Economy and Trade
A former British colony, the island of Cyprus became independent in 1960 following years of resistance to British rule. Tensions between the Greek Cypriot majority and Turkish Cypriot minority ultimately culminated in an armed clash between Greece and Turkey, in 1974, which left more than one-third of northern Cyprus under Turkish control (Turkish Republic of Northern Cyprus, TRNC). In September 2008, the Turkish and Cypriot governments reopened unification negotiations under the auspices of the United Nations. The entire island joined the European Union in 2004, but the EU’s writ is suspended for the area under Turkish control. The economic performances of the two sides of the island tend to be evaluated separately, as they are under the de facto control of two different governments. The Turkish side has roughly 40% of the per capita GDP of the southern, Greek Cypriot side, and one-third of its budget is financed directly by Turkey.
Economic Policy over 12 Months
On the Turkish side of the divide, agriculture and services employ around 50% of the population, with the state employing most of the remaining workforce. The Turkish enclave’s fortunes are highly dependent on mainland Turkey, which has been heavily hit by the global slowdown. The Turkish Cypriot economy grew by around 10.6% in 2006, fueled by growth in the construction and education sectors, as well as increased employment of Turkish Cypriots in the area under Greek Cypriot government control. However, the Turkish side proved highly susceptible to the first signs of the global downturn, and GDP declined by about 2.0% in 2007. Turkish Cypriots are heavily dependent on transfers from the Turkish government. Ankara directly finances around one-third of the TRNC’s budget. Aid from Turkey has exceeded US$400 million annually in recent years. The Turkish Cypriot economy looks certain to experience a sharp slowdown in 2008–2009, as a result of the global financial crisis. The Turkish Cypriot financial sector is dominated by mainland Turkish banks, and relies heavily on the hard-hit British and Turkish markets for tourism.
On the Cypriot side, the economy is market-based and dominated by the service sector, which accounts for 78% of GDP. Tourism, financial services, and real estate are the most important sectors. Erratic growth rates over the past decade reflect the economy’s reliance on tourism, which often fluctuates with political instability in the region, and economic conditions in Western Europe. Nevertheless, the Greek Cypriot economy has grown at a rate well above the EU average since 2000. Cyprus joined the European Exchange Rate Mechanism (ERM2) in May 2005, and adopted the euro as its national currency on January 1, 2008. An aggressive austerity program in the preceding years, aimed at paving the way for the euro, helped turn a soaring fiscal deficit (6.3% in 2003) into a surplus of 1.2% in 2008. This prosperity will come under pressure in 2009, as construction and tourism slow in the face of reduced foreign demand, triggered by the ongoing global financial crisis. Growth is expected by many outside observers, including the International Monetary Fund (IMF), to slow to less than 2%, which would be its lowest level since 2003. As in the area administered by Turkish Cypriots, water shortages are a perennial problem; a few desalination plants have been added to existing plants over the last year, and are now on line. After 10 years of drought, the country received substantial rainfall over 2001–2004. Since then, rainfall has been well below average, making water rationing a necessity.
Economic Performance over 12 Months
In the first half of 2007, the Cypriot economy grew at a rate of 4%, a strong enough growth for Cyprus to feel confident about adopting the euro with effect from January 1, 2008. On December 5, 2008, Cypriot Finance Minister, Charilaos Stavrakis, presented the 2009 state budget, which underlined the fact that 2009 is expected to be a very difficult year because of the international economic slowdown. Despite this, the budget anticipated growth of 3%, which is at least 1 percentage point higher than most external analysts are anticipating. However, Stavrakis said that while it was possible that the government is being overoptimistic, a slightly lower growth rate would not affect implementation of the budget. The European Commission’s expectation for GDP growth in Cyprus for 2009 is just 1.1%.
Even with the downturn, Cyprus managed to retain near-full employment in 2008, and this is expected to continue into 2009. If the government is successful in its prediction of a borderline fiscal surplus for 2009, then public debt is expected to be reduced to below 48% of GDP. Inflation is expected to decline during 2009 to 2.5%. Growth for 2008 looks to have been of the order of 3.7–3.8%, well above the EU-wide growth rate of 1.4%. Cypriot banks had minimal exposure to the toxic investment projects which destroyed much of the United States, United Kingdom, and European banking systems.
Despite the downturn, the Cypriot government has increased budget spending by 11%, by comparison with 2008, with €7.37 billion in expenditure, and initial estimated revenues of €6.41 billion. Dramatically reduced capital gains tax receipts resulting from companies on the island making less profit because of the downturn, have reduced government revenue expectations by €165 million, Stavrakis said.
The government promised no new taxes for 2009, but anticipates putting in place the biggest social spending round for 10 years, with the budget for social spending increasing by 26%. Development spending will increase by 15.5%. The main challenges faced by the Cyprus economy, the minister said, was an ageing population, which weighs heavily on the island’s social security fund, and the need to bear down on consumer goods’ pricing now that oil and gas prices have slumped.
For the Turkish Cypriot side, tourism remains the major growth industry, with some agriculture, with the main products being citrus fruits, grapes, and vine production. High freight costs and the shortage of skilled labor are perennial difficulties, as is the isolation of the northern part of the island. Some flexibility and movement of trade between the north and south sides of the island have helped the economy. In August 2004, new EU rules paved the way for north Cypriot goods to be sold in the south, and, a year later the Turkish Cypriot authorities responded by allowing some goods from Cyprus to be sold in northern Cyprus, although trade between the two sides remains limited.
Support for Inward Investment and Imports
The Cyprus Investment Promotion Agency (CIPA) is the body that promotes foreign direct investment (FDI). The Cyprus government has removed all distinctions between foreign and local companies. State grants of up to €200,000 are available for new high-tech start-ups in special business incubators.
Statistics (not incl. TRNC)
GDP growth: 3.6% (2008)
GDP per capita: US$29,200
CPI: 5.1% (2008)
Key interest rate: 6.74% (December 2007)
Exchange rate versus dollar: euro per US dollar: 1.325 (April 2009)
FDI: U$15.04 billion
Current account deficit/surplus: −U$2.609 billion
Source: CIA World Factbook except where stated