Although it is clear that the ‘cash for passports’ scheme is boosting construction and real estate, there are two other reasons why I am forecasting a slowdown. These relate to tourism and consumer demand.
Slower Tourism growth
Cyprus enjoyed a record year for tourism in 2016. However, a large proportion of the demand came from Russian tourists finding alternatives to Turkey. The row between Turkey and Russia led to the cancellation of charter flights between the two countries and news reports suggest that this has led to a 90% drop in visitors from Russia to Turkey in 2016. The positive impact this created on Cyprus is clear. In 2015, arrivals from Russia dropped by 16.7% as the rouble slid. Yet in the first nine months of 2016, Russian arrivals soared by 44.5%.
This made a big difference to total numbers. Total arrivals from all countries in January-September rose by more than 400,000 compared with the same period of the previous year. Around half of those 400,000 additional tourists came from Russia. However, history is unlikely to repeat itself in 2017. Russia and Turkey have been reconciled and charter flights have now resumed. This means Cyprus is unlikely to get the same kind of boost from Russia in 2017 as it did in 2016.
Another concern is the UK, which is still the biggest market for Cyprus, accounting for 40% of all tourists. At the time of writing, the pound sterling was about 12% weaker than at the beginning of the year. Brexit uncertainties will continue to have an impact on sterling in 2017. There are indications the weak pound has already started to affect British tourism. Growth in UK tourism arrivals slowed to 6.8% in the third quarter, following double-digit growth rates for six consecutive quarters before that.
The expected slowdown in Russian and UK demand will be offset to a certain extent by the major efforts by all of those in the sector to increase airline and bed capacity and bring tourists outside the high season.
Inflation at last?
Cyprus is now into its third consecutive year of deflation, thanks to a combination of the financial crisis and low international oil prices. Despite the abundant sunshine and efforts to introduce renewable energy, Cyprus still depends on imported diesel and fuel-oil prices of electricity for more than 90% of its electricity production. This means that transport and heating are highly influenced bythe price of international oil.
At the time of writing, the price of Brent crude was over $55/barrel, compared with around $26/b in January. This will inevitably feed through into consumer prices in Cyprus. Sapienta Economics is, therefore, projecting an EU-harmonised positive inflation rate of 0.6% in 2017, compared with an estimated deflation rate of 1.3% in 2016.
Next year is likely to be the first time for almost a decade in which the government can boast a drop in the ratio of public debt to GDP.
The debt ratio reached a low of 44.7% of GDP in 2008, thanks to booming receipts from property. However, this started to climb rapidly even before the bailout programme, and had reached 79.3% of GDP by 2012. The bailout pushed that to 107.5% by 2015 and we estimate it will have tipped over 110% of GDP in 2016.
Even though the absolute level of debt is likely to be smaller in 2016 than in 2015, deflation depresses nominal GDP, and so pushes the ratio higher. With the combination of nominal growth, a bit of inflation and an expected primary surplus in 2017, we expect the debt/GDP ratio to drop to 106% of GDP in 2017.
Whether the downward trend can be maintained beyond 2017, will depend a great deal on whether or not parliament passes the public-sector reform bills, and on who is running policy after the presidential election due in February 2018.
There are signs consumer demand is slowing, although the evidence is mixed. On the negative side, imports of consumer durables for domestic consumption fell in value by 19%, compared with the year earlier in January-August.
This could reflect falling prices. However, retail sales volumes of computers, electrical goods and furniture also grew less quickly in the third quarter. This could be because households are finally starting to pay back their bad loans to the bank. Between August 2015 and August 2016, households reduced their non-performing loans (NPLs) by €600m. On the other hand, car sales continue to boom at rates of more than 20%. This is why I expect an overall slowdown, rather than a decline.
The year 2017 could be the one in which a settlement of a Cyprus problem is finally found. As noted in the ‘Peace Dividend Revisited’, co-authored by Alexander Apostolides and Mustafa Besim and me, there has been a tendency to see the costs and benefits of a solution in a static way: there is an appreciation of the immediate costs, but little understanding of the dynamic benefits.
Yet a solution will unleash a large array of recurring benefits from opening up the Turkish market of 74m people to Greek Cypriots, the European Union market of 500m people to Turkish Cypriots and leveraging the new economies of scale on the island. There will also be settlement-related investment.
Using very cautious assumptions about the impact of the various factors outlined below, we projected that the difference between economic performance with a solution and economic performance without one (the ‘peace dividend’) would rise to around €20 billion at constant prices by the 20th year of a solution. Since both sides of the island collect around 23% of GDP in tax revenue, this suggests extra tax revenue at constant prices of €4.6bn by Year 20. In nominal terms (including inflation), tax revenue would be even higher.
A settlement would attract new tourists to holy sites and ancient monuments on both sides of the island, such as the Hala Sultan Tekke mosque in Larnaca and the Salamis ruins in Famagusta, while shipping, including cruise tourism, would be liberated from current constraints.
The many universities on both sides of the island could establish themselves as an EU educational centre. New flight connections would allow Cyprus to become the regional professional services hub it has always sought to be, especially if accompanied by double taxation and bilateral investment treaties.
The removal of legal impediments to property would support the real-estate sector. Construction can be expected to enjoy a boom as a result of settlement-specific investments, such as the rejuvenation of Varosha and post-settlement investment in real estate. A solution of the Cyprus problem would also unlock Cyprus’ gas potential by increasing the number of export options.