25 December 2014 Economy in review: from crisis to stabilisation

This article appeared in the hard copy edition of The Cyprus Weekly on 25 December 2014

The year just past was one in which the economy began to find its feet again after it was blown sideways by the unforgettable events of March 2013 when the Eurogroup of Eurozone finance ministers decided to impose the unprecedented “haircut” on bank deposits.

Economic performance in 2013 had already outperformed expectations. Immediately after the crisis, the troika of international lenders expected a real decline in gross domestic product (GDP) of 8.7%. The final result was a contraction of 5.4%.

This year the economy surprised on the upside again, lending support to Cypriots’ reputation as resilient in the face of adversity.

At the beginning of the year the troika was forecasting a real GDP decline of 4.7% for the whole of 2014. The figures for the first three quarters of this year suggest that it will come in well below 3%.

In my latest monthly report, I am expecting a contraction of just 2.3%.



One reason for the better than expected performance was an upturn in retail sales. These started to increase again from March, after 25 months of consecutive decline.

Household consumption accounts for around two-thirds of GDP, of which retail sales are an important component.

Ironically an upturn in retail sales came despite the continued rise of non-performing loans (NPLs) in the banks and cooperatives, which reached 48.9% in September according to Central Bank figures.

One wonders if consumers were taking the last opportunity to spend before new legislation on foreclosures comes into effect that forces them to pay the bank rather than the retailer.

Stronger retail spending came on the back of an improvement in sentiment. The Economic Sentiment Indicator produced by the Economics Research Centre of the University of Cyprus is a broad measure combining sentiment among consumers as well as the services, retail, construction and manufacturing sectors.

The index flipped over 100 (positive sentiment) in May for the first time since the index was created and has stayed above 100 ever since.



Despite the rise in NPLs, stabilisation was also apparent in the banking sector, at least as regards liquidity.

In December 2013 deposits had dropped to €47 billion from €70.2b in the same month of the previous year.

This marked a fall of €23.1b or around €15b excluding the deposit haircuts. This year, the decline in deposits in January-October was just €1.2b.

Stabilising deposits also meant a rapid reduction in the infamous Emergency Liquidity Assistance (ELA) – a key sign of bank liquidity stress – which fell to €7.5b in November from a peak of €11.4b in March 2013.

More importantly, Bank of Cyprus and the cooperatives successfully concluded the EU-wide stress tests.

Although technically all three institutions failed when measured against December 2013, BoC and the cooperatives had filled the gap by September 2014 thanks to recapitalisation earlier in the year.

The cooperatives were recapitalised with €1.5b of troika funds, while BoC, somewhat against the wishes of the former board of directors, was pushed by the Central Bank of Cyprus to issue €1b in capital in August.

As it turned out, the Central Bank was right, because €1b was almost exactly the shortfall identified as of December 2013.

Had BoC not raised the €1b before the results, it would have found it far more difficult to find private investors after the stress tests results came out.

Instead, it was able to return to the stock market on December 16.

Hellenic Bank also quickly filled the small gap of some €175b identified in the tests.

The results of the stress tests finally put to bed the persistent rumours of bank failures or more haircuts.



Better than expected economic performance also had a positive impact on the government budget. As of October the government had a budget surplus of €275 million, or 1.6% of GDP, compared with a deficit of €475m in the same period of 2013.

More importantly, it had an enormous primary surplus (balance minus interest payments) of €680m in October, giving it a very comfortable cushion to cope with the unpredictability of parliament.

An EU-wide revision to GDP methodology was also beneficial to Cyprus, adding around €2b to the overall GDP figure thanks primarily to the large ship management sector.

This had the positive effect of cutting the debt/GDP ratio in 2013 to just 102% of GDP, compared with 112% before the changes. Suddenly Cyprus’ debt looks as though it will quickly fall below the psychologically important 100% threshold.

Even before this revision, Cyprus was able to tap the international markets in June, with a five-year €750m Eurobond that attracted a fairly low yield of 4.75%.



Despite the generally positive trend, the year ended on two negative notes.

First, the Onasagorou well drilled in Block 9 came up dry, and thus probably lays to rest any remaining hopes of Cyprus building a land-based liquefied natural gas (LNG) plant.

On the other hand, the government made progress on selling the gas in the Aphrodite field to Egypt, with hopes that a full agreement can be signed in 2015.

The other dampener at the end of the year was the IMF’s refusal to release the bailout tranche due in December, thanks to a capricious parliament that decided postponing the implementation of the foreclosure legislation was more important for the economy than being on good terms with the troika.

As a result, the troika is expected to postpone its next visit due in January.

The row over foreclosures, combined with a deterioration in financial markets and worries about political stability in Greece, mean that the government will probably not meet its objective of tapping the international markets again in early 2015.

Finally of course, there are still challenges ahead: tackling high youth unemployment, cutting NPLs and finding new sources of growth, especially now that a weaker Russian economy is affecting tourism.

But the least we can be fairly confident when we say that the worst is over.