EC Autumn Forecast: Cyprus growth expected to slow, then gradually pick up

Growth is expected to slow down in 2023, but gradually pick up pace over the next years, while inflation is expected to subside, according to the Autumn 2023 Economic Forecast presented by European Commissioner for the Economy, Paolo Gentiloni.

Gentiloni presented the findings on 15 November.

On an EU level, economic dynamism is expected to suffer due to the high cost of living, but gradual recovery is expected by 2025, along with a continued drop in inflation.

More specifically on Cyprus, the Commission expects that after robust growth by 5.1% recorded in 2022, growth will moderate to 2.2% in 2023 due to global uncertainty. Meanwhile, the labour market is expected to perform well, with unemployment dropping from 6.8% in 2022 to up to 5.9% in 2025.

The Commission also points out that the fiscal balance of the country continued to show a surplus of 2.4% of the GDP in 2022, which is expected to be at 2.3% in 2023, 2.1% in 2024 and 2.5% in 2025. The forecast adds that the projected gradual phasing out of energy - related measures, as well as the assumed ending of the mortgage-to-rent scheme will contribute positively to the budget balance by 2025.

The risks for the economy, according to the forecast, are related to the fact that Cyprus is highly dependent on oil imports, while important sectors such as construction, tourism and trade can be sensitive to higher interest rates.

The Forecast chapter on Cyprus

--------------------------

Following robust growth of 5.1% in 2022, economic activity is expected to moderate to 2.2% in 2023, amid continued global economic uncertainty and rising interest rates, but it will gradually pick-up again in 2024 and 2025. Following its peak of 8.1% in 2022, inflation is set to subside as global energy prices have moderated.

Supported by dynamic growth, the labour market is performing well. The general government balance is expected to remain in surplus over 2024- 2025, while the public debt-to-GPD ratio is set to decrease further to 66.3% by 2025.

Growth slows down in 2023

Real GDP is set to grow by 2.2% in 2023, driven mostly by domestic demand. Private consumption has expanded strongly as a result of continued dynamic growth of employment and wages. The automatic partial indexation of wages has somewhat cushioned the negative impact of elevated prices on consumption. Investment in residential and commercial construction has been supported by the interest-subsidisation scheme for mortgages and a vigorous influx of foreign companies. Tourism fully recovered from the pandemic crisis, as well as from the fall-out of the Russian war of aggression against Ukraine that has, however, negatively affected exports of financial and professional services.

Moderate growth over the forecast horizon

Economic activity is forecast to pick up to 2.6% and 2.9% in 2024 and 2025 respectively. Measures taken by the government to curb inflation together with the increased automatic partial wage indexation are expected to continue supporting consumption growth, albeit at a slower pace. Increasing interest rates are set to dampen the demand for residential properties, while foreign investments and the implementation of the Cypriot Recovery and Resilience Plan should boost infrastructure in the green and digital transitions as well as in healthcare, education and tourism. Tourism and other export-oriented services are expected to slow down following dynamic growth in previous years and due to weakened growth momentum in Cyprus’ trading partners.

Risks are skewed to the downside, especially given that Cyprus is highly dependent on oil imports and that important sectors such as construction, tourism and trade may be sensitive to higher interest rates.

Labour market is improving

Benefiting from continued strong economic growth, employment, increased by around 1.8% in the first half of 2023 and is set to remain robust as labour-intensive sectors such as tourism and ICT are projected to grow. Consequently, the unemployment rate is expected to decrease to from 6.8% in 2022 to 6.4% in 2023, and further to 5.9% by 2025 (lowest recording in the last 10 years).

Inflation to ease over the forecast horizon

The harmonised index of consumer prices (HICP) is expected to decrease to 4.1% in 2023, following its peak of 8.1% in 2022. It is set to continue decelerating to 3% and 2.2% in 2024 and 2025 respectively, on the back of declining energy prices and support measures adopted by the government. However, HICP excluding energy and unprocessed food prices remains elevated, due to second-round effects of the automatic indexation of wages.

Fiscal position to remain in surplus

The general government balance posted a sizeable surplus of 2.4% of GDP in 2022. In 2023, the surplus is expected to be 2.3% of GDP thanks to buoyant revenues offsetting most of the expenditure increases. VAT revenue was boosted by inflation and strong consumption growth.

Revenues from income taxation also grew significantly thanks to increasing wages and improved collection of corporate taxes. On the expenditure side, the withdrawal of COVID-19 support measures contributed further to a positive government balance. At the same time, changes in wage indexation and the reintroduction of some of the previously phased-out measures to mitigate the impact of high energy prices and other new fiscal measures decided in October 2023 are expected to put upward pressure on public expenditure over the forecast horizon.

The budget balance is forecast to remain in surplus at 2.1% of GDP in 2024 and 2.5% in 2025. The negative impact from housing policy measures, such as the government-subsidised mortgage-to-rent scheme and other direct subsidies for vulnerable households, on the budget balance in 2023 is set to continue and strengthen in 2024. The projected gradual phasing out of all the energy-related measures, the assumed ending of the mortgage-to-rent scheme and the increase in social security contributions are expected to contribute positively to the budget balance by 2025.

The debt-to-GDP ratio is set to decline rather strongly. It is projected to reach 66.3% in 2025, down from 85.6% in 2022, on the back of nominal GDP growth and significant primary surpluses, notwithstanding pressures from higher costs of funding.

Country-specific risks to the fiscal outlook are tilted to the downside as possible budget overruns in the ongoing and new government initiatives may reduce projected surpluses.

(Source: CNA)