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Republic of Cyprus - Economy

The discovery of significant amounts of hydrocarbons in Cyprus’ Exclusive Economic Zone (and in the surrounding Eastern Mediterranean region) continues to generate excitement within the government and private sector, and fosters realization that additional FDI is required for Cyprus to fully realize its potential in hydrocarbons development. U.S. energy companies Noble Energy’s and ExxonMobil’s exploration and eventual commercialization of Cypriot natural gas present an opportunity for additional U.S. FDI in energy services and associated sectors.

Cyprus can also serve as an energy services hub for hydrocarbons projects in the Eastern Mediterranean region – a safe and secure base with shipping and air connectivity, and an EU-connected banking and financial sector conducive to regional projects. Cyprus – with EU financial support – is the project base and hub for the EuroAsia Interconnector undersea electrical cable which will connect Israel, Cyprus, and Greece to the EU grid, and another similar project connecting Africa through Cyprus to the EU. Other energy projects – within Cyprus and connecting the region – involve pipelines and LNG import and export infrastructure. Both CIPA and the Ministry of Energy, Commerce, and Industry (MECI) prioritize, and help facilitate investment in the energy and energy-related services sectors.

Cyprus has an open, free-market, services-based economy with some light manufacturing. Cyprus' accession as a full member to the European Union as of May 1, 2004, was an important milestone in its recent economic development. It introduced the euro in 2008. The Cypriots are among the most prosperous people in the Mediterranean region. Internationally, Cyprus promotes its geographical location as a "bridge" between three continents, along with its educated English-speaking population, good airline connections, and telecommunications.

The north is a separate entity that is only recognized by Turkey as the Turkish Republic of Northern Cyprus. Turkey remains, by far, the main trading partner of the area administered by Turkish Cypriots, supplying 70% of imports and absorbing around 50% of exports (2008 figures). In another landmark case, the European Court of Justice ruled in 1994 against the British practice of importing produce from the area based on certificates of origin and phytosanitary certificates granted by "TRNC" authorities. This decision resulted in a considerable decrease of Turkish Cypriot exports to the EU--from $36.4 million (or 66.7% of total Turkish Cypriot exports) in 1993 to $17.2 million in 2008 (or 20.5% of total exports).

In the past 20 years, the economy of the Republic of Cyprus has shifted from agriculture and light manufacturing to services. Currently, agriculture makes up only 2.4% of the GDP and employs 7.5% of the labor force. Industry and construction contribute 19.0% and employ 20.4% of the labor force. The services sector, including tourism, contributes 78.6% to the GDP and employs 72.1% of the labor force. In recent years, the services sector, and financial services in particular, have provided the main impetus for growth, while tourism has been declining in importance. Manufactured goods account for 58.3% of domestic exports, while potatoes and citrus constitute the principal export crops. The island has few proven natural resources, although it is now gearing up to begin exploration for natural gas off its southern coast. Trade is vital to the Cypriot economy and most goods are imported. The trade deficit increased in 2008, reaching $9.1 billion. Cyprus must import fuels, most raw materials, heavy machinery, and transportation equipment. More than 67% of its imports come from the European Union, particularly Greece, Italy, and the United Kingdom, while 1.7% come from the United States.

GNP growth rates have gradually begun to decline as the Cypriot economy has matured over the years. The average rate of growth went from 6.1% in the 1980s, to 4.4% in the 1990s, to 3.1% in the 2000s. GDP fell significantly in 2009, as the effects of the global crisis hit Cyprus. It is estimated that the economy contracted by 1.0%-1.5% in 2009, compared to positive growth of 3.8% in 2008. The outlook for 2010 remains negative, with a growth forecast of barely 0.5%, below that of the EU average. Public finances also recorded a sharp deterioration in 2009, deviating considerably from the government's earlier predictions. The government's hopes of containing the deficit below 3.0% were dashed, as 2009 closed with the deficit running at 6.1%, from a surplus of 0.9% in 2008.

The outlook for the deficit in 2010 and beyond remained uncertain, pending the outcome of the government's ongoing efforts to contain spending and boost revenue. Total public debt grew from 48.4% in 2008 to 55.2% in 2009, and is poised to reach 60% in 2010. Amidst the turmoil, the banking sector on the island is holding up quite well, largely thanks to conservative banking practices domestically and a prudent Central Bank. Inflation was contained to 0.3% in 2009 (lowest since 1965), and unemployment shot up to 6.2% (highest since 1976 for Cyprus, although still moderate by EU standards).

In 2010, the Cypriot economy expanded by 1.0%, buoyed by a rebound in tourism and financial services, following a 1.7% contraction in 2009 in the aftermath of the global financial crisis. However, Cyprus' path to recovery is still fraught with difficulties. Structural rigidities in the labor market undermine Cyprus' competitiveness in most sectors, while a bloated civil service poses special challenges. Tourism, once the engine of growth for the island, has been stagnating over the last decade, facing stiff competition from the region. Most analysts agree that Cyprus will find it difficult to reach growth rates in excess of 2.0%-2.5% in the coming years--considerably lower than the 4.0% growth average recorded in the decade preceding the 2009 crisis.

