Overcoming the challenges of recent years, Cyprus has continued on a solid growth path and maintained its status as one of the fastest growing eurozone economies. With strong fiscal performance and new large-scale projects in the pipeline, the small EU country has exceeded international expectations and kept a steady pace in improving efficiency, implementing reforms and boosting investor confidence.
Cyprus has reclaimed its status as a self-determining and thriving economy. Having shown remarkable resilience following the financial crisis of 2013, it implemented tough austerity measures to restructure and diversify its economy and was able to exit the economic adjustment programme earlier than scheduled in 2016. Economic growth has surpassed all expectations in 2015-17, with the priority now shifting to ensure that the recent strong growth momentum is maintained
A History of Resilience
Cyprus gained independence from the UK in 1960, became a member of the EU in 2004, adopted the euro as its national currency in 2008 and was listed by the IMF as one of the 31 advanced economies in the world in 2016. roughout its history the Cyprus economy has experienced external shocks that have been followed by astonishing revival. The Greek sponsored coup d’ tat and subsequent Turkish invasion in 1974 of the northern part of the island led to a sharp real GDP contraction of 16.9% in 1974 and 19% in 1975. But hard work and collective focus led to a rapid bounce back, with growth of 18.2% in 1976 and 15.8% in 1977, followed by an uninterrupted period of strong growth lasting more than 30 years.
Since independence, the economy has gone through several transformations: from an exporter of minerals and agricultural products in 1961-73, an exporter of manufactured goods from the late 1970s to the early 1980s, to transforming into an international tourist, business and services centre since the 1980-1990s. Classified by the World Bank as a high income country, today the economy is mainly built upon the services sector, including tourism, financial services and real estate, which accounts for over 80% of both total GDP and employment.
The island went through yet another transformation in 2013, when at the height of the eurozone sovereign debt crisis Cyprus became the h EU member state to request a financial assistance package from the European Commission (EC), the European Central Bank (ECB) and the International Monetary Fund (IMF) – collectively known as the Troika. Cyprus recovered quickly from the €10-billion bailout deal and the controversial and unprecedented decision by the Eurogroup to impose a bail-in of bank deposits. The country exited the programme in early March 2016, having only drawn €7.2 billion of the €10 billion available, and cut its debt/GDP ratio below 100% in 2017. Restructuring the economy and restoration of credibility in Cyprus’ banks has been a top priority – and true to form, the country’s economic recovery has been faster than many first projected.
Back to Investment Grade
Cyprus’ speedy return to the international markets was a positive step towards restoring confidence and credibility in the eyes of the international business community. Successful bond issues raising over €3.8 billion, successive upgrades by international rating agencies and stabilisation in the banks have all contributed to stronger investor interest in Cyprus. A further boost in confidence came in September 2018, when after more than six years Standard & Poor’s upgraded Cyprus’ sovereign rating back to investment grade. Assigning the BBB- rating S&P also stated Cyprus has a stable outlook, while the country’s Finance Minister Harris Georgiades said strong economic growth is anticipated through 2021.
Despite the harsh terms of Cyprus’ international lenders, the country has taken full advantage of the tough supervision and reform programme to correct fundamental weaknesses in its financial system. A successfully recapitalised banking sector passed comprehensive and rigorous ECB stress tests and has stabilised after the turmoil of the 2013 bail-in. Liquidity and solvency in the banking system have improved significantly, with deposits increasing by more than €3 billion in 2016-17, allowing the full repayment of Emergency Liquidity Assistance (ELA). In addition, proactive measures combined with insolvency and foreclosure legislation has led to a reduction of more than €6.5 billion in non-performing exposures between 2015 and 2017.
Non-performing loans (NPLs) remain one of the biggest challenges for the banks and 2018 marked a watershed in efforts to tackle this. Major initiatives included the sale of mainly performing loans of the Cyprus Cooperative Bank to Hellenic Bank, the establishment of a state-owned ‘bad bank’ to handle the rest, and a new programme for supporting the most vulnerable borrowers. In addition, credit rating agencies welcomed a major set of laws passed in July 2018 that have significantly strengthened the legal framework for tackling NPLs, allowing for the securitisation of loans and the speeding up of loan recovery rates. Even before these laws, the drop in NPLs in Cyprus is proportionately the fastest in the EU.
Robust GDP Growth
The Cyprus economy has been expanding rapidly, with growth accelerating since 2015. The island was among the top five Eurozone performers in 2017, with an impressive growth rate of 3.9% in 2017, compared with an EU average of 2.5%. The European Commission predicts a growth rate of 3.2% in 2018 and 2.8% in 2019. The upturn is being driven by both strong private demand, spurred by expanding employment, and three successive years of record tourism arrivals.
