Cyprus: Country outlook

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Economist Intelligence Unit
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Economy, Outlook, Forecast, Overview
Political Geography

Cyprus: Country outlook


POLITICAL STABILITY: The president, Nicos Anastasiades, presides over a minority centre-right government, which needs to seek parliamentary support for its initiatives on a case-by-case basis. Although this support has generally been forthcoming in recent years, the imminence of the legislative election--which must be held by May--has encouraged political parties to increase their demands in exchange for their support, which has exacerbated shortcomings in policymaking. In December 2020 parliament rejected the government's draft budget for 2021 by 29 votes to 24. This was the first time that this has happened since independence from Britain in 1960. Given Cyprus's increasingly fragmented political landscape since 2016, The Economist Intelligence Unit considers it unlikely that the outcome of the forthcoming legislative election will make policymaking any easier in the future.

ELECTION WATCH: In the second round of the presidential election held in February 2018, Mr Anastasiades, who was backed by the centre-right Democratic Rally (Disy), defeated Stavros Malas, who had support from the left-wing Progressive Party of the Working People (Akel). Mr Anastasiades won about 56% of the vote. The next legislative election is due in May 2021. On the basis of the latest opinion polls, the main parties are each set to win a similar number of seats as in 2016, which would probably mean that the executive would still need to seek parliamentary support for its initiatives on a case-by-case basis

INTERNATIONAL RELATIONS: The division of the island will continue to shape Cyprus's foreign policy, particularly its relations with Turkey. In the absence of a settlement, the government of Cyprus will oppose any attempt by the EU to open accession negotiations with Turkey on the chapters that were frozen in December 2006.

POLICY TRENDS: In 2020 the government deployed an EUR899m (4.5% of GDP) emergency fiscal package to mitigate the impact of the coronavirus (Covid-19) pandemic on households and businesses. It includes EUR100m for the health sector; income support for households; wage subsidies for businesses to retain workers, grants to small firms and the self-employed, a three-month deferral of value-added tax (VAT) payments for small businesses, and a temporary VAT cut for the tourism and hospitality sector; and a debt moratorium for interest and principal repayments on loans for individuals and firms until end-2020. In October the authorities extended some of the measures until March 2021, including targeted support for businesses and the extension of unemployment benefits.

ECONOMIC GROWTH: The economic recovery following the country's financial crisis in 2013 was relatively solid. Real GDP growth averaged 4.4% in 2015-19, putting output about 10% above its pre-crisis peak. The coronavirus crisis reversed most of the gains made in recent years, as the pandemic and the measures adopted to contain it triggered a severe economic slump in Cyprus in 2020. Based on data available for the first three quarters, and our assessment of the impact on the economy of further restrictions put in place to combat a second wave of the virus, we estimate that real GDP contracted by 6.2% last year.

INFLATION: We estimate that consumer prices contracted by 0.7% on average in 2020, owing to the sharp decline in global energy prices (Cyprus is heavily reliant on oil imports), the hit to demand caused by the coronavirus and the cut to the VAT rate for the tourism/hospitality sector in July-December. The current fiscal and monetary stimulus measures have not yet fed into price rises, as people are still mostly saving rather than spending, but from mid-2021 a recovery in economic growth in the euro zone and a rise in average global oil prices this year will support inflation. Moreover, the end of the temporary VAT reduction on January 10th 2021 will result in stronger price growth in a month-on-month comparison from December 2020 and in a year-on-year comparison from July 2021 (because of base effects). In 2021-25 we expect inflation to average 1.6%--a comparatively high rate for a member of the euro zone.

EXCHANGE RATES: The euro experienced high volatility throughout 2020. Depreciation against the US dollar in the early months of the year, when the coronavirus forced European countries into lockdown, was followed by rapid appreciation after the EU announced the establishment of a new recovery fund worth EUR750bn. We forecast that the single currency will stabilise at an average of US$1.18:EUR1 in 2021 as the euro zone starts to recover. In 2022 muted inflation and growth prospects in the single-currency area will force the European Central Bank (ECB) to maintain its ultra-loose monetary policy stance for longer than the Federal Reserve (the US central bank), prompting a slight depreciation of the euro against the dollar. The euro will strengthen from 2023 onwards, supported by the euro zone's structural current-account surplus and the gradual unwinding of the ECB's PEPP.

EXTERNAL SECTOR: We estimate that the current-account deficit expanded from 6.3% of GDP in 2019 to 9.5% in 2020. The goods trade deficit narrowed sharply, reflecting the impact on imports of a contraction in domestic demand and lower international energy prices. However, this was offset by a significantly smaller services surplus, on the back of a collapse of travel and transport earnings from tourism and shipping.

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