Eurozone EY Eurozone Forecast March 2015 Austria Belgium Cyprus Estonia Finland France Germany Greece Ireland Italy Latvia Lithuania Luxembourg Malta Netherlands Portugal Slovakia Slovenia Spain
Outlook for Cyprus Impact of Russian recession will delay recovery in Cyprus until 2016 Finland Estonia Latvia Lithuania Ireland Netherlands Germany Belgium Luxembourg France Italy Austria Slovenia Slovakia Portugal Spain Greece Malta Cyprus Published in collaboration with
Highlights GDP growth The recovery expected in the Cypriot economy is now likely to be deferred until 2016 due to the mounting external headwinds, in particular the impact of the deep recession expected in Russia. We have lowered our forecast of GDP growth in 2015 and now see a contraction of 0.4%, compared with the expansion of 0.3% seen in our December report, after a 2.4% fall in 2014. Looking further ahead, growth is expected to reach 1.1% in 2016 and then 2.5% in 2019. The risks to the forecast have been rising as the main drivers of growth tourism and other services face continuing problems. Tourism, equal to over % of GDP in Cyprus, will suffer from the recession forecast in Russia. Normally, 25% of tourists in Cyprus are Russian, but numbers fell sharply in Q4 2014 and are expected to decline by 15% 20% in 2015 overall. The island s banking sector will also be hit by the problems in Russia, and other services will remain constrained by weak demand in the Eurozone. 2015 0. 4% GDP growth In addition, the conditions of Cyprus 2013 bailout require continued tight fiscal policy in 2015 16, constraining recovery and leaving it dependent upon exports, which are possibly faltering. Although cuts in the state wage bill have kept the budget on track for a primary surplus in 2016, the tight capital budget will restrict investment growth to just 1% in 2015. Furthermore, while the plunge in oil prices will bring some benefits for consumers, deflation at the end of 2014 (with prices falling 1% on the year in December) reflects ongoing constraints on consumer spending from the high unemployment rate, which is still over 16%, and could hold back the investment recovery in 2015. The return of moderate inflation, forecast to average 0.4% in 2015 and climb to 2% in 2018 19, should help demand by reducing real interest rates and the burden of debt. 2016 2015 1. 1% Unemployment 16. 0% Consumer prices 2015 0. 4% EY Eurozone Forecast March 2015 Cyprus 1
Impact of Russian recession will delay recovery in Cyprus until 2016 Weak tourism will mean another year of contraction in 2015 After three years of recession, the Cypriot economy had appeared on course to return to growth in 2015, helped by lower oil prices, but the impact of the deep recession expected in Russia on tourism and the banking sector will defer the recovery until 2016. Although the quarterly drop in GDP slowed to 0.3% in Q3 last year, a larger fall of 0.7% in Q4 meant that the contraction in 2014 overall was 2.4%. And due to the mounting external headwinds, our forecast for 2015 GDP is now for a decline of 0.4%, compared with the 0.3% growth seen in our December report. The problems in Russia will weigh on the improvement in exports of goods and services, which cut Cyprus current account deficit to just 0.5% of GDP in 2014, a sharp fall from almost 7% in 2012 and double-digit deficits in 2008. And another factor weighing on the economy will be restraint on public spending as the bailout conditions imposed by the International Monetary Fund (IMF) and the European Union (EU) in 2013 force the Government to target a return to primary budget surplus in 2016. As a result, investment growth will remain subdued in 2015, rising by just 1% after a rise of nearly 6% in 2014, but declines in the five years prior to that. At the same time, consumer demand remains subdued, held down by the need for fiscal austerity, and the high unemployment rate, which is expected to remain close to 16% this year. Private consumption is forecast to be broadly unchanged for a second successive year in 2015. A gradual pickup in growth forecast for 2016 19 However, the relaxation of budget pressures from 2016 will allow an acceleration of investment growth. At the same time, exports and tourism should begin to improve more strongly as Eurozone demand picks up steadily and the Russian economy returns to growth. These factors should lead to a fall in unemployment and a rise in personal incomes, helped also by low world oil prices, in turn leading to stronger private consumption growth. As a result, GDP growth is seen at 1.1% in 2016, picking up to 2.5% in 2019. But the growth forecast is fairly subdued due to the severity of the 2008 09 recession and the brevity of the recovery that followed it before the renewed Table 1 Cyprus (annual percentage changes unless specified) 2014 2015 2016 2017 2018 2019 GDP 2.4 0.4 1.1 1.0 1.8 2.5 Private consumption 0.1 0.1 0.6 1.1 1.6 1.9 Fixed investment 5.9 1.0 4.5 5.3 6.9 7.5 Stockbuilding (% of GDP) 0.6 1.5 1.1 0.8 0.7 0.6 Government consumption 7.7 1.1 2.0 0.9 1.0 1.8 Exports of goods and services 1.1 2.3 2.5 3.2 3.4 3.8 Imports of goods and services 6.6 0.2 1.1 3.9 4.2 4.3 Consumer prices 0.3 0.4 1.5 1.7 2.0 2.0 Unemployment rate (level) 16.1 16.0 15.5 13.8 11.9.1 Current account balance (% of GDP) 0.5 0.5 0.3 0.3 0.5 0.6 Government budget (% of GDP) 3.0 2.9 2.4 2.2 2.1 1.2 Government debt (% of GDP) 8.0 1.9 1.5 9.7 7.7 4.1 ECB main refinancing rate (%) 0.1 0.1 0.1 0.1 0.1 0.3 Euro effective exchange rate (1995 = 0) 123.6 8.6 4.7 5.4 6.6 8.0 Exchange rate (US$ per ) 1.33 1.07 1.01 1.01 1.02 1.04 2 EY Eurozone Forecast March 2015 Cyprus
