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The impact of economic and financial crisis

CYPRUS is a small country with a dynamic economy that is service orientated (80 per cent) and where growth sectors such as ship management bring in around a billion euros a year, the large number of foreign exchange on-line operators may well contribute even more, and the fastest growing economic sector is “house maids”. 

The aim of this article is to shed light on the economy, and to examine the impact of the international economic and financial crisis. Since the establishment of the Republic 1960, this is the first recession that has been caused by economic factors. The recession of 1964 was caused by inter-communal fighting and that of 1974-1976 by the Turkish invasion, while in 1991 it was caused by the first Gulf war. For all these the government (in cooperation with business and the trade unions) took immediate action, and the recovery from the 1974 Turkish invasion has been characterised an economic miracle. Unfortunately this time both the government and the Central Bank were found lacking, and there has been a total lack of cooperation on both the political level, and the business/labour level.   

The international financial crisis started in 2006 in the form of problems in the USA subprime mortgage market, which affected the financial sectors including the banks in almost all the major economies. It had an immediate effect on the UK in the form of a banking crisis, which led to recession in Cyprus’ major market in 2008 (-1.1 per cent GDP). The effects were a decline in outbound UK tourism from 2007 to 2011, while at the same time the demand from the British for houses in the whole Mediterranean region virtually evaporated, effecting the economies of Portugal, Spain and Cyprus. 

As a consequence Cyprus was hit in tourism and construction/real estate because in both sectors the British market accounted for over 50 per cent of the market. Cyprus at that stage had virtually no “toxic bonds”. The eurozone began to be affected in 2008, and in 2009 GDP fell in all the eurozone countries, and 4.3 per cent overall. Cyprus came through relatively mildly with a GDP contraction of only 1.9 per cent, the lowest in the eurozone. There was a decline in tourist arrivals from the UK, the Scandinavian states, Ireland, France and most other European countries. Business in hotel accommodation and restaurants fell (-6 per cent), construction sector was the most affected (GDP fell -18,7 per cent), followed by the associated sectors of quarrying (-25 per cent) and manufacturing (-5.8 per cent).

Construction fell largely because of the collapse of the UK market, which affected primarily the real estate/construction sector in Paphos and in Famagusta coastal areas. In 2007 the Department of Lands and Surveys registered 14,586 contracts for real estate sales from foreigners, of which 43 per cent from Paphos. In 2011 only 1,670 foreign purchase contracts had been submitted, with less than a third from Paphos. 

Since 2009 the economy has been in stagnation, and appears to be back into recession in 2012. The sectors that are showing growth are first and foremost employment by households, that is foreign housemaids and those engaged in gardening activities, followed by  the financial sector including the banks, services and the public sector. Transport and communications were in recession in 2009 and 2011, while hotels/restaurants have recovered strongly in 2011, and tourism revenues have sharply increased in 2012 also. 

The retail sector has been hit by the reduction in personal consumption in 2009, and many shops have closed, leading to major changes in the real estate sector.

In contrast to the relatively moderate effects on GDP of the crisis, unemployment has risen sharply from 2009 onwards and reached 7.5 per cent of the economically active population in 2011, and is currently around the EU average of about 11 per cent. Cyprus has never experienced such a high rate of unemployment other than in the period of 1974-1976. This is the most tragic effect of the crisis that is affecting the population at large, especially young people. The fact that the economy is not growing also resulted in a fall in productivity in 2009, and stagnation in productivity in 2011, as well as the probability that school leavers will not get jobs in June.

The recession and stagnation in the economy have had the effect of increasing pressure on government services such as health and education because many people can no longer afford private sector services.  

State revenues fell sharply in 2008 from €7.4 billion (about 9 per cent) to €6.7 bln in 2009 (fully absorbing for the surpluses of 2007/2008). By 2011 state revenues were still below the 2008 level. At the same time state expenditures continued to increase from €7.2 bln in 2008 to €8.4 billion in 2011, mainly owing to an increase in social welfare  provisions (€633 mln) and civil service pay (€310 mln). As a result a fiscal problem arose, because the public sector went from small surplus in 2008 (€161 mln) to a deficit of around a billion euro in each of the following years (2009, 2010, 2011). 

The deterioration in public finances was the reason why credit rating agencies began to downgrade Cyprus in 2011 junk status in 2012. As a result the government has had difficulty raising funds in the market, and cannot finance a recovery programme. The credit rating agencies are, therefore, preventing a recovery and restructuring programme from taking place, though it must be stressed that the government failure to consider the effect of recession on its revenues and its insistence on proceeding with additional social benefits, exacerbated the problem and contributed to the present situation. 

The major failing, however, has been in monetary policy. Not only because the banks invested in Greek bonds, but due to the high interest rates of 7 per cent to 9 per cent charged to consumers and businesses, which are preventing growth. Without lower interest rates economic growth cannot take place, the situation cannot be remedied, but there have been few practical proposals put forward in this regard.

Costas Apostolides is Chairman of EMS Economic Management Ltd


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