Unemployment is set to continue its decline. The unemployment rate started to fall in the first half of 2015, averaging 14.9% in that year. It dropped to 13% in 2016 and 11% in 2017. The unemployment rate was 8.2% in June 2018, which is the sixth lowest in the EU according to the European Commission’s statistical office. Youth unemployment continues to be a serious challenge but fell from a peak of 38.7% in 2013 to 22.3% in March 2018. Cyprus’ medium-term goal is to reach full employment conditions by 2020.
Trade & Investment
More than half of Cyprus’ trade in goods is done with the European Union, and the country has achieved strong numbers in recent years for exports of both services – €9.9 billion in 2017 from €8.1 billion in 2014 – and domestically produced goods – €1.25 billion in 2017 from €735 million in 2014. Cyprus’ main export partners for goods are Greece and the United Kingdom, while Israel has recently started to compete with other countries for third place. The main domestic export commodities are pharmaceutical products, raw and manufactured food products, and scrap products. The three leading import partners are Greece, the United Kingdom and Italy. The island mainly imports hydrocarbons, machinery, chemicals, vehicles, and iron and steel.
As a small open economy that is currently dependent on energy imports, Cyprus’ trade balance is traditionally in deficit, while its services balance is normally in surplus. After a recession-driven divestment in 2013-14, foreign direct investment (FDI) liabilities (reflecting investment into the country) turned positive, reaching €7.4 billion in 2015, €2.4 billion in 2016 and €9.4 billion in 2017. In 2017, net FDI (net of assets, or outward investment) was a negative €398 million, reflecting outward investment (an increase in assets abroad). A range of new initiatives under way are attracting more investment and there is renewed investor interest in large-scale developments. Legislation establishing new deputy ministries for shipping in 2018 and tourism, expected in 2019, will also provide for increased focus on key growth sectors.
Recently approved tax measures have further improved the long-established comprehensive and transparent character of the Cypriot tax frame- work. The new measures, which are fully aligned with EU directives, support the promotion of economic development by encouraging the intro- duction of new equity capital as an alternative to excessive debt financing – Notional Interest Deduction (NID) regime on equity – and encourage the creation of business substance by offering compel- ling advantages to individuals from a personal tax perspective, including benefits for non-domiciled individuals. Tax incentives for intellectual property, innovative small and medium-sized enterprises (SMEs), start-ups and film production were also introduced in 2016 and 2017. These incentives will further improve Cyprus’ international competitiveness as a location of choice for multinationals seeking to do business in the EMEA region.
Main Economic Activities
Cyprus is a small and adaptable free-market economy with a positive long-term outlook. The island promotes itself as the business gateway between Europe, Asia, the Middle East and Africa, and leverages its highly educated, English-speaking population. Its EU and eurozone memberships, excellent information and communications technology (ICT) infrastructure and business-friendly environment continue to attract international companies and investment – particularly in natural gas exploitation following the discovery of significant reserves in Cyprus’ waters. Company formation, tax planning, trusts, foreign exchange trading and fund administration are all strong segments of the business services industry, encouraged by a network of double tax treaties with over 60 countries and a legal system based on English Common Law.
The key instrument of Cyprus holding companies has attracted hundreds of thousands of companies to set up and channel their investments into key markets through the island. Despite the challenging economic climate in 2012-14, the attraction of Cyprus has not faded, and the number of applications led for registrations of new companies has seen a solid increase since 2014. The developing funds industry, which is evolving into a multibillion business for Cyprus, is also placing the island on the map as an exciting emerging market. Professional services continue to be one of the country’s most consistently growing sectors, rising on average by 5.1% per year in 2015-17.
Cyprus hosts the largest third-party ship management centre in the EU, underlining the success of the country’s formidable maritime sector. The Cyprus Registry is classified as one of the top ten merchant fleets in the world and ranks as the third largest fleet in the EU. Flying its flag are more than 1,600 ships, totalling a gross tonnage of around 23 million.
The tourism sector has shown solid growth and 2017 saw a third record year for tourist arrivals. Efforts to upgrade the product could lead to a renaissance of the industry, which currently contributes over 13% to GDP. After a long decline, construction has also been rebounding, growing by 25% in 2017.
Although traditionally strong, primary sectors such as agriculture and manufacturing – contributing around 2% and 4.4% respectively to GDP – have faced challenges which have led both to follow a similar strategy of creating value-added products targeting niche markets willing to pay a premium for quality. Both sectors of the economy have placed strong focus on innovation and diversification, which has supported the industries’ efforts to increase productivity.
