articles | 18 December 2023

Cyprus economic outlook for 2023: growth, inflation concerns

The Central Bank of Cyprus (CBC) has released a report delving into the country’s financial stability in 2022, as well as its preliminary estimates for the current year, noting that the Gross Domestic Product (GDP) growth rate is expected to reach 2.4 per cent in 2023, while inflation is expected to stand at 3.9 per cent.

The report highlighted Cyprus’ economic resilience throughout 2022, noting a significant 5.6 per cent growth compared to a 3.5 per cent increase in the Eurozone. This growth was propelled by better-than-expected tourism performance, the economic impact of foreign companies relocating to Cyprus under the Strategic Framework for Attracting Companies (international headquartering), and the country’s limited dependency on natural gas compared to other European nations. However, in 2022, domestic inflation hit record highs, averaging 8.1 per cent, mainly due to unprecedented negative effects from the Russian invasion of Ukraine, particularly on energy and food prices, impacting various sectors of the local economy. The CBC explained that despite the prolonged war in Ukraine and ongoing global challenges, it still expects Cyprus’ positive economic momentum to continue in 2023.

The CBC’s September 2023 projections indicate a GDP growth rate of 2.4 per cent for 2023, with forecasts of 2.7 per cent for 2024 and 3.1 per cent for 2025. However, the report noted that these predictions were made before the Middle East conflict erupted, raising uncertainties about potential impacts on Cyprus’ economy. These effects will depend on the war’s duration, intensity, and extent. The Central Bank highlighted concerns about the financial sector’s resilience in the face of prolonged conflict and the involvement of other nations, which could indirectly pose further challenges for financial institutions.

For Cyprus, key risks to GDP are linked to potential adverse impacts on service exports due to geopolitical tensions abroad. Additionally, these risks relate to possibly higher-than-expected prices of essential goods and products.

The Central Bank of Cyprus also shed light on the economy’s post-pandemic phase in 2022, pointing to new external uncertainties impacting Cypriot households and businesses. It noted that entities with loans tied to the Euribor or ECB interest rates face fresh challenges regarding their debt servicing. However, a significant portion of loans linked to the base interest rates of banks in Cyprus hasn’t shown substantial increases so far, as it’s associated with the funding costs of these institutions, including deposit rates, which haven’t risen significantly. “Consequently, households and businesses falling into this category are not expected to be significantly affected at present,” the CBC stated. Moreover, it added that the full impact of prolonged high inflation and consequent significant interest rate hikes on the balance sheets of the private non-financial sector is expected to become more pronounced over time.

It also explained that the high debt of the private, non-financial sector, coupled with increased borrowing costs and cost-of-living pressures due to prolonged high inflation, poses additional challenges for the sector, especially vulnerable households and businesses, in meeting their obligations. “Considering the anticipated reduction in households’ disposable income, potential declines in non-financial business profitability, and rising interest rates, the risk of a new wave of distressed households and businesses cannot be disregarded,” the CBC stressed.

Yet, there are no indications to date that this risk has materialised, it reported. While vulnerabilities in the household and business sectors appear to have increased, economic growth, fiscal measures to alleviate the impact of prolonged inflation, and private sector precautionary savings support the financial sector’s resilience.

The CBC noted that despite positive profitability and solvency prospects, the potential deterioration in the quality of property assets remains a challenge, particularly for the banking sector, as approximately 80 per cent of these assets pertain to this sector. Moreover, the potential increase in Non-Performing Exposures (NPEs) will directly impact the profitability of banks due to heightened provisions and could affect their capital adequacy and asset quality, limiting their ability to offer new loans to the economy, the report states. Nonetheless, positive growth rate forecasts for GDP, low unemployment rates, and projected wage increases according to the Central Bank’s latest projections may help mitigate these risks.

Regarding the auction framework, the Central Bank underscored the importance of a stable legal framework, stating that a seamless auction framework is vital for managing both the inherited volume of NPEs and any new ones in the future.

It concluded by noting that this framework should serve as an effective tool for addressing strategic defaulters and as a pressure lever for creditors and borrowers to reach sustainable restructuring agreements.

Source: Cyprus Mail

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