Ser­vices pre­vent free fall in Cyprus, pro­vide hope for re­cov­ery

Al­though bank­ing has taken a hit af­ter the is­land’s bailout, per­for­mance of other sec­tors gives some en­cour­age­ment for tough road ahead

Kathimerini English - - Front Page - BY NICK MALK­OUTZIS

Leav­ing Lar­naca Air­port, on the road to the is­land’s cap­i­tal, you meet two large bill­boards ad­ver­tis­ing cour­ses at Nicosia Univer­sity. One in­vites young Cypri­ots to study law, the other ac­count­ing. They are sym­bols of Cyprus’s past, when the econ­omy was largely built around banks that seemed to be thriv­ing. But per­haps they are a sign of the is­land’s fu­ture as well. A Eurogroup de­ci­sion in March to ap­ply a huge hair­cut to de­posits at Cyprus’s main banks put paid to the is­land’s fi­nan­cial sec­tor and dealt a body blow to its econ­omy. But ser­vices still pro­vide the coun­try’s best route to sta­bil­ity and pros­per­ity.

The Eurogroup’s de­ci­sion was driven by a be­lief among some eu­ro­zone mem­bers that Cyprus’s eco­nomic model was un­sus­tain­able due to the size of its banks, which came to al­most eight times the coun­try’s GDP. But as a small, semi-arid is­land, Cyprus’s op­tions for gen­er­at­ing rev­enues and jobs are lim­ited. The ser­vices sec­tor ac­counts for more than three-quar­ters of the Cypriot econ­omy, while man­u­fac­tur­ing amounts to less than 10 per­cent.

The over­whelm­ing be­lief on the is­land is that the eco­nomic model should not be re­built from scratch but sim­ply im­proved. This means that Cypriot banks have to be smaller, as they al­ready are, and bet­ter man­aged. It also means that all the el­e­ments which gave Cyprus an edge over other coun­tries in terms of busi­ness ser­vices and tourism should still form the ba­sis of the is­land’s eco­nomic fu­ture.

“Cyprus can­not be­come a dif­fer­ent beast,” says Charis Pa­pachar­alam­bous, di­rec­tor gen­eral at the Cyprus In­vest­ment Pro­mo­tion Agency. “Each coun­try has its com­par­a­tive ad­van­tages and ours are in the ser­vices sec­tor, not heavy in­dus­try or any­thing else. We have built on this for many years but now there is an op­por­tu­nity to add to it.”

Cyprus is grad­u­ally com­ing to terms with the shock of the Eurogroup de­ci­sion in March, which led to the coun­try agree­ing a 10-bil­lion-euro bailout with the eu­ro­zone and In­ter­na­tional Mone­tary Fund. Greek Cypri­ots, who have to work within the bound­aries of cap­i­tal con­trols (the re­stric­tions on the move­ment of money en­forced in March to pre­vent re­main­ing de­posits be­ing with­drawn), are still bristling with anger and frus­tra­tion at the way they were han­dled by their peers in the euro area.

“Cyprus was an ex­per­i­ment,” says Pa­pachar­alam­bous. “Those who took the de­ci­sion didn’t re­ally know how it would be im­ple­mented. This made things much worse.”

Con­fi­dence re­turn­ing

A num­ber of re­cent de­vel­op­ments have led to some con­fi­dence re­turn­ing to Cyprus, though. In Novem­ber, the troika, which has given two pos­i­tive quar­terly re­views of the Cypriot ad­just­ment pro­gram so far, re­vised its eco­nomic fore­cast for last year, pre­dict­ing the econ­omy would shrink by 7.7 per­cent, rather than the 8.7 per­cent it orig­i­nally thought.

At the be­gin­ning of Novem­ber, Hel­lenic Bank com­pleted its 100-mil­lioneuro re­cap­i­tal­iza­tion through pri­vate in­vest­ment, with US fund Third Point putting up 40 mil­lion eu­ros for a 30 per­cent stake in the lender, which had been short of the eq­uity needed to meet core cap­i­tal ad­e­quacy re­quire­ments.

On Novem­ber 29, Stan­dard and Poor’s raised Cyprus’s long-term sov­er­eign debt rat­ing to B-, the first rat­ings up­grade for Nicosia in three years. Sav­ings, a good tourism sea­son and “re­silient” busi­ness ser­vices sec­tors had helped Cyprus avoid an even deeper re­ces­sion, the rat­ings agency said.

