Cyprus Maintains Economic Stability but Faces Sectoral Risks, EU Report Highlights

The 17th post-programme surveillance mission by European authorities has affirmed Cyprus’ economic and financial stability while drawing attention to emerging risks in key areas.

Conducted by the European Commission, European Central Bank (ECB), and European Stability Mechanism (ESM), the mission’s latest report applauded Cyprus’ robust fiscal framework while highlighting vulnerabilities that require vigilance.

The report, released on Tuesday, pointed to Cyprus’ strong economic fundamentals, supported by prudent fiscal management and a resilient banking sector. It stated, “Economic growth accelerated to 3.7 per cent year-on-year in the first half of 2024, driven by strong investments and a recovery in net exports.” Improvements in household purchasing power and savings rates were also noted as factors bolstering private consumption.

Inflation is expected to stabilize around 2 per cent, in line with the ECB’s price stability target, while unemployment has reached its lowest point in a decade. Despite these positive indicators, the report raised concerns over external risks.

“Geopolitical tensions pose a significant risk to the economy,” the report noted, referencing disruptions in supply chains and rising production costs as potential threats to sectors such as tourism, which remains in recovery mode following previous crises.

Energy dependence was another focal point of concern. The report explained, “Cyprus relies heavily on fossil fuels and has limited integration into the European electricity market, making it susceptible to energy price volatility.”

On the fiscal front, Cyprus is projected to achieve a surplus of 3.5 per cent of GDP in 2024, with public debt expected to decrease to 56.7 per cent of GDP by 2026. However, the report flagged delays in critical infrastructure projects, particularly the liquefied natural gas terminal in Vasilikos. These delays, it cautioned, “may add up to 1 per cent of GDP to the budget.”

Rising public expenditures, particularly in wages, pensions, and healthcare, were also highlighted as potential risks. The report urged caution, stating, “Rising public spending could challenge fiscal sustainability.”

The resilience of the Cypriot banking sector was another key focus, with the report noting stable profitability and a decline in non-performing loans (NPLs). However, it also pointed out challenges faced by smaller financial institutions. “Less significant institutions (LSIs) had an average NPL rate of 21 per cent in June, unchanged from December,” the report said.

The limited appetite for new lending in the Cypriot banking sector was also addressed. The report highlighted, “Cypriot banks held 32 per cent of their assets in central bank deposits and 42 per cent in loans and advances, compared to the EU average of 12 per cent and 63 per cent, respectively.” While recent interest rate hikes have prompted loan renegotiations, repayment capacity has remained strong.

Cyprus’ current account deficit remains high, reflecting its dependency on imports and substantial profit outflows by foreign companies. While foreign direct investment inflows are strong, the report observed, “A large portion involves special purpose entities with limited contribution to local production and employment.”

Other risks identified include climate change, geopolitical tensions, and cyberattacks. While banks have made investments in cybersecurity, the report emphasized the importance of maintaining vigilance against both physical and transitional climate risks.

Despite these challenges, the report concluded that Cyprus’ debt-servicing capacity remains robust. However, it warned, “Geopolitical uncertainties and sectoral vulnerabilities require continuous attention to preserve investor confidence.”

Additionally, the report noted that Cyprus’ first repayment to the ESM is set for 2025, with annual repayments averaging €0.99 billion until 2031.

While Cyprus has shown strong economic performance, the report highlights that the country must address emerging risks and external challenges to sustain its stability and investor confidence.

By fLEXI tEAM