Cyprus` unemployment rates will further decline to 9.0% in 2018 and 7.1% in 2019 (11.1% in 2017) according to the Spring Economic Forecast of the European Commission, published today in Brussels. According to the same forecast, public debt will rise again to 105.7% in 2018, only to decline to sub 100% (99.5%) levels in 2019 (in the no policy change scenario), while Cyprus` budget will remain on the positive side with overall surpluses of 2.0% and 2.2% for 2018 and 2019. GDP will continue growing by 3,9% in 2017, 3,6% in 2018 and 3,3% in 2019.
The European Commission foresees that the “strong growth momentum continues” in the coming years, but, downside and upside risks widen.
According to the spring forecast, “recent developments in the financial sector have widened the risks to the outlook”, as tourism faces both upside and downside risks, and gas exploration projects could further support the outlook in the short to medium term.
More specifically the Commission says that “while the recently expanded air transport and accommodation capacity brightens the sector’s prospects, the reopening of neighboring markets for this season increases competition and at the same time, even stronger investment than currently foreseen and advancement of gas exploration projects could further support the outlook in the short to medium term.”
The Commission recognizes that Public debt fell significantly in 2017, however, it is expected to rise by around 8 points of GDP in 2018 to 105.7%, “due to the government’s operations with the CCB, which included the issuance of bonds of EUR 2.35 bn, the proceeds of which were deposited with the CCB”. Public debt is projected to steadily decline thereafter, “mostly owing to the projected primary surplus and strong real GDP growth”, says the EC.
Overall according to the Cyprus chapter of the forecast, “economic growth is expected to be strong, fuelled by foreign-funded investment and solid private consumption, unemployment has fallen below 10% and is expected to continue decreasing, inflation remains very low and is set to stay moderate, the budget surplus is projected to further improve, although risks to the fiscal outlook remain and public debt is expected to increase in 2018 but to decline again in 2019.”
The Commission states that after strong growth of 3.9% in 2017, early hard data and survey indicators point to robust growth in the first quarter of 2018. “The growth momentum is expected to continue with GDP forecast to expand by 3.6% in 2018 and 3.3% in 2019, underpinned by strong domestic demand. Net exports, by contrast, are projected to have a negative impact on growth”.
Furthermore, “private consumption accelerated in 2017, as rapid employment growth and low inflation provided a boost to households’ real disposable incomes, most sectors of the economy have markedly increased the number of employees, the unemployment rate fell below 10% in early 2018 and employment expectations and consumer confidence are on the rise, supporting the outlook”, says the European Commission report, but warns that inflation will remain subdued: “after a very modest 2017, inflation was surprisingly weak in the first quarter of 2018 (-0.9%), with all components, except services, in negative territory.”
“While some of the deflationary pressures came from one-off factors, notably in unprocessed food category, stronger competition among suppliers keeps prices in Cyprus low”, says the report, and foresees that “inflation is expected to rebound somewhat, driven by energy and service prices, but to remain low at 0.7% for the year as a whole before increasing moderately to 1.2% in 2019”.
According to the report, investment becomes the engine for growth as in 2017, investment surged further, strongly supported by construction, as the tourism boom has created additional demand for accommodation and other infrastructure, while new residential construction also increased.
The report states that “investment in equipment has been even stronger, mainly as a result of the growth in ship registrations”, and “the near- term outlook for investment is very positive, supported by foreign-funded large-scale projects”, while “a gradual revival of new bank lending is expected to lift investment further.”
Furthermore, “amid strong domestic demand, imports increased sharply in 2017, outweighing the healthy growth of exports and leading to a marked widening of the current account deficit.”
The Commission finds that “activities of special purpose entities, particularly linked to ship registration, heavily influence the current account in Cyprus, determining a very large share of its deficit” and warns that “a further deterioration of the current account is projected in both 2018 and 2019 due to the high import content in investment and consumption, which should outweigh the forecast increase in service exports.”
“General government surpluses increasing further, but risks to the outlook remain.”
When it comes to public finances the Commission registers the primary balance of 5.0% of GDP in 2017, “one of the highest in the EU”, attributing it “to high tax collection, in particular of VAT, social security contributions and corporate income taxes”. “In structural terms, this corresponds to a surplus of about 11⁄2% of GDP”, states the EC.
“In 2018, the headline and primary surpluses are forecast to remain high at 2.0% of GDP and 5.0% of GDP respectively”, mainly explained by the “expected good performance in revenues underpinned by the positive economic outlook and the improving labor market.”
Both total revenue and total expenditure are forecast to increase (by around 4% each), but they are set to marginally decline as a percentage of GDP (to 39.6% and 37.6%, respectively).
Finally Downside risks to public finances stem from:
– the absence of a mechanism regulating public sector payroll growth from 2019 onwards,
– the potential additional costs of the national health system reform and the contingent risks from the high proportion of NPLs in the banking sector and
– uncertainties on the budgetary impact of the government’s transaction on 3rd April 2018 related to the Cyprus Cooperative Bank (CCB).