Re­newed growth, but frag­ile re­cov­ery, says EY Fore­cast

Financial Mirror (Cyprus) - - FRONT PAGE -

With the pace of de­cline in eco­nomic ac­tiv­ity slow­ing in 2014, Ernst & Young (EY) be­lieves that Cyprus re­mains on track for a re­turn to growth next year. How­ever, the main driv­ers of the turn­around - tourism and the ser­vices sec­tor - will only be suf­fi­cient to gen­er­ate mod­est GDP ex­pan­sion of around 0.3% in 2015, after a 2.9% con­trac­tion in 2014, the ad­vi­sory firm said in its EY Eu­ro­zone Fore­cast for De­cem­ber.

The re­port said that “although the big­gest banks have passed stress tests after suc­cess­fully rais­ing cap­i­tal, the sec­tor’s non-per­form­ing loans have con­tin­ued to rise (to over half the to­tal). At the same time, new fore­clo­sure pro­ce­dures have been de­layed in par­lia­ment. Bad debts will con­tinue to re­strain do­mes­tic credit growth and house­hold and small­busi­ness spend­ing even after the re­ces­sion ends.”

EY warned that Cyprus’ bailout con­di­tions re­quire con­tin­ued tight­en­ing of fis­cal pol­icy in 2015–16, con­strain­ing re­cov­ery and leav­ing largely de­pen­dent on ex­ports.

“Although cuts in the state wage bill have kept the bud­get on track for pri­mary sur­plus in 2016, the tight­ened cap­i­tal bud­get means only a muted re­turn to fixed in­vest­ment growth in 2015,” it said.

With hourly wage costs down by 4.5% on the year (and to­tal hourly costs down by 3.9%) in Q2, the re­sult­ing com­pet­i­tive­ness gains will help to support an ac­cel­er­a­tion of ex­port growth in 2015–18, the re­port said. But a cor­re­spond­ing re­bound in im­ports will pre­vent any move into cur­rent ac­count sur­plus, mean­ing a need for con­tin­ued di­rect and port­fo­lio in­vest­ment in­flows.

“Price de­fla­tion at the end of Q3 re­flects on­go­ing con­straints on con­sumer spend­ing, and fear of fur­ther falls will hold back in­vest­ment re­cov­ery in 2015. The re­turn of mod­er­ate in­fla­tion, fore­cast to av­er­age 0.7% in 2015 and climb to 2% by 2018, will pro­mote re­cov­ery by re­duc­ing real in­ter­est rates and grad­u­ally low­er­ing the real bur­den of debt.”

The EY fe­ro­cast added that “although the im­pact of Rus­sia’s Euro­pean Union ex­port ban has been limited, min­i­mal growth in the Rus­sian econ­omy in 2014–15 is likely to hold back the Cypriot econ­omy by de­lay­ing the re­cov­ery of bank de­posit in­flows.”

In­di­cat­ing a “cau­tious re­turn to growth in 2015,” the EY re­port said that “after three years of re­ces­sion, the econ­omy is on course to re­turn to growth in 2015, as a re­vival in ex­port growth leads to a re­sump­tion of in­vest­ment.”

It added that although fur­ther drops are ex­pected in the next few quarters, growth is fore­cast to re­sume by mid-2015, un­der­pinned by this year’s fur­ther re­duc­tion in the cur­rent

it ac­count deficit to just 0.3% of GDP, a sharp im­prove­ment on the un­sus­tain­able dou­ble-digit deficit in 2012. It will also fea­ture a re­turn to pos­i­tive price in­fla­tion, after the brush with fall­ing prices dur­ing 2014. Pub­lic spend­ing will con­tinue to de­cline in 2015, as the bailout con­di­tions im­posed by the In­ter­na­tional Mon­e­tary Fund (IMF) and the EU force the gov­ern­ment to con­tinue tar­get­ing a re­turn to pri­mary bud­get sur­plus by 2016. How­ever, the re­lax­ation of bud­get pres­sures from 2016 will al­low an ac­cel­er­a­tion of in­vest­ment growth, lifting it to around 7% by 2018.

The growth out­look re­mains ex­tremely sub­dued given the sever­ity of the 2008–09 re­ces­sion, and the brevity of the re­cov­ery that fol­lowed it be­fore the lat­est down­turn be­gan in 2011. GDP re­mains well be­low the pre-cri­sis level, de­spite an up­ward re­vi­sion un­der new Euro­stat method­ol­ogy.

More­over, risks to the fore­cast re­main firmly on down­side, the EY re­port said.

On the bank­ing sec­tor, it said that the slow pace of the fore­cast re­cov­ery lim­its the pro­por­tion of bad debts that are likely to come good again in 2015–17, and their per­sis­tence will be an ob­sta­cle to the re­sump­tion of credit growth to non­fi­nan­cial busi­nesses. The past two years’ sharp drop in real in­comes, which will not be fully re­versed by re­cov­ery of wage growth in the fore­cast pe­riod, will con­strain the rate of re­cov­ery in do­mes­tic bank de­posits even when trust in the sys­tem is fully re­stored. Non-res­i­dent de­posit growth will be held back in 2014–15 by slow growth in the Rus­sian econ­omy, after its down­turn in the first half of this year.

The re­port con­cluded that the gov­ern­ment’s tight fis­cal

the tar­gets have pre­vented it from cre­at­ing a “bad bank” for non­per­form­ing as­sets or oth­er­wise ex­tend­ing debt re­lief, leav­ing the banks to reschedule or write off much of the re­main­ing bad debt with­out di­rect as­sis­tance. Cap­i­tal con­trols im­posed after the bailout may have helped stem fur­ther out­flows of de­posits, but only by fur­ther test­ing the pa­tience of the banks’ larger cred­i­tors (al­ready hit by the bail-in ar­range­ment that forced them to ab­sorb the res­cue cost along­side share­hold­ers).

This may make non-res­i­dent de­posits hard to re­build to the un­usu­ally high level achieved be­fore 2008, EY said.

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