Inflation is projected to turn moderately positive this year and the labour market is expected to perform strongly.
Banks remain burdened by non-performing loans, despite the ongoing deleveraging efforts. The general government position is expected to remain broadly balanced.
More specifically, the European Commission forecasts growth of 2.8% in 2016, 2.5% in 2017 and 2.3% in 2018. Employment grew by 2.7% in 2016, will grow by 2.2% in 2017 and an additional 1,8% in 2018 with unemployment declining from 13.3% in 2016 to 12% in 2017 and 11% in 2018.
Similarly, the debt will be in 2018 for the first time below 100% (namely 99.6%) after dropping at 103.2% in 2017 (for 2016 it stood at 107.4%). Finally, the budget of 2016 will be balanced (zero deficit), of 2017 will show a deficit of -0.2% and the 2018 and the 2019 surplus of 0.4%.
The structural deficit is projected at -0.7% in 2017 and -0.9% in 2018, the cyclically adjusted deficit has the exact same figures. Finally inflation will float around 1.2% in 2017 and 1.1% in 2018 from 1.2% in 2016.
Private consumption led real GDP growth, supported by declining consumer prices, increasing employment, and rising disposable income.
Net exports also contributed positively to growth. Service exports were particularly strong, as Cyprus experienced a record-high tourism season, benefitting from geopolitical tensions in competing destinations and successful efforts to extend the tourist season.
Meanwhile, imports grew less than expected, with a contraction of imported services recorded in 2016-Q3. With the turn of the economic cycle, accumulated inventories started being used up in 2016, resulting in a negative contribution to real GDP. Investment was volatile, influenced by acquisitions in shipping equipment.
A stabilising real estate market, together with increased foreign direct investment, is likely to provide some lift for investment. However, as banks are burdened with a very high share of non- performing loans, credit remains scarce.
Thus, corporates are expected to continue to use their internal resources to finance investment. Similarly, households are expected to continue using accumulated wealth to fund part of their expenditure and the household saving rate is expected to remain negative over the forecast horizon.
Given the limited room to further expand the tourism sector, exports are expected to grow less dynamically and the contribution of net exports to growth is expected to be negligible.
Risks to the outlook remain, mainly associated with the UK referendum and the depreciation of the pound (the UK is one of Cyprus’ major trading partners), as well as the geopolitical situation in competing tourist destinations.
While limited in the short term, these risks may significantly increase in the medium term. In addition, the large share of non-performing loans and their restructuring could lead to a prolonged period of tight credit, dampening growth.
Employment is estimated to have increased by 2.7% in 2016, across most sectors. With the ongoing recovery, job creation is expected to continue in the coming years.
The unemployment rate, however, remained higher than previously expected. This is partially explained by revisions in past data, but also by the return of discouraged workers to the active labour force.
In 2016, the general government primary balance is expected to improve further, reaching a surplus of 2.5% of GDP which corresponds to an almost balanced headline general government position.
The general government primary balance, excluding one-off measures recorded in 2015 related to the recapitalisation of the banking sector, is expected to show a deterioration of 0.2 pps. of GDP in 2016.
This is mostly due to a significant reduction in property tax on the revenue side and the effect of the partial switch to professional soldiers and continued reduction in intermediate consumption and interest expenditures on the general government expenditure side.
In 2017, the general government primary surplus is forecast to decrease marginally to 2.2% of GDP, which corresponds to a general government headline deficit of 0.2% of GDP.
Total expenditures are expected to diminish by 0.4 pps. of GDP led by intermediate consumption and interest expenditures, while compensation of employees is forecast to increase despite the freeze on public sector hiring (due mainly to the full effect of the switch to professional soldiers).
Total revenues are influenced by a combination of new fiscal policy measures as well as the full year impact of the measures enacted in 2016. The authorities are expected to abolish the immovable property tax paid to the central government without compensatory measures.
In addition, a special payroll contribution levied in response to the crisis is expected to expire at the end of 2016. The implementation of the new place-of-supply rules regarding VAT for e-commerce services is also expected tohave a negative impact on government revenue in 2017.
In 2018, the expected improvement in the general government headline balance should be largely driven by the improving economic outlook and the slight reduction, in percentage of GDP terms, in intermediate consumption, interest expenditure and most social transfers.
The structural balance is expected to deteriorate over the forecast horizon as there has been some loosening in the fiscal policy, taking into account the current cyclical position of the Cypriot economy.
Public debt remains high but declining and is expected to fall just below 100% of GDP in 2018. The decline in the debt-to-GDP ratio over the forecast period is due mainly to expectations of better primary surpluses.