Then, there is the prom­ise of se­ri­ous rev­enues from the sale of nat­u­ral gas. One gas field, Aphrodite, has al­ready been dis­cov­ered and there are high hopes that more re­serves will soon be con­firmed.

Th­ese are among the fac­tors that are help­ing some Cypri­ots see the fu­ture in a slightly more op­ti­mistic light than dur­ing the dark days of March.

“Since then, a lot of changes have hap­pened in Cyprus and peo­ple here have seen things with the be­lief that the glass is half full,” says Pa­pachar­alam­bous. “We re­al­ize that we can­not turn back time.”

Tourism boost

Tourism, such an im­por­tant driv­ing force of the Cypriot econ­omy, has not suf­fered as had been feared. Last year was the sec­ond best on record for Cyprus in terms of ar­rivals dur­ing the last decade, with 2.4 mil­lion peo­ple vis­it­ing the is­land. This was partly on the back of a sim­pli­fi­ca­tion of the visa process for visi­tors from Rus­sia and Ukraine, who were able to make their ap­pli­ca­tions online.

“There were indi­ca­tions that we were on course for a record year in 2013 but the neg­a­tive events at the Eurogroup caused se­ri­ous dam­age and the flow of book­ings dropped by up to 70 per­cent com­pared to the pre­vi­ous year,” says Marios Han­nides, di­rec­tor gen­eral of the Cyprus Tourism Or­ga­ni­za­tion.

At the time there was ex­ten­sive cov­er­age of events in Cyprus, much of it re­flect­ing neg­a­tively on the is­land and ques­tion­ing whether it would be a suit­able place for a va­ca­tion due to sup­posed fears about whether ATMs would be able to dis­pense cash and stores would have sup­plies.

Nev­er­the­less, con­cern that visi­tors would stay away proved un­founded. By the end of Oc­to­ber, 2.2 mil­lion tourists had been to Cyprus – just 2.5 per­cent lower than in 2012. Be­tween Jan­uary and Septem­ber 2013 tourism rev­enues came to 1.7 bil­lion eu­ros, an im­pres­sive 8.3 per­cent up on the pre­vi­ous year. Han­nides puts this down to Cypriot of­fi­cials mov­ing quickly to re­as­sure tour op­er­a­tors and mak­ing ef­forts to coun­ter­bal­ance the neg­a­tive cov­er­age.

“Tourism is the only sec­tor in Cyprus that has suc­ceeded,” says Han­nides. “Our aim is to build on this suc­cess so we can use it as a pow­er­ful weapon to help Cyprus move for­ward and as a ba­sis to put the coun­try on the global tourism map.”

How­ever, to make more of its tourism po­ten­tial Cyprus will also have to ad­just its im­age as a largely sum­mer desti­na­tion.

“Cyprus has to be about more than sea and sun,” says Han­nides. “Neigh­bor­ing coun­tries have th­ese el­e­ments and are more com­pet­i­tive than us but we have qual­ity, small dis­tances to cover, his­tory, cul­ture, dig­ni­fied peo­ple and hos­pi­tal­ity that you can’t find in sur­round­ing coun­tries.”

From this year there will be an ef­fort to make Cyprus a year-round desti­na­tion as ho­tels and re­sorts that closed in the fall will re­main open af­ter the tourism or­ga­ni­za­tion spoke to own­ers. “Even in De­cem­ber tem­per­a­tures ex­ceed 20 Cel­sius and peo­ple can go to the beach,” he says.

Han­nides be­lieves al­ter­na­tive forms of tourism could also help Cyprus boost vis­i­tor num­bers. Re­li­gious, sports and health tourism are just some of the forms that have the po­ten­tial to at­tract more peo­ple to the is­land. “For ex­am­ple, Cyprus is in the top five coun­tries in the world in terms of suc­cess­ful heart surg­eries,” he says.

Nelly Kou­lia, di­rec­tor of trade at the Min­istry of En­ergy, Com­merce, In­dus­try and Tourism, also be­lieves that Cyprus can at­tract health tourists due to the high qual­ity of its pri­vate-only health­care sys­tem. She adds that den­tal treat­ment and plas­tic surgery are two other ser­vices that could po­ten­tially at­tract visi­tors. A rise in health tourism would then al­low other busi­nesses, such as well­ness cen­ters and health spas, to be built around it.

