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Cyprus: from rags to riches?

Media headlines seem to have given much larger attention to the bailout programme in Greece than to those of most other countries. But Greece’s experience with economic adjustment is in many ways an outlier, complicated by the election of the radical-left government of Tsipras.

Cyprus offers the interesting example of an economy saved with the help of economic adjustment and responsible reforms. Cyprus under centre-right leadership seems to be a rags-to-riches story after being shut out of financial markets only six years ago.

During the 2000s Cyprus registered strong growth driven by buoyant domestic demand according to a European Commission report. On average, Cyprus’ real GDP grew at a rate of 2.75% between 2000 and 2010 compared to the 1.4% of the euro area for the same timeframe.

The country enjoyed high employment rates, low inflation rates and rising real disposable income. This led to real convergence with the stronger economies in the European Union. Apart from domestic demand, Cyprus’ accession to the European Union in 2004 and its joining the euro area in 2008 contributed to this growth by boosting investor confidence.

While Cyprus resembles other countries in the euro area most affected by the crisis, it represents a success story in crisis management.

However, this positive image was underpinned by economic vulnerabilities and imbalances due to the mismanagement of the public finances. Notably, Cyprus ran current account deficits averaging 6.9% of GDP for approximately one decade during EU accession and entry to the euro area. In order to finance its current account deficit, Cyprus relied on foreign direct investment, which provided little added value to the economy.

Furthermore, the public sector had grown extensively in the 2000s, taxpayer compliance was low, and total government expenditure as a share of GDP increased. Additionally, the banking sector was vulnerable because of inadequate prudential supervision and because of its openness toward Greece.

When the financial crisis and subsequent euro crisis hit, the Cypriot banking sector was severely impacted. Cyprus reached a 6.3% budget deficit and gross debt rose sharply to 85.8% of GDP and subsequently going over 100%. Cyprus was shut out of financial markets for 18 months starting in mid-2011.

In order to adjust its economy, Cyprus agreed a bailout programme and undertook comprehensive structural reforms under centre-right President Anastasiades. The implementation of the bailout programme of €10 billion (56% of Cypriot GDP) took place between 2013 and 2016.

It was one of the largest sovereign bailouts in history. The bailout programme targeted Cypriot banks and involved a severe austerity programme (cuts to public spending, tax increases, and privatisation of semi-government organisations).

The reform to the banking sector, which saw Cyprus’ second-largest bank shut down, was received negatively by the public as it involved losses to all stakeholders in the banking sector, especially bondholders and depositors.

The government in Cyprus was determined in its response to the crisis and Cypriots were stoic in their resolve to see the reforms through. Apart from minor unrest toward the beginning of 2013, there were little protests and no riots against the austerity programme.

While Cyprus resembles other countries in the euro area most affected by the crisis, it represents a success story in crisis management.

The performance of Cyprus is a clear example of the positive link between a bailout programme for a country in deep crisis and sustainable economic activity. 

The country exited the bailout programme on track in 2016 due to ambitious and consistent implementation of necessary reforms by the centre-right government led by President Anastasiades.

Statistical data from Eurostat supports the positive contribution government policy since 2013 has made to the country’s recovery. Cyprus ranks among the top ten countries in the European Union on key financial indicators.

Data for the third quarter of 2017 shows a 0.9% increase in GDP over the previous quarter and a 3.9% increase over 2016. Employment has increased by 0.7% in the third quarter when compared to the second and by 3.5% when compared to 2016.

Equally, Cyprus registered the fifth largest year-on-year decrease in unemployment in the European Union, from 13.1% in 2016 to 11.0% in the third quarter of 2017.

Cyprus had the largest year-on-year drop in government debt to GDP ratio (7.4%) in the EU in the third quarter of 2017. According to a European Commission forecast, growth is expected to remain strong in 2018 and 2019 coupled with a strong labour market and modest inflation.

The economy of Cyprus has outperformed the government’s budgetary targets, and government debt is likely to fall below 100% of GDP in 2019.

The academic literature on public administration reform often emphasises the difficulty of agreeing to and implementing reforms as well as of deciding whether or not the intended reforms had the intended outcome.

In this respect, the performance of Cyprus is a clear example of the positive link between a bailout programme for a country in deep crisis and sustainable economic activity. Notably, it is a victory for the centre-right, which has once more shown its ability to deliver results in highly challenging circumstances.

Even so, the Cypriot economy should not rest on its laurels even if it has registered a significant improvement. A forecast by Oxford Economics warns that reform is still necessary as the ‘legacy of the 2012-2013 crisis can still be seen in the banking sector’.

Further work on restructuring non-performing loans and improving public finances is required in order for the positive forecasts to become a reality. Rags-to-riches stories are popular, but so are riches-to-rags.