When Cyprus’ fiscal and banking crisis culminated in the March 2013 bailout agreement, its economic prospects were at their worst for nearly four decades.
Economic output had already contracted in 2012 and losses sustained by depositors at both the island’s major lenders were expected to lead to an 8.7 per cent economic contraction in 2013 and 3.9 per cent the following year. This in turn was expected to drive unemployment to close to 20 per cent. While the implementation of reforms agreed with international creditors promised long-term growth, forging majorities in the 56-seat parliament proved difficult.
To help the economy return to growth as early as possible, President Nicos Anastasiades’ government decided in early 2014 to give the construction sector a boost, both with supply and demand boosting measures. Town planning relaxations would allow developers to build, while issuing passports to high-spending foreign property buyers would induce them to buy those properties.
Economic output declined 5.9 per cent in 2013 and by a further 1.4 per cent the following year. But in 2015 the economy returned to growth, and in 2017 the economy is projected to have expanded a 3.9 per cent compared to 3 per cent in 2016.
The citizenship-by-investment scheme has been a major reason behind the growth, economists say. At first the investment scheme required an overall investment in Cyprus of €5m, some of which had to be in property. This was later reduced to €2m. According to the latest official figure, the investment inflow attributed to the scheme exceeds €4.5m and is estimated to have flown mainly to real estate.
“There is little doubt that the scheme has been one of the key drivers of the economic growth of the last two-three years,” said Sofronis Clerides who teaches economics at the University of Cyprus. “A lot of the construction activity we are witnessing is clearly driven by demand for high quality residences from individuals seeking to qualify for the scheme.”
But Clerides warned there were also costs and risks associated with such this kind of one-dimensional development, including environmental and planning issues.
“There is the problem of rising property prices in the high-end of the market, which crowd out other investments and raise the cost of living.”
Issuing Cypriot passports to foreign property buyers appears to have halted or at least mitigated the decline of property prices. By as early as the second quarter of 2016, property prices started to recover according to Central Bank of Cyprus data. This in turn, may have spared the balance sheets of the island’s battered banks additional losses.
“The extent to which this scheme has helped the banks is a big question mark,” Clerides said. “One can assume that it did help by stabilising property prices and, by extension, the value of banks’ collateral. It is likely that protecting banks from a real estate price slump was one of the reasons that this scheme was launched.”
Furthermore, the scheme may have also helped developer companies “honour their obligations to the banks”.
Construction companies have indeed reduced their non-performing loans from €5.1bn in December 2014 to €3.2bn in September 2017, but lenders are still struggling with a non-performing loans mountain of over €21bn, which accounts for 44 per cent of the total. This amount exceeds a year’s economic output.
“Luckily, because of this scheme, all those developers who were at the brink of collapse five to six years ago, including the big names, are now performing well and have liquidity,” said Philippos Nikiforos, director and founder BuySell Cyprus, a major real estate company based in Paphos.
Property sales in recent years, Nikiforos continued, were “100 per cent related to the passport”.
In 2017, non-Cypriots acquired 1,208 properties compared to 958 the year before, according to the website of the Department of Lands and Surveys making out 14 per cent of the respective total. The number of citizenships extended to investors, including members of their family, in 2017 and 2016 was 1,013 and 904 respectively. Since 2013, when the government introduced the citizenship-by-investment scheme, the total number of beneficiaries, including family members, is 3,153.
Clerides said that as Cyprus is facing pressure to terminate its programme which is particularly popular with financially prominent Russians, it should initiate a gradual phasing out of the scheme.
“Some people object when Cyprus is criticised for selling passports,” he said. “We only have ourselves to blame for that. We have allowed real estate agents and other intermediaries to abuse the scheme, displaying ads showing the Cypriot passport.”
In January, the council of ministers decided to update the scheme by introducing a “code of conduct” prepared by the Cyprus Investment Promotion Agency (CIPA) that will include guidelines governing the promotion of the scheme and the banning of public and online advertisement and penalties for offenders.
“The government is finally cracking down on this kind of behaviour, but it should have happened a long time ago,” Clerides said. “Our image has been damaged.”
Still, this measure may prove unenforceable, Nikiforos countered.
“Let’s assume that we stop saying ‘gentlemen, invest in Cyprus to get a passport’ and instead say ‘buy homes in Cyprus and if you do so you get a present from the government; you will get the citizenship’,” he said.
“Can we as Cyprus control what every agent in Russia, China or Dubai will say on his website? At the end of the day, we will be shooting ourselves in the foot. They will advertise on our behalf to send us customers and will ask for commission,” he said.
“For all its shortcomings, this scheme was necessary during the crisis years in order to help kickstart the economy,” economist Clerides said. “Even so, the time has come for a shift in emphasis.”