Im­pact of Rus­sia will de­lay re­cov­ery un­til 2016, says EY re­port

Financial Mirror (Cyprus) - - FRONT PAGE -

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.

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