[Accountancy Cyprus, No. 118, March 2015.]
The Cypriot economy’s path towards recovery was put in jeopardy during the last few months of 2014 but more recent developments hold promise for a return to a positive trajectory.
The Cypriot economy’s path towards recovery was put in jeopardy during the last few months of 2014 but more recent developments hold promise for a return to a positive trajectory.
The damage was primarily due to exogenous developments. Foremost among them was the economic crisis in Russia (highlighted by the collapse of the ruble), and the imposition of EU sanctions against Russian interests. In addition, a deterioration of the climate in Greece that led to rising Greek bond yields last fall also affected Cypriot bonds at the time. Domestically, the impasse over the foreclosure law and the consequent delay in the Troika’s evaluation of the Memorandum of Understanding (MoU) contributed to the climate of uncertainty.
As a result of these developments, the improvement in the Cypriot GDP growth rate reversed itself slightly in the second half of 2014. The year closed with a -2.3% growth rate, compared to -5.4% in 2013.
Fortunately, the climate reversed itself again in January due to the European Central Bank’s announcement of its Quantitative Easing program (QE). This important development had an immediate impact, leading to a depreciation of the euro and a drop in European bond yields. Cyprus stands to gain from both of these developments.
Actual implementation of the program starting March 9 led to further declines in both the value of the euro and bond yields. The yield of the Cypriot 10-year bond dropped below 4%, to its lowest point since 2010. Growth prospects in the euro area are looking more favorable, something that will also benefit Cyprus.
On the domestic front, there finally seems to be light at the end of the tunnel on the controversial issue of the foreclosure law. The political parties appear to be converging and – barring any unforeseen surprises – the law should be passed before the end of March. This will open the door to an evaluation by the Troika in April. A positive evaluation will allow Cyprus to participate in the QE program.
Given these developments, the outlook for a return by Cyprus to international markets within 2015 currently seems very positive. The major downside risk to the economy now comes – yet again – from Greece. The newly elected Greek government has adopted a confrontational stance towards its European partners. This has led to a rapid deterioration in the country’s position: tax revenues have declined, deposit withdrawals have increased significantly and talk of “Grexit” has returned. Greece’s “tough” stance caused some excitement in Cyprus and there were suggestions that it should adopt a similarly confrontational approach.
These voices have fortunately died down since the Eurogroup decision of February 20th, which showed that Greece’s approach was not paying off. Nonetheless, the situation in Greece must be monitored closely. The links between the economies of Greece and Cyprus are not as close as they used to be, but Greece remains an important trading partner and subsidiaries of Greek banks operate in Cyprus.
Yet the most important risks to Cyprus of continuing tension in Greece and even a Greek exit from the euro are not economic but political. Many outsiders view Greece and Cyprus as similar. If Greece heads towards the exit, some might be tempted to think that Cyprus will follow along. Cyprus must fight this perception and convince the outside world that, despite the similarities, Cyprus is not Greece. There is one surefire way of achieving this: stick to the plan of sound fiscal management and timely completion of the MoU.
