By Erol Riza
Over the last few months, we have witnessed a sharp deterioration in global economic and financial developments which should temper any positive outlook for the world economy in the coming year.
With this background it is important for Cyprus’ policymakers to be ready to act if they wish to see an inclusive and sustained growth in the Cyprus economy. There are no excuses for painting a rosy outlook for 2019 for Cyprus by failing to consider factors that will impact the Cyprus economy: Brexit negotiations have created a lot of uncertainty in the UK and weakened sterling and unless there is a resolution soon this may affect tourism bookings; the trade rift between the USA and China has not been resolved and these tensions are impacting global investment flows; the economic outlook of the eurozone has deteriorated significantly especially in Germany where the automotive sector has suffered big time; the stock market in the US having, peaked last October, has lost nearly 20 per cent of its value, and interest rates in the US, as well as the reduction of asset purchases by the European Central Bank, will tighten liquidity conditions.
Why should the above affect the trajectory of the Cyprus economy in 2019? To answer that question, it is important to briefly explain why the Cyprus economy has had such a remarkable performance in the last two years and why some of the factors that have underpinned economic growth may not be present as before. The Cyprus economy is not immune to what happens in the world since it is a very open economy, and it is important for policymakers to have in reserve measures they should take if their predictions are proved unsound in the coming months.
Cyprus experienced record numbers of tourist arrivals in 2018 and this, together with consumer expenditure, construction investment and business services have provided a very positive influence on the economy. Inward investment in the property sector linked to the acquisition of residency and passports has been a fundamental factor leading to the recovery of the property sector in the coastal towns, and it is not too difficult to measure the short-term gains made by developers and selected support services in the construction sector. This has enabled developers to restructure non-performing loans (NPLs) and invest in new projects. This is a very cyclical sector and maybe we have seen the best of that allowing for the factors mentioned above.
The predictions of the Central Bank of Cyprus (CBC) in their latest economic bulletin states that domestic demand will continue to underpin economic growth. In summary the CBC predicts private consumption to grow by 3.3 per cent and 2.7 per cent in the years 2019-20, public consumption by 0.6 per cent and 0.7 per cent in the same period, Gross Fixed Capital Investment by 12.8 per cent and 9.9 per cent while net trade will record a negative 1.2 per cent in both years. There are two factors which have boosted private consumption and fixed investment; these are the broad fall in unemployment and thus an increase in disposable income for consumption and the transfer of economic ownership of ships via special purpose vehicles set up in Cyprus. The latter, which is reflected in the large fixed investment, maybe a one-off factor unless officials have knowledge of the shipowners’ intentions to move more of their fleet holdings to Cyprus.
Further scrutiny of the CBC predictions show that they expect significant investment in energy infrastructure, in tourism investment linked to casinos and marinas, in transport linked to shipping and lastly in the real estate sector linked to commercial investment as well as hotels. The only dampeners to their predictions are the large current account deficit and thus a negative contribution from net trade and the deleverage in the banking system as well as the level of NPLs which could dampen private consumption.
If only the world of predicting economic aggregates was quite as straightforward as the CBC predicts and these predictions should be set against the EU Commission’s Post Programme Surveillance Report published in autumn 2018.
The EU Commission acknowledges that Cyprus’ growth was supported by domestic and external demand and also applauds the fiscal improvement of Cyprus in terms of budgetary surpluses which it has recorded. However, the commission points out the significant challenges ahead which can possibly derail the predictions of the central bank and the government.
The key factors are the following. Cyprus has both very high public and private debt. The former stands at 105 per cent of GDP (following the bail out of the Co-operative Central Bank) and the hitherto improvement has been sustained by tax buoyancy which may not continue to benefit primary surpluses. Private debt, despite the reduction of NPLs to about 30 per cent on bank balance sheets, has remained within the financial system albeit in the books of government or with funds which have purchased these NPLs. While some improvement may occur as a result of Estia when it is up and running, the reliance of further improvement in reducing NPLs is linked to foreclosure and more effective judicial process with borrowers so that collateral is enforced by lenders or funds. The commission has also noted that nothing has been done regarding privatisation and very little in terms of establishing a competitive electricity market. The latter two factors hinder the attraction of foreign investment that will increase productivity and make Cyprus more competitive.
Regarding global developments, and in particular the withdrawal of liquidity in the banking systems by central banks in the US and the EU and the increase in interest rates, together with the very high level of private debt in Cyprus, it is not too difficult to see that the predictions of the central bank and the government can be frustrated and growth could fall short of that predicted. In fact, if the lenders more actively pursue borrowers to pay their NPLs (non-payment has allowed borrowers to continue living their lives without much adjustment) and if collateral is to be taken over by banks to be sold off, the sustainability of private domestic consumption may be less. The external demand linked to tourism may also suffer if the weakness of sterling continues until the end of February when bookings have to be made for the new year. One can be forgiven for bringing up the question of privatisation since this is a political hot potato.
In short, the government should be ready to boost public investment very swiftly if the predicted level of growth is not achieved and this investment could be in sectors where there is scope to boost productivity potential such as renewable energy and higher grade telecom infrastructure. Other sectors which seem to offer scope are affordable housing and logistics. The continued public ownership of Cyta and the EAC has been to the detriment of the competitiveness of Cyprus and the sooner a competitive market is allowed to develop the better.
In short, the government should reflect on recent economic history in 2008 when the global financial crisis was unfolding and the government continued business as usual.
Erol Riza is managing director of SME Markets Limited
