Economic Progress Report

26 Oct 2017

Economy: opportunities and challenges
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A brief overview of the economy, its strenghts, opportunities, and challenges. By Glafkos Mavros

With the exception of the banking sector, the Finance Minister has good reasons to be satisfied with the current economic developments. Following dramatic and unprecedentedly difficult conditions in the last three years - which saw a cumulative reduction of 10.5% in GDP between 2012 and 2014 – the economy, it appears, is finally looking upwards.
 
Economic Growth is currently running at a very high rate; we are expecting GDP to reach 3.5% by year end and probably beyond that. We are experiencing a flourishing tourist sector for the second consecutive year, with the sector currently recording an annual increase of 18%. Meanwhile, developments are currently driven by improvement and a strong sentiment for consumption and gross fixed capital formation, which is expected to continue driven from the encouraging results of Q1.
 
Further, labour market conditions have improved: the latest announcement put unemployment figures at a 5-year low (currently standing at 10.8% or the lowest since March 2012). Further de-escalation of unemployment is expected in the next few months as well.
 
Property market stabilization is expected to improve still further, strongly supported by the latest figures of building permits. These have recorded an increase of 10% as of June 2017 compared with 2016. Property sales up to May 2017 went up by 17% compared with same period in 2016. 60% of this increase is attributed to the international market and the very attractive program for citizenship currently in place. There have, of course, been some recent negative comments in the international press, but the scheme has generated almost €5bn.
 
Special reference must also be made to the successful launching of the first sovereign transaction in the international capital market in 2017 and the raising of €850mn 7-year Eurobond with a coupon of 2.750% and a yield of 2.8%.
 
Another positive development concerns the latest sovereign rating by S&P, the international rating agency that affirmed the rating of the Cyprus economy on 18/09/2017 at BB+/B, while revising the long-term rating to positive from stable. The agency also stated that it could consider raising the rating over the next 12 months, provided of course that all the budgetary considerations announced recently by the Finance minister are met and the economy continues its recovery path and achieves growth rates to pre-crisis levels. That said, the above rate is still just one notch below investment grade. Fitch and Moody’s have kept the Cyprus economy three grades below investment status.
 
It would seem, then, that we are experiencing a healthy macroeconomic environment, which itself is expected to improve the attractiveness of the Cyprus economy to foreign investors. The recent very successful Foreign Investors Summit organized recently by CIPA in Limassol attracted more than 150 potential international investors and foreign funds – yet another proof of Cyprus’s continued attractiveness.
 
The government still faces a number of challenges, however.
 
The recently-announced balanced budget by the Finance minister must be maintained at any cost. This is of paramount importance for the rating agencies to further upgrade our economy to the much desired investment grade, which would allow borrowing from the international capital markets at low interest rates. In view of the current government debt, which still stands at the negative rate of about 107% of GDP, the wisdom of the recently-announced government intention for new employment positions in the public sector, as well as the planned additional expenditure in various sectors of the economy, must be debated. The government must ensure that its policies do not threat planned balanced growth.
 
There is also the persisting problem of non-performing loans, currently stranding at almost €24bn on local operations or 47.0% of all outstanding loans of €44.4bn (May 17). The inability of our banks to successfully achieve bankable restructuring solutions for their borrowers creates a serious and persisting exposure for our financial institutions, which is expected to stay with them for some years still to come. The recent warning of CBC must be taken into account.
 
Another serious problem, which admittedly has been with us for many years, is the persisting leverage private sector. Domestic households continue to be highly indebted with the domestic private non-financial debt standing at the astonishing negative record of 273% of GDP by the end of 2016 – the highest among all countries within the Euro area. There was a slight reduction by 3% recently due to the banking deleveraging process which is currently in place, but the problem and all its negative implications are still there.
 
Repossession of properties by banks, commonly known as Debt to Asset, appears, for the moment, to be the only effective way to reduce NPEs. This might create a dangerous market oversupply, of course, since the banks will soon benefit from the recently enacted Property repossession laws. This will exert a downward pressure in the property market, which is just starting to recover from the deep depression of the last five-six years.
 
A critical reduction will be observed on bank loans collaterals, creating at the same time an obligation to increase their provisions as per the ECB directives presently in place. This in itself will negatively affect their capital adequacy, creating an additional obligation on their shareholders to increase the Tier 1 capital of the banks.
Based on the above, we can safely conclude that the economy has recorded remarkable improvements over the last two years and that this is largely due to firm and decisive governmental policies (implemented by the Finance minister), which have included amending essential tax laws and introducing new investment relaxation policies to attract foreign investments.
 
We must not estimate challenges and the negative features of our economy, which constitute a real threat to our efforts for a final recovery and our return to the international markets the soonest possible.

 
 

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