Pa­pachar­alam­bous be­lieves that Cyprus could even be­come a fo­cal point for the in­ter­na­tional film in­dus­try. “We have the top-to-bot­tom fa­cil­i­ties needed to host a film in­dus­try here, not just of­fer tax cred­its for films to be made on the is­land,” he says. “Our ge­o­graph­i­cal po­si­tion, dis­tances, costs, ho­tels, in­fra­struc­ture are very im­por­tant fac­tors in this.”

Kou­lia says that ter­tiary ed­u­ca­tion is also another area where Cyprus is look­ing to do more in terms of pulling in peo­ple from abroad.

Do­ing busi­ness

Cyprus’s ge­o­graph­i­cal lo­ca­tion means that it has long been a place to trade and some­where for peo­ple of many na­tion­al­i­ties to meet. More re­cently, it proved an at­trac­tive spot for Rus­sians to do busi­ness. Moody’s rat­ings agency es­ti­mated that there was 31 bil­lion eu­ros of Rus­sian money de­posited in Cypriot banks ahead of March’s hair­cut. While much was im­plied ear­lier this year about the shady na­ture of some of th­ese de­posits – al­le­ga­tions the Cypriot au­thor­i­ties de­nied – nu­mer­ous Rus­sians still own hold­ing com­pa­nies in Cyprus de­spite the hit they took fol­low­ing the de­posits hair­cut.

“I don’t think the Rus­sians will leave Cyprus,” says Kyr­i­akos An­gelides, busi­ness as­so­ci­a­tions’ co­or­di­na­tor at the

Banks de­ci­sive

into a Bank of Cyprus branch in the cap­i­tal, Nicosia. Cyprus’s cen­tral bank agreed last year a 47.5 per­cent hair­cut with in­ter­na­tional cred­i­tors on de­posits ex­ceed­ing 100,000 eu­ros in the Bank of Cyprus in an at­tempt to re­cap­i­tal­ize it. The coun­try’s sec­ond­largest bank, Laiki, went through a res­o­lu­tion process. Cyprus Em­ploy­ers and In­dus­tri­al­ists Fed­er­a­tion.

“Rus­sians have many rea­sons to stay: Our cor­po­ra­tion tax, which is still just 12.5 per­cent de­spite an in­crease from 10 per­cent, so­cial and re­li­gious con­nec­tions and the fact that the Rus­sians have been in Cyprus for some time – they have their lawyers and ac­counts here.”

Le­gal and ac­count­ing ser­vices flour­ished when Cypriot banks boomed but their foun­da­tions go much deeper than just the last decade or so. Cyprus adopted in­ter­na­tional ac­count­ing prin­ci­ples in the 1980s and its le­gal sys­tem is based on English com­mon law. It also has a straight­for­ward tax sys­tem that boasts one of the low­est cor­po­rate rates. Last year’s events have not changed the fact that th­ese el­e­ments re­main at­trac­tive to for­eign en­trepreneurs and firms, pro­vid­ing a con­vinc­ing ar­gu­ment for those al­ready based on the is­land to re­main there.

“For­eign in­vest­ment in Cyprus has tra­di­tion­ally been low but we will see this change now with pri­va­ti­za­tions and other projects such as nat­u­ral gas and the build­ing of a casino re­sort,” says Pa­pachar­alam­bous, whose job it is to help at­tract for­eign cap­i­tal to Cyprus.

“We have seen in­ter­est in Cyprus grow over the last few months. This is the re­sult of two things: There are in­vestors who be­lieve there are op­por­tu­ni­ties here, whether those are dis­tressed as­sets or some­thing else, but there are also those who are seek­ing other kind of in­vest­ments. They see that the sit­u­a­tion is im­prov­ing and the state is chang­ing.”

Ac­cord­ing to the World Bank, Cyprus is 39th in terms of ease of do­ing busi­ness, which is one of the high­est rank­ings in the eu­ro­zone, while Greece finds it­self in 72nd place de­spite a re­cent im­prove­ment.

“For­eign firms have not de­parted en masse, as we feared. There has, how­ever, been a re­duc­tion in the num­ber of new firms set­ting up in Cyprus,” says Kyr­i­akos Ior­danou, gen­eral man­ager at the In­sti­tute of Cer­ti­fied Pub­lic Ac­coun­tants of Cyprus.