Energy will be a significant new source of growth, following the discovery of natural gas reserves in Cyprus’ EEZ. The island has ambitious plans to become a regional energy hub in the eastern Mediterranean and the successful extraction of natural gas from its waters could allow the island to export to European or East-Asian markets. The already-established involvement of major oil and gas companies in Cyprus, such as US energy giant ExxonMobil, French energy major Total, the Italian-Korean consortium ENI-Kogas, and the UK-Dutch company Royal Dutch Shell, have strengthened the development of these plans coming to fruition. The sector saw a further vote of confidence during the third licensing round in 2016, when Total, ENI and US major ExxonMobil all made bids for off-shore blocks and were awarded licences. New large discoveries have already been made as a result of these licences.
Privatisation and New Projects in Cyprus
Cyprus has recently embarked on several major projects to upgrade and expand its tourism offer. One of the most exciting developments is the licensing of Cyprus’ first-ever integrated luxury casino resort, which was awarded to a consortium including the globally renowned Melco and Hard Rock – with Melco later buying Hard Rock out of the project. The €550-million resort – branded ‘City of Dreams’ – will be located in Limassol and started operations in 2018, with a fully operational resort expected in 2021. Government chiefs expect the project could increase tourist numbers by up to 500,000 and create thousands of job opportunities. Several new marinas are also planned in key coastal towns of Cyprus, with luxury marina complex Limassol Marina already attracting record sales and the Ayia Napa Marina already under construction with significant Egyptian investment. Cyprus also commercialised services at Limassol port in 2016, while other potential prospects for future privatisation are the State Lottery and dominant telecommunications provider Cyprus Telecommunications Authority (Cyta).
The headline budget balance recorded a surplus of 1.7% of GDP in 2017, while the primary balance (balance excluding interest payments) reached a large 4.4% of GDP. Both of these surpluses were larger than projected. The government intends to maintain both a general government and a primary budget surplus in 2018. Cyprus’ debt-to-GDP ratio peaked in 2015 and dropped below 100% of GDP in 2017, thanks to early repayment of Central Bank and IMF debt. While debt is expected to rise in 2018 owing to expenditure relating to the closure of the Cyprus Cooperative Bank, the most recent IMF forecast envisages the debt ratio falling back below 100% of GDP in 2019. Ongoing structural reforms are expected to put long-term public finances on a more sustainable path at the same time as improving competitiveness.
Inflation has been muted in recent years. After declining by 1.2% in 2016, owing to low oil prices and historically high unemployment, the EU-harmonised consumer price index rose by just 0.7% in 2017. It is expected to rise by 1.2% in 2018 and to 1.3% in 2018, according to the European Commission. After four years of decline, earnings have stabilised, and wage developments are expected to begin warming up slowly in 2018 and 2019.
The next main challenge for the Cyprus economy is to ensure that the robust growth of 2015-17 can be maintained. Fiscal discipline has already brought the debt-to-GDP ratio below 100%. The key challenges that remain are to further reduce high levels of non-performing loans (NPLs), to follow through with further implementation of structural reforms that will increase the efficiency and effectiveness of the public sector and improve Cyprus’ attractiveness as an investment destination. The legal framework for foreclosures and insolvency, passed at the end of 2015 and bolstered in 2018, has borne fruit supporting banks with loan restructuring and reviving the economy. Although there are still challenges ahead before Cyprus can declare that it has fully put the crisis behind it, there is growing confidence and interest from foreign investors in the country. The significant boost in the tourism sector, the rapidly developing investment fund sector and the discovery of significant quantities of natural gas in Cypriot waters raise the prospect of a transformation of the Cypriot economy in the medium to long term.
Cyprus Settlement Opportunities
Research suggests that a solution of the Cyprus Problem could bring an additional ‘peace dividend’ of €20 billion, through an expansion of markets in areas such as tourism, shipping and professional services. It would also attract more foreign investment, boosting the economy and creating new employment opportunities for the young. A solution would also open up substantial opportunities for energy, especially given the synergies available from regional cooperation on hydrocarbons.
Strong Economic Performance
Cyprus has an open, free-market, service-based economy with a long record of successful economic performance. Its strong business environment, highly educated workforce and favourable and stable tax regime have remained in place and allowed the country to pass quickly through the crisis. Looking ahead, with measures ongoing to reform public spending, accelerate initiatives to boost investment, develop the investment fund sector and a push forward with natural gas exploitation, Cyprus is ensuring that its prosperity endures.
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