Exceeding international expectations with a return to growth in 2015, Cyprus is making steady progress in restructuring its economy and regaining investor confidence.
Cyprus surpassed all expectations exiting recession in 2015 – a year earlier than first projected – and continuing to economic growth in 2016. The country has been remarkably resilient following the financial crisis and has implemented tough austerity measures to restructure its economy. Although a challenging time for one of the smallest EU member states, the economic adjustment remains on track, with progress made in all key objectives set out by the country’s international lenders. Hailed a success story by the Eurogroup, the island nation is determined to exit the programme in early 2016 and 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 sponsored coup d’etat 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 tourist, 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 the international markets was a positive step towards restoring confidence and credibility in the eyes of the international business community. Successful bond issues raising well over €2 billion, successive upgrades by international rating agencies and positive bank results have all contributed to stronger investor interest in Cyprus. The Cypriot Ministry of Finance predicted a growth rate of 1.5% in 2015 although final figures could be closer to 1.9%, while the European Commission (EC) upgraded its forecasts for the growth of the Cyprus economy to 1.4% in 2016 and a growth rate of 2% in 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, with exchange controls fully lifted in May 2015. Contrary to expectations, the country did not see an outflow of deposits but rather a gradual increase over the last two years. In addition, recently approved insolvency and foreclosure legislation has led to a positive outlook for the economy. 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% by 2017 with improving public finances.
Unemployment is set to continue its decline, although tackling youth unemployment continues to be a significant challenge. The rate of unemployment started to reduce in the first half of 2015, from around 16% and is expected to fall to 14.6% in 2016 and to 13.3% in 2017.
In 2015, investment growth turned positive in Cyprus, mainly driven by new ship registrations, however, the positive impact on growth was offset by higher imports. More than half of Cyprus’ trade in goods is done with the European Union and although in recession, exports saw a boost with a significant 14% increase between January and July 2015, with help from the euro’s exchange rate. Cyprus’ main export partners are Greece, the United Kingdom, Germany and Lebanon. The main domestic export commodities are pharmaceutical products, photo-sensitive devices, and raw and manufactured food products. The three leading import partners are Greece, Israel and the United Kingdom and 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 drop to less than €665 million in 2012, foreign direct investment (FDI) is expected to recover as a result of new initiatives under way to attract more investment, as well as the privatisations of state-owned assets and renewed investor interest in large scale developments.
Recently approved tax measures are set to further improve 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. 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 despite the current challenging environment. 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 recent 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 close to 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.
Although facing a challenging economic climate today, 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 market. Professional services is set to once again be the fastest growing sector in 2016, building on its success in 2015 when the sector grew a phenomenal 5%, compared with 1% 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 the tenth largest merchant fleet in the world and the third largest fleet in the EU and flying its flag are some 1100 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 2015 saw record numbers of tourist arrivals. Efforts to upgrade the product could lead to a renaissance of the industry, which currently contributes around 11% to GDP. Traditionally, tourism was the key driving force of Cyprus, however today professional and financial services have overtaken its position.
Although traditionally strong, primary sectors such as agriculture and manufacturing – contributing around 1.9% and 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 on 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 and the Italian Korean consortium Eni-Kogas, have strengthened the development of these plans coming to fruition. The sector saw a further vote of confidence in November 2015, when BG Group acquired a 35% stake in Block 12, following an agreement with concession holder and operator Noble Energy.
Privatisation is a new opportunity in Cyprus as the terms of the bailout envisage raising €1 billion in privatisation proceeds by 2016 and a further €0.4 billion thereafter. Targets for privatisation are the dominant telecommunications provider Cyprus Telecommunications Authority (Cyta), the State Lottery and the Ports Authority – by commercialising services at the port of Limassol with plans of selecting the winning parties by March 2016. 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 has already garnered much interest from top names in the global casino industry. Official announcements on the final bidders are expected in early 2016, and government chiefs expect the project could increase tourist numbers by up to 500,000 and create hundreds of job opportunities.
The primary balance for the government is forecast to reach a surplus of 2.1% of GDP in 2015, corresponding to a headline deficit of 0.7% of GDP. The general government primary surplus is expected to increase to 2.6% of GDP in 2016 and to remain broadly unchanged in 2017, according to the European Commission. Cyprus’ debtto- GDP ratio peaked in 2014 and is projected to decline from about 107% in 2015 to 95% in 2017. 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 -1.2% in December 2015 and is expected to rise to 0.6% in 2016 and to 1.3% in 2017, according to the European Commission. With unemployment still high and inflation expectations still subdued, wage developments are expected to begin warming up slowly in 2016 and 2017.
Cyprus is manifesting positive signs of the economy bouncing back, yet serious challenges remain. The country continues to struggle with non-performing loans (NPLs) and public debt. To achieve real recovery, NPLs must be substantially decreased and moved away from the balance sheets of banks. A recently approved new legal framework for foreclosures and insolvency is a positive development and is expected to support banks with loan restructuring and in turn revive the economy. Although there is much work to be done before Cyprus can regain the strong economic stance it once held, 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. The tourism and business services sectors have fared particularly well in spite of the crisis and the country has continued to attract and retain business regardless of the downturn over the last few years.
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 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 2016 as a pivotal year of reaching a solution. There is some trade across the UN-monitored Green Line between the 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. Though the economy is still tackling structural challenges, the strong business environment, highly educated workforce and favourable tax regime remain in place. Looking ahead, with measures to reform public spending, privatise major utilities, accelerate initiatives to boost investment, develop the investment fund sector and a push forward with natural gas exploitation, there is scope for cautious optimism for Cyprus to quickly return to the prosperity of recent years.
Updated: February 2016