The report said “although the biggest banks have passed stress tests after successfully raising capital, the sector’s non-performing loans have continued to rise (to over half the total). At the same time, new foreclosure procedures have been delayed in parliament. Bad debts will continue to restrain domestic credit growth and household and small-business spending even after the recession ends.”

EY warned that Cyprus’ bailout conditions require continued tightening of fiscal policy in 2015–16, constraining recovery and leaving it largely dependent on exports.

“Although cuts in the state wage bill have kept the budget on track for primary surplus in 2016, the tightened capital budget means only a muted return to fixed investment growth in 2015,” it said.

With hourly wage costs down by 4.5% on the year (and total hourly costs down by 3.9%) in Q2, the resulting competitiveness gains will help to support an acceleration of export growth in 2015–18, the report said. But a corresponding rebound in imports will prevent any move into current account surplus, meaning a need for continued direct and portfolio investment inflows.

“Price deflation at the end of Q3 reflects on going constraints on consumer spending, and fear of further falls will hold back investment recovery in 2015. The return of moderate inflation, forecast to average 0.7% in 2015 and climb to 2% by 2018, will promote recovery by reducing real interest rates and gradually lowering the real burden of debt.”

The EY forecast added that “although the impact of Russia’s European Union export ban has been limited, minimal growth in the Russian economy in 2014–15 is likely to hold back the Cypriot economy by delaying the recovery of bank deposit inflows.”

Indicating a “cautious return to growth in 2015,” the EY report said “after three years of recession, the economy is on course to return to growth in 2015, as a revival in export growth leads to a resumption of investment.”

It added that although further drops are expected in the next few quarters, growth is forecast to resume by mid-2015, underpinned by this year’s further reduction in the current account deficit to just 0.3% of GDP, a sharp improvement on the unsustainable double-digit deficit in 2012. It will also feature a return to positive price inflation, after the brush with falling prices during 2014. Public spending will continue to decline in 2015, as the bailout conditions imposed by the International Monetary Fund (IMF) and the EU force the government to continue targeting a return to primary budget surplus by 2016. However, the relaxation of budget pressures from 2016 will allow an acceleration of investment growth, lifting it to around 7% by 2018.

The growth outlook remains extremely subdued given the severity of the 2008–09 recession, and the brevity of the recovery that followed it before the latest downturn began in 2011. GDP remains well below the pre-crisis level, despite an upward revision under new Eurostat methodology.

Moreover, risks to the forecast remain firmly on the downside, the EY report concluded.

Source: Financial Mirror