives to boost investment, develop the investment fund sector, privatisations and a push forward with natural gas exploitation, Cyprus is fast returning to the prosperity of the past.
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Updated May 2017