downturn in 2011. GDP (in real terms) in 2014 was still some % below the pre-crisis 2008 level, and the latter is not expected to be regained until 2020. Moreover, in the short term, the risks to our forecast remain on the downside. Russian recession casts doubts over tourism in 2015 The recession in Russia and the steep fall in the rouble have cast doubt over the prospects for exports of goods and services from Cyprus in the near term. The island s tourism industry accounts for over % of GDP and relies heavily on Russian visitors, who normally make up 25% of the total number of tourists to the island (second only to those from the UK) and some 30% of revenues for the sector. Overall tourist arrivals rose 1.5% in 2014, but, as the situation in Russia worsened toward the end of the year, the number of Russian visitors to Cyprus fell by over 18% from a year earlier for November and December. And with the economic climate in Russia worsening, local industry sources suggest that Russian arrivals could fall by 15% 20% this year, after rising almost 5% in 2014. There should be some offset from a higher number of visitors from the UK (up 5% on the year in December but down by 2% in 2014 overall) where growth and incomes are rising faster and the weakness of the euro will encourage foreign holidays to Eurozone countries. Visitors from Greece have also started to pick up as its economy begins to improve. But the continued sluggish recovery seen in the Eurozone as a whole will mean there will be little overall boost to exports of goods and services from this source. Given the problems facing tourism and the slow growth of merchandise exports to the EU, the improvement in Cyprus current account deficit will probably stall this year as revenues falter. But the sharp fall in oil prices will help to curb the import bill, meaning that the external deficit will persist at around 0.4% of GDP in the coming years. Imports will outgrow exports once output starts to recover, reflecting the limited scope for substituting externally sourced consumer-goods and energy. Offshore oil and gas could improve the external balance (and help to meet tightening EU emission targets). But commercial supplies are unlikely to come onstream in the forecast period, especially given doubts about the returns on investment in energy projects due to the sharply lower oil price profile now expected. Figure 1 Real GDP growth Figure 2 Inflation % year 8 Forecast % year 5 Cyprus Forecast 6 Cyprus 4 4 2 3 0 Eurozone 2 2 1 Eurozone 4 0 6 2000 2002 2004 2006 2008 20 2012 2014 2016 2018 1 2000 2002 2004 2006 2008 20 2012 2014 2016 2018 Table 2 Forecast for Cyprus by sector (annual percentage changes in gross added value) 2014 2015 2016 2017 2018 2019 GDP 2.4 0.4 1.1 1.0 1.8 2.5 Manufacturing 0.4 0.1 3.4 5.8 5.0 4.5 Agriculture 0.2 0.9 0.8 2.1 1.5 1.0 Construction 14.2 1.2 1.3 4.0 3.5 3.8 Utilities 0.7 0.4 2.1 1.1 1.9 2.6 Trade 0.2 0.3 1.1 0.4 1.4 2.1 Financial and business services 0.3 0.7 2.5 1.8 2.5 3.1 Communications 0.6 1.9 3.5 2.0 2.8 3.5 Non-market services 6.0 2.0 1.4 0.7 0.4 1.5 EY Eurozone Forecast March 2015 Cyprus 3
Impact of Russian recession will delay recovery in Cyprus until 2016 and the banking sector will also be subdued The recession in Russia will also hit the Cypriot banking sector further. Close ties between the two countries meant that up to a third of all bank deposits in Cyprus were of Russian origin. When the crisis hit in 2013, Russians withdrew large amounts from the banking system. And the current problems in Russia mean that companies there have been instructed to reshore some of their assets from the island as capital controls are gradually removed, which will also have implications for government tax revenues in Cyprus. In addition, there may be complications for the banking sector due to the latest developments in Greece. This means that the banking sector will remain a drag on the economy, with its capacity to lend still held down by the level of non-performing debt, which accounts for more than 50% of total lending despite some restructuring. So even though three of Cyprus biggest four banks passed the EU stress tests last October, and the fourth was required to raise a modest level of capital, the gradual pickup in GDP growth that we are forecasting means that the level of bad debts will fall only slowly in 2015 17 and will deter any rapid resumption of credit growth to non-financial businesses. Moreover, the sharp drop in real incomes in the past two years will also constrain the rate of recovery in domestic bank deposits even when trust in the system is fully restored, with non-resident deposit growth held back until the Russian economy starts to grow again in 2016. Fiscal squeeze will continue to