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The Cyprus economy

Date 18/06/2001

The Cyprus economy has continued its robust growth during 2000, with GDP growth estimated at 4.8% (1999: 4.5%). According to the Department of Statistics and Research of the Ministry of Finance, the economy maintained its upward trend, with the tourism and financial services sectors being the major drivers of this growth. On the political front the proximity talks between the Cyprus Government and the Turkish Cypriots have not led to any breakthroughs, despite increased diplomatic activity. What is important however, is the EU's decision at the Helsinki Summit held in December 1999 that a solution to the Cyprus problem is not a precondition for the island's accession to the Union. This effectively opens up the way for Cyprus to become a member of the EU at the next enlargement round.

Key macro statistics






GDP (real) CYPm





GDP (nominal) CYPm





Government Deficit





Total Public Debt





Tourist arrivals (millions)





GDP Growth rate





Inflation rate





Deficit % GDP





Debt % GDP





Unemployment rate





Source: Ministry of Finance, Department of Statistics

Annual real GDP growth for 2000 is estimated at around 4.8% reaching CYP4.8bn at real market prices. Domestic demand remained fairly strong, despite the 66% drop in the CSE Index and fears that such a drop would have had much more profound effects on the economy. A record tourist year was probably the most important growth driver, combined with the continued growth in the services sector.

The outlook for the current year remains positive, but expect a slowdown in GDP growth to around 3.5%. Again tourism will be the major growth driver of the economy, but initial optimism for a record year in tourist arrivals is fading away, especially following the devaluation of the Turkish pound, which is an increasingly important competitive destination for Cyprus.

Inflation has climbed to 4.1% (1999: 1.7%), aided by oil price increases that have touched USD39/barrel and an increase in the VAT by two percentage points to 10%. Lower commodity prices should help confine current year inflation at around 2.5%. Unemployment remained at around 3.5% and is not a major issue.

Over the past few years, the economy had suffered from worsening public finances, which were diverging away from the Maastricht criteria of a maximum 3% for the budget deficit, and 60% for the public debt. The past year did show some improvement, with the budget deficit falling to 2.8%, compared to 4% in 1999. Increased revenue from the newly imposed levy on Cyprus Stock Exchange (CSE) transactions, increased VAT and, most importantly, a clear improvement in the collection procedures for corporation tax are considered the major drivers for this improvement. The total public debt as a percentage of GDP is estimated at 60.9%, just outside the Maastricht requirement of 60%. The improved economic indicators has led Moody's, the credit rating agency, to raise its rating outlook from negative to stable, and confirm its A2/P-1 rating. According to the agency, "the authorities have made progress in converging the tax and regulatory structure with the EU, and at the same time narrowing the fiscal debt".

There are two specific issues we consider vital for the economy and its prospects, which we address in more detail. The first is the prospects of the tourism sector, and the second the efforts for alignment with the acquis communautaire, and more specifically with the requirement for a wider system liberalisation. 


The tourism sector remains the economy's most important driver. It is a significant contributor to the island's GDP, and a determining factor in the performance of other sectors of the economy. The direct contribution of tourism to GDP is around 10% while its indirect impact is estimated to exceed 20%.

Tourist arrivals continued to rise in 2000, as the island remains a popular tourist destination. Total arrivals rose by 10.3% to 2.7m compared to 2.4m in 1999. The main factors underlying this positive trends over the past years are the strength of the Sterling to the Cyprus Pound, a strong UK economy and the establishment of Cyprus as a popular and affordable tourist resort. British tourists increased their traditional lead at the top of the tourist arrivals list since they account for almost 51% in 2000 (1999: 47.4%), while the Cyprus tourism sector is also significantly exposed to tourist arrivals from Germany and Scandinavian Countries. These figures however, also reveal a threat faced by the Cyprus tourism industry: its over-dependence on the UK tourism market and the fact that UK tourist arrivals are highly sensitive to the Sterling/Cyprus Pound exchange rate.

[click for full image]

[click for full image]

The Government, spearheaded by the Ministry of Tourism, is now making a conscious effort to improve the quality of the domestic infrastructure, which should help attract upmarket holiday tourists. Six new marinas will be created, as well as new golf courses, casinos and theme parks. We anticipate that such projects will be in demand over the next few years, and will help attract higher income tourists.

Although initial indications at the back end of 2000 were pointing towards another record year for Cyprus tourism, this initial optimism is now fading away. Bookings from the UK and Germany are down, affected by the Turkish pound devaluation, which seems to redirect UK and German tourists to the cheaper Turkish market. Overall, we expect arrivals to be marginally higher than 2000, and for the sector to continue its strong contribution to the local economy.

System liberalisation

The Cyprus Government's stated objective of becoming a member of the EU suggests that a number of the existing economic system rigidities, insufficient market orientation and protectionism will have to be eliminated.