“As an ac­count­ing in­sti­tute, our in­ter­est is that they keep their hold­ing com­pa­nies here and not so much their bank­ing ac­tiv­ity. Our sim­ple and low tax­a­tion, dou­ble tax­a­tion agree­ments with other coun­tries, and the cost of ser­vices that we of­fer in com­par­i­son to com­pet­ing coun­tries, such as Lux­em­bourg, are help­ing to keep for­eign firms here.”

There is, how­ever, another rea­son keep­ing for­eign-owned com­pa­nies in Cyprus: Many of them have in­ad­ver- tently be­come share­hold­ers in the is­land’s main bank as a re­sult of the March Eurogroup de­ci­sion. The bailout terms meant that Laiki Bank, the coun­try’s sec­ond-largest lender, had to be wound up and de­posits over 100,000 eu­ros in its largest lender, Bank of Cyprus, had to un­dergo a 47.5 per­cent hair­cut. In­vestors were com­pen­sated for their losses by re­ceiv­ing shares in the Bank of Cyprus. In Septem­ber, six Rus­sians were ap­pointed to the bank’s 16-mem­ber board of di­rec­tors.

Some steps have been taken to­ward shoring up lo­cal banks but the sec­tor re­mains in a frag­ile state. Bank of Cyprus in par­tic­u­lar is in a pre­car­i­ous po­si­tion. It holds around half of the is­land’s loans and de­posits but it has also been lum­bered with around 10 bil­lion eu­ros in Emer­gency Liq­uid­ity As­sis­tance (ELA) granted to Laiki by the Euro­pean Cen­tral Bank. Cyprus’s banks may be pick­ing up the pieces af­ter the bail-in bomb was dropped on them in March but they are not yet in a ro­bust enough po­si­tion to drive an eco­nomic re­cov­ery.

“The main prob­lems our econ­omy faces are re­duced eco­nomic ac­tiv­ity, a lack of liq­uid­ity, high in­ter­est rates, non­per­form­ing loans, a drop in con­sump­tion and high un­em­ploy­ment,” says Marios Tsi­akkis, sec­re­tary gen­eral at the Cyprus Cham­ber of Com­merce and In­dus­try. “More than 99 per­cent of our com­pa­nies are small and medium-sized and they are fac­ing dif­fi­cul­ties. Some have closed, oth­ers have fired staff or re­duced em­ploy­ees.”

Ob­sta­cles ahead

In up­grad­ing Cyprus’s credit rat­ing in Novem­ber, S&P warned of the pre­car­i­ous­ness of its eco­nomic sit­u­a­tion. “Fac­tors pre­vent­ing a more se­vere con­trac­tion – sav­ings that have helped to sup­port con­sump­tion and Cyprus’s tourism and busi­ness sec­tors have proved re­silient – are, in part, tem­po­rary,” it said.

The third quar­ter of last year was the eighth con­sec­u­tive three-month pe­riod of con­trac­tion for the Cypriot econ­omy and a lack of liq­uid­ity due to the frag­ile state of the is­land’s lenders.

“Banks do not have the abil­ity to fi­nance com­pa­nies and, com­bined with cap­i­tal con­trols, this makes it very dif­fi­cult for firms to do busi­ness,” adds Tsi­akkis. “Also, those com­pa­nies that had de­posits in Laiki Bank lost money and are fi­nan­cially weak at the mo­ment.”

By the end of Septem­ber, un­em­ploy­ment had reached 17.1 per­cent, from 12.7 per­cent a year ear­lier. This was the high­est in­crease in the eu­ro­zone for that pe­riod and leaves Cyprus with the third-high­est job­less rate among the 17 mem­bers of the sin­gle cur­rency.

“Un­em­ploy­ment has grown, in­come has been squeezed as a re­sult of job losses and wage re­duc­tions, com­mer­cial ac­tiv­ity has con­tracted partly due to the cap­i­tal con­trols but also a lack of credit, and a num­ber of small com­pa­nies have closed,” says Ior­danou, who rep­re­sents the is­land’s ac­coun­tants.

“In terms of our do­mes­tic clients there is a prob­lem, mainly due to the lack of liq­uid­ity,” he adds. “Those who haven’t shut down find it dif­fi­cult to pay or at least to pay on time. For ac­count­ing firms that deal with for­eign clients, the sit­u­a­tion is bet­ter.”

Other sec­tors are suf­fer­ing too. Af­ter a real es­tate boom over the last few years, the con­struc­tion sec­tor has now suf­fered a big de­cline. The num­ber of build­ing per­mits is­sued in Septem­ber was 30 per­cent down on a year ear­lier.