The state payroll represents about 30% of public spending annually. The government pledged to engage civil service unions in a discussion to effect wide-ranging cutbacks, including seeking union agreement on shaving €70 million (approx. $96 million) off the civil service payroll over 2 years (2011 and 2012) and discussing civil service pension reform. Civil service employees do not contribute toward their own pensions, but this may have to change in order to safeguard the long-term viability of the social security system.

In early 2012, all three major credit rating agencies downgraded Cyprus (both its sovereign debt and its main banks) over concerns of fiscal slippage and exposure of the Cypriot financial system to the Greek market and debt. The banks' combined total assets are eight times as high as Cyprus's yearly economic output. In comparison, the European average is 3.5. These interest-bearing deposits account for 70 billion euros, and more than half of that money comes from abroad, primarily from Russians and British nationals. These downgrades effectively place Cyprus only marginally above the Eurozone's most troubled countries (Greece, Portugal, and Ireland). Inflation remained stubbornly above the average EU 27 level at 2.6% in 2010, a trend continuing in 2011. Unemployment remains below the average EU level, but its 2012 level of over 7.0% is a 35-year high for Cyprus.

In July 2012 Cyprus asked Russia for a five billion euro loan to partially cover its budget deficit. Cyprus needed the funds to recapitalize local banks which are under stress due to the eurozone debt crisis. International rating agency Moody’s cut the ratings of Cyprus’s two largest banks, Bank of Cyprus and Hellenic Bank, in June 2012, and put the island’s third largest bank, Cyprus Popular Bank, on review for a possible downgrade. By early 2013 it appeared that Russia was likely to extend a credit of 2.5 billion euros until 2021 and was willing to lower the interest rate.

According to Russian state statistics agency Rosstat, Cyprus businesses invested $78.2 billion (60.4 billion euros) in Russia in 2011 alone. That is almost three times as much as Cyprus's investments in Germany. The small EU country is by far the largest investor in Russia and accounts for almost half of all foreign investments. That is by no means Cypriot money. The invested funds were Russian money that gets re-invested via Cyprus. Cyprus, with its low tax rates, is considered an important station for Russian cash flows. Cyprus is where Russians transfer money in order to protect it against the grip of the Russian state.

The European Union and the IMF agreed on 16 March 2013 to bail out Cyprus’ debt-laden economy and grant the island nation a loan worth 10 billion euros ($13 billion) in return for the government’s obligation to tax all deposits kept at Cypriot banks. Under the terms of the bailout deal, Cyprus would have to impose a levy of 6.75 percent on deposits of less than 100,000 euros and 9.9 percent on deposits with greater amounts. Cypriots reacted with shock and rushed to cash machines to withdraw their savings, but many machines refused to pay out. Cypriot President Nicos Anastasiades said he had to choose between the “catastrophic scenario of disorderly bankruptcy and the scenario of a painful but controlled management of the crisis.”

Cyprus failed twice to raise the funds needed to secure a $13 billion emergency loan. Cyprus's government proposed changes to the EU's rescue plan. Savings of up to 20,000 euros should be exempt from getting taxed; savings from 20,000 to 100,000 euros in turn should pay a one-off tax of 6.75 percent. But the Cypriot parliament rejected plans for a one-time levy on bank deposits. And Russia also turned down Cyprus' appeal for help.

Cyprus' collapse would not endanger Europe as a whole, because its economy is small when compared to other eurozone countries. Even the Greek economy is almost 12 times as big, while Germany's economy is 145 times as large as Cyprus' performance. With a GDP of 18 billion euros in 2011 and a population of 862,000, Cyprus is one of the smallest of the EU's economies. The country was hit by a recession in 2012. Unemployment rates are on the rise: From 7.9 percent in 2011 to an estimated 13 percent in 2013. The recent debt crisis has made it difficult to navigate. At the end of 2011, debt accounted for 71.1 percent of GDP. The European Commission expects that number to rise to 97 percent by 2014.

Stock markets rallied and politicians praised a European Union and International Monetary Fund bailout agreement for Cyprus reached early 24 March 2013 after marathon talks in Brussels. The deal radically cut Cyprus's oversized banking sector, and forces losses on depositors holding more than 100,000 euros (about $130,000) in savings. It also called on the government to cut spending and carry out economic reforms, including privatizing state assets.

In the long run, Cyprus will be able to reorganize its finances by selling state-owned companies such as telecommunications, electricity suppliers and its harbors. According to an analysis carried out by the Royal Bank of Scotland (RBS), Cyprus also has untapped gas reserves worth more than 600 billion euros. But Cyprus would only benefit from this in the long haul.

On April 30, 2013 the Cypriot parliament approved an international bailout Tuesday in a very close vote, with just over half of lawmakers voting in favor. The "yes" vote lined Cyprus up for a range of austerity measures. Of 56 lawmakers, 29 voted in favor of the bailout and 27 voted against. The approval secures a $13 billion loan from European nations and the International Monetary Fund. And, according to the Cypriot government, it saves the island from the threat of an imminent default on its debts.

The deal that was eventually reached with international lenders made Cyprus responsible for raising $17 billion. Spending cuts and tax hikes are in the pipeline. And the island has agreed to shut down its second largest bank and make major reforms to its largest. Depositors with over $130,000 in savings will incur major losses. The deal was deeply unpopular with many both inside Cyprus and overseas.