Impact of Russia will delay recovery until 2016, says EY report
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, according to the EY Eurozone Forecast (EEF) Spring 2015.
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, EY’s forecast for 2015 GDP is now for a decline of 0.4%, compared with the 0.3% growth seen in the previous report in December.
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 2008–10, the report said, adding that another factor weighing on the economy will be restraint on public spending as the bailout conditions imposed by the Troika of international lenders 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, the EY report said, 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.
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 downturn in 2011. GDP (in real terms) in 2014 was still some 10% 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.
ON the negative front, 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 10% of GDP and relies heavily on Russian visitors, who normally make up 25% of the total number of tourists (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
to 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 exports of goods and services from this overall boost source.
The recession in Russia will also hit the Cypriot banking sector further. 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.
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.