Real GDP is forecasted to have increased by 2.9% in 2016. In 2017, real GDP is projected to grow by 3.1%. The main drivers of the growth forecasts are given below.
· Robust GDP and employment growth continued in the third quarter of 2016 and many leading indicators with respect to domestic activity improved further during the final quarter of 2016.
· Moderate growth in the euro area and the EU, stronger-than-expected growth in the UK (in spite of the June 2016 Brexit vote) and the moderation of the recession in Russia.
· Further strengthening of economic sentiment in Cyprus and in the EU.
· Improved performance of foreign stock markets, reflecting less adverse external economic conditions now vis-à-vis the conditions in the first half of 2016.
· The prolonged period of declining energy prices and the subdued non-energy commodity prices.
· The ongoing normalisation of the domestic banking sector marked by increases in deposits, deleveraging and low lending interest rates.
· The improved general government balance and primary balance in January – November 2016, relative to the same period in 2015.
The low levels of European interest rates have been supportive of the recovery in Cyprus; however, the protracted period of low interest rates also reflects uncertainties about the growth momentum in the euro area which could weigh on the strength of the recovery in Cyprus in subsequent quarters.
Downside risks to the growth forecasts are associated with the following factors.
· A considerable slowdown in the UK and further depreciation of the pound against the euro, as a result of increased political and economic uncertainty following the Brexit vote, are expected to directly affect the Cypriot economy, primarily through weaker exports of services.
· Weaker-than-expected growth in the EU and the euro area as a result of (i) the Brexit vote – impacting activity through e.g. trade and confidence channels – and (ii) worsening growth prospects in emerging market economies.
· The high private indebtedness levels that have led to deleveraging and increased default rates continue to pose significant risks to the stability of the domestic banking system and to the outlook for the economy, especially in conditions of subdued property prices.
· The high public debt-to-GDP ratio renders Cyprus vulnerable to external negative shocks; thus delays in the advancement of structural reforms may create risks to public finances, Cyprus’s credibility and market borrowing costs.
· A protracted period of elevated unemployment could undermine the growth prospects of the Cypriot economy.
Upside risks to the outlook include (i) improved economic conditions in Russia as oil prices are rebounding, and (ii) new investment projects linked to tourism, energy and public infrastructure. In 2017, inflation is projected to turn positive; CPI inflation is forecasted to reach 1.5% as activity growth is anticipated to continue and energy prices are expected to increase.