“The ser­vices sec­tor has shrunk but things are not as bad as some peo­ple had feared,” says An­gelides of the Cyprus Em­ploy­ers and In­dus­tri­al­ists Fed­er­a­tion. “Con­struc­tion and real es­tate, on the other hand, have suf­fered ir­re­versible dam­age.”

Full cir­cle

The hope on Cyprus, though, is that its be­lea­guered banks are on the way back. Cypriot au­thor­i­ties an­nounced in July that the Bank of Cyprus had been fully re­cap­i­tal­ized by con­vert­ing 47.5 per­cent of unin­sured de­posits into shares in the bank. This was fol­lowed by news of Hel­lenic Bank’s re­cap­i­tal­iza­tion in Novem­ber. Be­yond Cyprus’s two main lenders, the is­land’s credit co­op­er­a­tive banks, which rep­re­sent the bulk of the re­main­der of the bank­ing sys­tem, are due to re­ceive a 1.5-bil­lioneuro cap­i­tal in­jec­tion and be re­struc­tured as part of Nicosia’s bailout pro­gram.

The credit rat­ing of Cypriot banks re­mains poor but in a state­ment in Oc­to­ber, Fitch Rat­ings said the com­ple­tion of the re­cap­i­tal­iza­tion and re­struc­tur­ing process for the main banks should im­prove con­fi­dence and con­trib­ute to fund­ing sta­bil­ity in the sys­tem.

“We think it’s a pos­i­tive de­vel­op­ment that Bank of Cyprus has been re­cap­i­tal­ized via de­posits and that Hel­lenic Bank has been able to at­tract for­eign in­vestors,” says Tsi­akkis. “This is a sign that trust in our bank­ing sys­tem is re­turn­ing.”

Nev­er­the­less, the on­go­ing ef­fort to sta­bi­lize Cypriot banks af­ter the almighty jolt they suf­fered last year, the con­tin­u­ing lack of liq­uid­ity, a sec­ond year of re­ces­sion and the pub­lic spend­ing cut­backs the gov­ern­ment has to im­ple­ment as part of the EU-IMF bailout agree­ment, mean that 2014 will bring fur­ther se­ri­ous chal­lenges for the is­land’s econ­omy.

“This year will be more dif­fi­cult, there is no doubt about that,” says Pa­pachar­alam­bous. “Al­though the con­trac­tion this year will be smaller, it will be another year of re­ces­sion.”

In fact, whereas the troika re­vised down its re­ces­sion fore­cast for 2013, it now be­lieves the Cypriot econ­omy will shrink by more than pre­vi­ously ex­pected in 2014. Cyprus’s lenders es­ti­mate the con­trac­tion will reach 4.8 per­cent in 2014, as op­posed to the 3.9 per­cent they orig­i­nally pre­dicted. Fitch sees shrink­age of 4.9 per­cent for this year.

“We still haven’t over­come the shock ef­fect,” says Ior­danou. “The im­me­di­ate im­pact will be felt [this] year. That’s when the real econ­omy will suf­fer most.”

He makes the point that Cypri­ots had been dip­ping into their sav­ings – or what was left of them – to cover ex­penses last year, cit­ing the ex­am­ple of the pay­ment of prop­erty tax, which went up from 20 mil­lion eu­ros to about 100 mil­lion eu­ros. “[In 2014] what will be dif­fer­ent is that the money peo­ple had as cash re­serves will not ex­ist any­more,” says Ior­danou.

This is also likely to have an im­pact on Cyprus’s banks, with Cypri­ots find­ing it more dif­fi­cult to pay back their loans, which out­pace de­posits by more than 15 bil­lion eu­ros. In an en­vi­ron­ment where there will be sub­stan­tial delever­ag­ing, the stur­di­ness of the is­land’s lenders is likely to be se­verely tested – even more so when cap­i­tal con­trols are lifted. “Fi­nan­cial sta­bil­ity does re­main a key risk,” said S&P. “Once cap­i­tal con­trols are lifted, the sta­bil­ity of pri­vate sec­tor de­posits will be un­cer­tain.”

For Cyprus, it seems, the key to meet­ing the huge eco­nomic chal­lenges it faces lies where it all be­gan: with the banks. In the mean­time, its ser­vices sec­tor, driven by the pis­tons of ac­count­ing, le­gal ser­vices and tourism, has the po­ten­tial to drive the coun­try for­ward through this dif­fi­cult pe­riod.

A woman walks

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