By Stelios Orphanides
The University of Cyprus said that the economy is forecast to expand 3.9 per cent this year before growth slows down to 3.3 per cent in 2019, amid a favourable external environment that may change, ongoing turbulence in the banking sector and deteriorating competitiveness.
“The main drivers of the outlook in 2018 and 2019 include the recent strong economic performance in Cyprus, the supportive external environment, the low levels of interest rates and inflation, and the high levels of domestic and European economic sentiment,” the Economic Research Centre (ERC) of the university said in a statement on its website.
The ERC said that the modernisation of the foreclosure and insolvency framework as well as the legislation on the sale of laws and loan securitisation more than two weeks ago, “are expected to enhance the soundness of the banking sector, reduce uncertainty and restore depositors’ and investors’ confidence, with positive effects on economic activity”.
The new laws were a condition for the European Commission to approve the acquisition of the Cyprus Cooperative Bank’s operations, a casualty in the battle of Cypriot banks against strategic default and a €19.9bn mountain of delinquent loans.
“Nevertheless, significant downside risks to the outlook continue to stem from the high levels of indebtedness and non-performing loans as well as from the reinforcement of the feedback loop between bank and sovereign risk,” the ERC said. “The effectiveness in the management of problematic assets via the recently amended legal tools as well as the provisions of the proposed government subsidy scheme for vulnerable borrowers, will influence repayment culture, banking sector soundness and economic confidence, and could tilt risks to the outlook in either direction”.
The scheme, dubbed Estia which subsidises loan repayment of households with a primary home with a value of up to €350,000 as collateral to a loan, including to small and medium-size enterprises (SMEs), other net property of up to 125 per cent of the value of the primary residence and annual income of up to €50,000, could result in a moral hazard for both borrowers and banks.
In turn, the moral hazard “could involve significant downside risks to both public finances and growth,” the ERC continued adding that given the size of public debt, delays in structural reforms, including the justice system and public administration, combined with unwise fiscal practices may weaken confidence and undermine both public finances and growth.
The Cypriot economy which emerged three years ago from a prolonged recession, expanded 3.9 per cent last year. The government, which last year generated a fiscal surplus of 1.8 per cent of economic output is forecast to generate a fiscal surplus of 1.7 per cent this year, agreed two months ago to reverse pay cuts in the wider public sector made necessary six years ago when the island plunged into a fiscal cliff. Last year, public debt fell to 97.5 per cent of the economy and is expected to increase this year again beyond the 100 per cent mark as a result of the €3.2bn in bonds issued in favour of the Co-op.
The island’s credit rating continues to be non-investment grade mainly on high public and private debt. Household and corporate debt combined accounts for 2.5 times the size of the economy and half of it is non-performing.
“Other downside risks to the outlook are associated with a potential slowdown in the euro area, weaker-than-expected growth in the UK due to Brexit negotiations, and losses in the competitiveness of the Cypriot tourist product vis-à-vis other destinations,” the university said. “Upside risks to the outlook are associated with stronger-than-expected demand, mainly due to public and private investment projects, and domestic consumption”.