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State of the Cyprus economy in 2008

Economic OutlookA recent poll by the CFA/Financial Mirror predicts lower growth and higher inflation in 2008.

The Cyprus GDP growth rate is expected to decline below the government’s forecast of 4.0% in 2008 with inflation also seen well above the official target, as financial turbulence now faced in the US and some EU countries spreads to Cyprus, according to the first forecasting poll conducted by the CFA Society of Cyprus and the Financial Mirror.

Members of the CFA Society polled by the Financial Mirror see GDP growth in 2008 at an average of 3.84%, short of the government’s prediction that GDP growth will reach 4.0%.

Michalis Florentiades, Head of Research at Hellenic Bank, and Ioannis Georgiou, Head Capital Markets CISCO, agree with the government’s forecast of 4.0% GDP growth, but Michalis Kyrou submitted the most pessimistic forecast of 3.50% growth.

More worrisome is the forecast by all CFAs that the rate of inflation in 2008 will be well above the government’s forecast of 2.30-2.50% compared to 2% in 2007 and 2.2% in 2006. The average result of the CFA/Financial Mirror poll shows headline inflation racing by 3.38% in a range of 3.00% to 4.00%.

Oil prices, commodities, China’s growth and fluctuations in interest rates are seen playing havoc with inflation with a possible US recession the only factor seen limiting price appreciation,” noted Constantinos Papanastasiou, Head of Corporate Finance, CISCO.

The CFAs appear to be more optimistic regarding the headline unemployment target with an average 3.80% forecast, with only Demetris Nicolaou, Finance Director at D. Nicolaou & Sons agreeing with the government’s target jobless rate of 4.1%. Unemployment in 2007 was 4.3% while in 2006 the jobless rate was 4.5%.

Finance Minister Michalis Sarris has forecast that the fiscal surplus will be around 0.5% of GDP in 2008, which may increase if the government succeeds in collecting the earmarked CYP 184 mln (EUR 314 mln) in revenue from the latest tax amnesty.

The Economic Intelligence Unit, meanwhile, has revised its Cyprus GDP growth forecast for 2007 and 2008 at 4.1% and 3.7%, respectively, while it forecasts a 3.5% growth in 2009. The EIU expects real GDP growth to slow to 3.5% in 2009, as the rapid growth of bank lending (driven by demand for undeveloped land ahead of the imposition of VAT in 2008) will probably slow in 2008, reflecting the impact of VAT on borrowing, a weaker UK economy, which will dampen foreign demand for real estate, and as banks themselves find borrowing more expensive.

Euro rates

The CFA/Financial Mirror poll finds the ECB Refinancing rate, on which all loans are based at an average of 4% during 2008, but there are diverging opinions as to where interest rates are headed.

In response to our question as to where CFAs see the ECB Refinancing rate by March 2008, the average response finds the rate at 4.10% in a spread of 4.00-4.50%. By June 2008, the CFAs see the rate at 4.10% but in a wider spread of 3.75% to 4.50%, while by December 2008, the main euro borrowing rate is seen at 4.00% in a spread of 3.50-4.25%.

In another positive development, tourism arrivals are seen either flat or registering a 2% increase with revenue from tourism also seen higher.

Biggest threat…

We asked our CFAs to list the biggest threat to the economy and the majority named property prices as their biggest concern since it is obvious that if property prices stop rising and (heaven forbid) turn lower, then it would have negative repercussions for the economy in general and banks in particular.

Some of our survey participants named excessive government spending, others named imported recession and the continued credit crunch as worrisome factors. Another factor named as a major threat is that of higher inflation, which is in line with the higher than the government’s forecast of inflation.

Strongest points

Cyprus’ heavy reliance and dependence on the services sector is seen by all CFAs as the best cushion to protect the economy from external factors as our well-educated workforce combined with an excellent location, secure and friendly links with CIS countries and a competitive tax regime are seen attracting foreign investments to push the economy forward.

The introduction of the euro as official currency is also seen as a highly beneficial factor, with all CFAs agreeing that with Cyprus joining the eurozone from January 2008, there will be no currency risk, reduced country risk and certainly lower borrowing costs for the government, but not for the average consumer as it appears CFAs expect borrowing spreads to widen.