weigh on domestic demand The b IMF and EU support program remains broadly on track because of continued success in meeting fiscal deficit reduction targets. And there is 1b in the financial support program intended to cover the capital needs of the banking system that will not be used for this purpose (although, on the other hand, the December tranche of IMF funding has been withheld because of the failure to implement an agreed foreclosure rule). The budget deficit narrowed to 5.4% of GDP in 2013, and we estimate that it fell to 3% in 2014, well within the target ceiling of 4.25% of GDP. The primary deficit which excludes debt repayments is officially projected at just 1.6% of GDP in 2015 before swinging into a surplus of 1.2% of GDP in 2016. After briefly talking of a move into primary surplus this year, the finance ministry has recognized that austerity fatigue is mounting (a factor that may gather momentum following the outcome of January s election in Greece). As a result, the Government has promised to find room for targeted spending increases in 2015, to maintain social programs and ensure full use of EU co-funding for various projects. Threat of deflation persists as unemployment remains high Eurozone membership has meant that Cyprus needs internal wage and cost reduction to reignite exports and rebalance the current account, which is estimated to have posted a deficit equal to just 0.5% of GDP in 2014, down from % in 20. Average hourly wages were down 3.8% on the year in Q3, extending the reduction seen since Q4 2012. And together with an unemployment rate still around 16%, this will maintain the squeeze on household spending. These cost reductions and weak consumer demand brought inflation down sharply in 2013 and then resulted in an average decline of 0.3% in 2014 (on the EU-harmonized basis). The annual inflation rate picked up to almost 1% at the start of Q3 last year, lifted by indirect tax increases, but then fell back as oil prices plunged and in December was 1%. And given the trend in the Eurozone and the lagged impact of lower oil prices, there may be further weakness in the early months of 2015. As a result, we have lowered our forecast of inflation in 2015 to just 0.4%. But we still expect a gradual pickup to about 2% in 2018 19, above the Eurozone average, pushed up by VAT increases this year and then by gradually rising oil prices and strengthening domestic demand. This expected rise should promote investment and consumption recovery without provoking higher wage pressures because of the lingering threat from unemployment, which we expect to decline only slowly to 15.5% in 2016 and then 13.8% in 2017. Figure 3 Unemployment rate Figure 4 Government budget balance % 18 16 14 Forecast b 0.8 0.4 b (left-hand side) Forecast % of GDP 4 2 12 0.0 0 8 0.4 2 6 0.8 4 4 2 0 2000 2002 2004 2006 2008 20 2012 2014 2016 2018 1.2 1.6 % of GDP (right-hand side) 2000 2003 2006 2009 2012 2015 2018 6 8 4 EY Eurozone Forecast March 2015 Cyprus
Eurozone Forecast December 2014 4.0 0 2.0 2.8 80 1.4 1.6 0.2 60 0.8-0.6 0.4 2.0 40 0.2-1.5 0.0-2.3 20-0.8-0.4-2.0-3.2-4.0 7.2 4.4 1.6-1.2-0.6-0.4-0...4 2.0 0.4 4.0 0.8-1.20.4 0.8 6.0 1.3 1.6 2.8 8.0 1.6 1.7 2.4 5.2 4.4 3.2 7.6 7.2 4.0 4.0 2.2 Macroeconomic data and analysis at your fingertips Learn more about the EY Eurozone Forecast at ey.com/eurozone: Download the latest EY Eurozone Forecast and individual forecasts for the 19 member states. Use our dynamic Eurochart to compare country data for the next five years. Use the trend analysis tool to compare forecasts for specific economic indicators across the 19 Eurozone nations. You can select multiple countries to display on the chart. Trend analysis Country Germany Government Debt France Italy Spain Government Budget Netherlands Belgium Austria Current Account Balance Greece Finland Ireland Portugal Unemployment rate Slovakia GDP Private Consumption Fixed Investment Stockbuilding Government Consumption Luxembourg Slovenia C Clear selection Consumer Prices Exports of Goods and Services Imports of Goods and Services Select a year to compare: 2013 2014 2015 2016 2017 2018 EY Eurozone Forecast: outlook for financial services Winter 2014 The EY Eurozone Forecast: outlook for financial services explores the implications of the latest Eurozone economic forecasts for banks, asset managers and insurers. Our latest forecast sees improving GDP, growth in consumer spending and falling unemployment across the Eurozone. Learn more and download the report at ey.com/fseurozone. EY s attractiveness survey: Europe 2014 EY Rapid-Growth Markets Forecast: July 2014 EY s Rapid-Growth Markets Forecast provides analysis of 25 emerging economies. Our latest report explores the role of urbanization in the rapid-growth markets. Learn more and download the report at ey.com/rapidgrowth. EY s attractiveness surveys are annual reports that examine the attractiveness of selected nations and regions to foreign investors. EY s attractiveness survey: Europe 2014 finds that Europe remains the world s top destination for foreign direct investment. Learn more and download the report at ey.com/attractiveness.
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