EC forecasts strong growth momentum for Cyprus, fears about public wages, GHS cost

May 7, 2019 at 5:04pm

Cyprus’ economic growth is expected to remain strong, driven by domestic demand, but downside risks are on the rise, according to the European Commission`s Spring Economic Forecasts, which were discussed today at the College of Commissioners and presented by Pierre Moscovici in Brussels.

According to the forecast for the Cyprus economy, GDP will continue to grow at 3.9% in 2018, 3.1% in 2019 and 2.7% in 2020, while unemployment will drop from 8.4% 2018 to 6.7% in 2019 and 5.9% in 2020.

Debt is down from 102% in 2018 to 96.4% in 2019 and 98.9% in 2020 while the -4.8% deficit in 2018 is again turning into a surplus of 3.0% in 2019 and 2.8% in 2020 without a policy change .

The Commission warns against negative risks to the financial perspectives related to “uncertainties about the macroeconomic outlook, the effects of court decisions on past measures on public sector wages, and the potential shortage of public healthcare providers first years of the national health insurance scheme “.

Cyprus’ economic expansion is set to remain robust, driven by domestic demand, but risks are tilted to the downside. Inflation is forecast to remain subdued.

The budget is expected to return to surplus and public debt to steadily decline from 2019 onwards. Risks to the fiscal outlook are also mainly on the downside.

Solid growth but increased downside risks

Cyprus continues to enjoy a remarkable post-crisis rebound with real GDP growth of 3.9% in 2018. Growth is forecast to ease to 3.1% this year and 2.7% in 2020 as the external environment turns less favourable and the private sector continues to deleverage.

Private consumption remains a key growth driver due to rapid employment growth. Employment in 2018 rose by 4% and more recent labour market indicators remain favourable. The unemployment rate fell to 7.1% in February 2019, with a significant reduction in long-term unemployment.

Wages increased moderately over the previous year and are set to continue rising, with employers in several sectors scheduled to renegotiate wages with unions amid tightening labour market conditions.

Public consumption is also set to provide support to growth, driven by the automatic indexation of public wages, wage increments and the unfreezing of promotions.

Investment is forecast to be robust, growing more strongly than the overall economic activity. An important part of investment comes from ongoing tourism-related projects.

Other investment projects relate to residential construction, with half of all transactions in the sector driven by foreign demand, which in turn is supported by the Citizenship by Investment programme. Finally, a large share of investment in Cyprus is associated with ship registrations. These are inherently volatile but more likely to increase following efforts to strengthen the shipping sector in the country.

Net exports are projected to be a drag on economic growth. Imports are set to increase reflecting the large import content of domestic demand.

Meanwhile, exports in Cyprus are dominated by services and the largest share of services is linked to tourism. The outlook of tourism-linked services is clouded by the recent bankruptcies of several airlines servicing Cyprus, slowing global demand, fierce competition, and high Brexit-related uncertainty (UK citizens account for more than a third of all tourists).

Risks to the outlook are tilted to the downside. As a small open economy, Cyprus would be exposed to strong headwinds from slowing global growth. The economy’s heavy reliance on foreign funding also leaves it vulnerable to external developments.

Headline HICP inflation in 2018 was 0.8%, almost the same as it was in 2017 (0.7%). Inflationary pressures came mainly from energy and unprocessed food categories, while core inflation fluctuated around zero. Two factors seem to provide some explanation for this.

First, the increasing competition among wholesalers, retailers and internet platforms, as well as the absence of legislation on when shops can offer sales, is weighing on prices.

Second, although the unemployment rate has fallen sharply in recent years, the fastest job creation occurred in low-paid sectors and there is still significant slack in the labour market to be absorbed. Inflationary pressures are thus expected to remain subdued.

The general government headline balance is expected to return to surpluses of around 3% of GDP in 2019 and 2020, after posting a temporary deficit of 4.8% of GDP in 2018. This was entirely due to the one-off support measures related to the Cyprus Cooperative Bank sale.

The underlying fiscal performance is projected to remain strong, on the back of the supportive macroeconomic environment and the improving labour market.

The general government surplus is forecast to reach 3.0% of GDP in 2019. Revenue is forecast to continue increasing, mainly as a result of a sizable rise in social security contributions, partly offset by a reduction in the excise duties on fuel and the revision of vehicle taxation. Compared to public expenditure net of one-offs in 2018, expenditure is forecast to rise at a higher rate than revenue.

This is mostly due to deficit-increasing measures, such as the gradual increase in public wages to reverse wage cuts implemented after the crisis, the Estia scheme to support non-performing loan repayment and the government’s support for low-income pensioners.

The forecast takes into account the start of contributions to the national health insurance system as of March 2019 and the inclusion of the two entities resulting from the sale of the Cyprus Cooperative Bank within the general government sector. Under a no-policy-change assumption, the general government surplus is forecast to narrow slightly to 2.8% of GDP in 2020.

The structural budget surplus is set to decline over the forecast period from 2% of GDP in 2018 to around 3⁄4% in 2020, mainly due to the positive output gap.

The main downside risks to the fiscal outlook relate to uncertainties surrounding the macroeconomic outlook, the outcome of court rulings on past measures concerning the public sector wage bill and the potential deficit of public healthcare providers during the first years of the national health insurance system. Positive cash balances from the resulting CCB entities constitute an upside risk.

After increasing considerably to 102.5% of GDP in 2018, due to the government’s one-off support for the Cyprus Cooperative Bank sale, public gross debt is forecast to steadily decline to below 90% of GDP by 2020. The decrease is mainly due to projected primary budget surpluses and strong nominal GDP growth.