Probably, the most important structural change over the past few months was the abolition of the 9% ceiling on lending rates as of January 1. 2001. Certain restrictions for housing loans and loans to small and medium-sized enterprises remain in force, financed by the drop in Central Bank reserve requirements from 8% to 6.5%, with the balance moved to a special fund. The base rate was set at 7% and has remained unchanged since.

A six-member Monetary Policy Committee has also been set up, chaired by the Governor of the Central Bank. Our view is that over the next 12 months the Committee will proceed with at least a 50bp drop in interest rates, supported by the low inflation, low EU interest rates and in an attempt to alleviate a significant slowdown in the economy following the 75% CSE Index drop.

The liberalisation of interest rates is part of a wider system liberalisation, in an attempt to align the economy with EU's acquis communautaire. Already, most of the restrictions on foreign (long-term) borrowing have been lifted, even though there are still some capital movement restrictions. Liberalisation of the telecoms industry and opening up of air traffic routes are also on the way, as Cyprus has increased the pace for EU alignment.

The Cyprus Stock Exchange

The Cyprus Stock Exchange started its operations on March 29, 1996 and until the end of 1998 investor interest was limited, with trading volumes rarely exceeding CYP1m per day. Then came 1999, when the CSE Index rocketed to 849 points in November 1999 from 91 points at the beginning of January, with most of the Companies trading at PE ratios of 100-150x. The CSE's short history, its own structural inefficiencies to cope with increased trading volumes, and investors' limited equity investment experience, were the main reasons that have led share prices at the back end of 1999 running well ahead of fundamentals.

With hindsight, the result of this unprecedented increase in prices was predictable: the CSE All Share Index has lost 66% during 2000, closing at 244 points. The drop in the Index has continued through to 2001, with further losses of 16%. Average daily volumes of £25.3m during 2000 have been followed by £8.9m for the year-to-date.

We will not attempt to analyse who and what was to blame, but instead we will concentrate on looking forward and evaluate the prospects of the local Bourse over the medium term, having in mind what has happened over the past couple of years. Experience from markets around the world show that burst bubbles are followed by years of neglect and underperformance. We are convinced however, that this will not happen to the CSE, for a number of reasons:

  1. First, the market is no longer expensive on fundamentals as most of the stocks are no longer overvalued. Based on current prices, our projected 2001F P/E ratio is around 14-16x, which compares favourably with the more mature markets; it seems that all the bad news has already been discounted for by the market. The banking stocks (which comprise in excess of 35% of the Index) are trading at lower multiples compared to their closest comparables, the Greek banks. Some peripheral stocks remain, in our view, expensive but there is enough value around for patient, long-term investors. The fundamentals of some of the bigger companies have also been strengthened following substantial cash inflows (from rights issues, warrants exercise, dual listings), strengthening of the management teams and diversification of operations abroad, primarily in Greece, Lebanon and Eastern Europe. Good examples include Bank of Cyprus which is rapidly expanding in Greece, Australia and the USA targeting the Greek expatriate communities, LK Globalsoft with approximately 75% of its revenues derived from its overseas operations, and Logicom, the IT distributor, expanding in Lebanon and the wider Middle East region.
  2. The newly set Monetary Policy Committee has left interest rates unchanged at 7%. However, we expect at least a 50bp drop in the interest rates over the next twelve months, and there are a number of reasons to support this view. The CSE Index is down 75% from its 850 points peak, back in November 1999. We believe the Committee acknowledges the need to avoid any structural effects on the economy, as a result of the substantial investors' losses. Slowing inflation, indications of a slowdown in the economy and a downward trend in European interest rates (with the Cyprus pound still pegged to the Euro), seem to support an interest rate drop without any unpleasant side effects. We believe however that the market has not as yet fully discounted the probability of an interest rate drop.
  3. We believe there is still plenty of money (both institutional and retail) waiting for the right moment to be invested in the market. Investors seem to be waiting for signs of market stabilisation and that the negative sentiment prevailing during the first quarter of 2001 is fading away. It is our view that market conditions have improved and expect investors to slowly re-enter the market. By our estimates, the Approved Investment Companies alone have cash balances in excess of CYP200m (or around 4% of GDP), and this excludes any other institutional money, insurance funds, the government's social insurance fund, retail funds, as well as the possibility of the setting up of a "Stabilisation Fund".
  4. Finally, looking at the longer-term fundamentals, we pinpoint the likelihood that Cyprus will join the European Union in the next enlargement round. The Government's economic reform agenda is centred towards the task of EU harmonisation and efforts to meet the terms of the acquis communautaire, where Cyprus seems to be ahead of the other accession countries. We expect Cyprus' accession into the EU to have profound effects on the economy and the Stock Exchange, as was the case with Greece and Ireland when they joined the Union.

For investors, the past couple of years seem like a sharp roller coaster ride with mixed outcomes. But with investors' confidence slowly building up, improvements made to the legal framework, the generally positive outlook for the economy and expected strong organic growth from the big Corporates, the medium term outlook and prospects of the CSE are promising.