'Nimble and dynamic economy presents significant upside potential'

Cyprus has shown resilience in the face of successive economic shocks, with growth remaining among the highest in the euro area, according to the International Monetary Fund (IMF).

In a statement released on Friday, at the conclusion of an IMF mission to Cyprus from March 17 to 28, mission chief Alex Pienkowski highlighted key economic developments and policy priorities for the country.

“Cyprus has demonstrated impressive resilience to successive shocks,” he said. “Growth has remained among the highest in the euro area, mainly supported by foreign investment, strong tourism, and a boom in the ICT sector“.

“Inflation is declining but remains above 2 per cent and signs of moderate overheating have emerged,” he added.

Pienkowski also said that “fiscal performance continues to be strong, with debt on a firm downward trajectory”.

Robust growth with signs of overheating

The IMF noted that Cyprus’ economy grew by 3.4 per cent in 2024, placing it among the top performers in the euro area.

This growth was driven by strong service exports and robust consumption.

However, the IMF cautioned that the economy showed modest signs of overheating due to a tight labour market and high, albeit moderating, job vacancy rates.

Growth is projected to moderate to 2.5 per cent in 2025 and stabilise at 3 per cent in the medium term.

“Growth has been robust, albeit with some signs of moderate overheating,” said the IMF.

“Last year, growth of 3.4 per cent was among the highest in the euro area, supported by strong export of services and consumption,” it continued. “The labour market remains tight, with the unemployment rate declining further and high but moderating job vacancy rates”.

The fund also said that “although uncertainty is high, taken together there are modest signs of economic overheating”.

“However, growth is expected to moderate to around 2.5 per cent this year and gradually stabilise at 3 per cent in the medium term,” the IMF added.

Inflation and fiscal strength

Despite a declining trend, inflation remains above 2 per cent due to rising services prices and wage pressures.

The IMF expects inflation to stabilise at 2 per cent by the end of 2025.

“Inflation remains somewhat elevated,” the IMF said. “Consistent with the euro area trend, rising services prices have kept inflation above 2 per cent.”

It explained that “part of this is due to the ongoing pass-through from the 2022 energy price shock”.

It also said that “a tight labour market and rising wages have also contributed to price pressures“.

At the same time, inflation is expected to stabilise at 2 per cent by the end of the year.

On the fiscal front, Cyprus recorded a primary fiscal surplus of 5.8 per cent in 2024, with strong revenue growth offsetting higher public wages and social transfers.

The country’s public debt declined from 74 per cent of GDP in 2023 to 65 per cent in 2024, aided by a strong fiscal position.

“The strong fiscal position is rapidly lowering public debt,” said the IMF.

“The primary fiscal surplus recorded 5.8 per cent in 2024, as strong revenue growth overshadowed higher public wages and social transfers,” it added.

It also mentioned that “high growth and strong fiscal performance led to a further decline in public debt to 65 per cent of GDP at the end of 2024, from 74 per cent a year before, amid ample cash buffers”.

Risks and policy recommendations

The IMF identified external risks such as potential trade conflicts affecting Cyprus’ main trading partners, regional tensions, and energy price shocks.

Domestically, risks include possible economic overheating and fiscal policy loosening.

“Near-term risks are tilted to the downside, while longer-term risks are more balanced,” the IMF said.

“External risks include potential trade conflicts impacting Cyprus’ main trading partners, the intensification of regional tensions, or new energy price shocks,” it added.

Moreover, it noted that “domestic risks include further overheating, potentially triggered by looser fiscal policy“.

“Further out, investment-driven growth will depend on steady progress on structural reforms, including those outlined in the Recovery and Resilience Plan (RRP),” it added.

Conversely, the IMF said that “Cyprus’ nimble and dynamic economy presents significant upside potential“.

To mitigate these risks, the IMF advised Cyprus to prioritise reducing its debt below 60 per cent of GDP, avoid fiscal loosening, and ensure targeted public spending.

“Fiscal policy should prioritise debt reduction,” it said. “Given overheating risks, new discretionary measures that loosen fiscal policy should be avoided.”

“Instead, fiscal policy should target bringing debt sufficiently below 60 per cent of GDP to allow a robust buffer against potential shocks,” the IMF added.

Financial sector resilience

The banking sector in Cyprus remains resilient, with strong capital and liquidity buffers, record-high profitability, and declining non-performing loans (NPLs).

However, the IMF stressed the need for continued vigilance, especially in the real estate sector.

“The banking sector has large capital and liquidity buffers, and financial sector risks appear to be contained,” the IMF stated.

“Profitability metrics are at record highs for the second year in a row, while capitalisation levels grew to among the highest in Europe,” it added.

It also said that “despite high interest rates, asset quality improved further as non-performing loans (NPLs) declined, supported by strong economic growth”.

Nevertheless, the IMF said that “continued vigilance is required, including the close monitoring of the real estate sector”.

It also welcomed recent macro-prudential measures, including the increase in the Counter-Cyclical Capital Buffer (CCyB), which will help secure capital buffers without significantly affecting credit growth.

“Recent tightening of the macro-prudential policy stance will further strengthen buffers,” it said.

“The announced increase to the Counter-Cyclical Capital Buffer (CCyB) will build greater resilience by securing already high capital buffers with little impact on credit and economic growth,” it added.

Looking ahead, the IMF said that “careful calibration of macro-prudential policies should continue balancing financial stability and healthy credit intermediation”.

Long-term growth potential

In its report, the IMF underscored the importance of structural reforms, particularly in the judicial sector, to support investment-driven growth.

Enhancing labour productivity and addressing skill mismatches were also highlighted as key priorities.

“Structural reforms aimed at improving the efficiency of the judiciary and increasing labour productivity are essential to support long-term growth,” the IMF said.

“With employment already at a high level, capital will become an increasingly important driver of growth,” it added.

“Therefore”, it continued, “policies should ensure a stable and streamlined business environment conducive to investment.”

Energy sector reforms, including the completion of major projects such as the Vassiliko LNG terminal and the Great Sea Interconnector, were identified as crucial to reducing energy costs and enhancing security.

“Key energy projects and reforms must be expedited to lower energy prices, improve energy security, and meet climate commitments,” the IMF said.

“Completing the Vassiliko LNG terminal and the Great Sea Interconnector would be significant steps toward achieving these goals,” it added.

The IMF also stressed the importance of maintaining strong anti-money laundering (AML) measures to protect Cyprus’ financial reputation.

“Maintaining a strong anti-money laundering (AML) framework is crucial for safeguarding against reputational risks and business uncertainty,” the fund said.

It also said that “ongoing efforts to extend the definition of obliged entities for AML supervision are welcomed”.

“The proposed establishment of the National Sanctions Implementation Unit at the Ministry of Finance will provide greater clarity to reporting entities regarding sanctions compliance,” the IMF concluded.