EU forecasts of the Cyprus economy: blowing smoke

by George Hatjoullis

Ledra Street, Nicosia

Ledra Street, Nicosia (Photo credit: Wikipedia)

On February 22, 2013, the EC commission published the following forecasts for the economy of the Republic of Cyprus:

European Commission – European Economic Forecast Winter 2013
Forecasts for Cyprus 2011 2012 2013 2014
GDP growth (%, yoy) 0,5 -2,3 -3,5 -1,3
Inflation (%, yoy) 3,5 3,1 1,5 1,4
Unemployment (%) 7,9 12,1 13,7 14,2
Public budget balance (% of GDP) -6,3 -5,5 -4,5 -3,8
Current account balance (% of GDP) -4,2 -6,0 -1,7 0,1
>> Full forecasts for Cyprus  22 February 2013
European Commission
European Economy n° 1|2013

This is how the EC perceived the outlook before Cyprus was ‘rescued’. It already looked uncomfortable. Unemployment was expected to rise to 14.2% in 2014. The incumbent Cyprus administration can only dream of such an outcome now. Liquid wealth equal to about 2/5 of Cyprus GDP has been confiscated or put under a restraining order and not allowed to see its owner for an indefinite period. The owners will feel proportionately poorer overnight and such abrupt negative wealth shocks typically reduce consumption and investment spending by a significant amount. Impossible to say by exactly how much but this impact alone could, conservatively, reduce GDP by 5-10% in 2013. Unfortunately this is not the only problem. The offshore banking sector has been dealt a fatal blow and has been contributing a substantial portion of employment and income in recent years. Again precise estimates are impossible but let us say, conservatively, it has contributed 20% of GDP. That is at least another 2.5% off GDP in 2013. Credit growth will be negative and foreclosures will be evident. The banks have little choice. Given the practice of co-guarantee of loans in Cyprus every foreclosure will affect several different households. Even if banks adopt a gentle approach, the uncertainty will impact spending plans as rapidly rising unemployment (especially in high paid financial service posts) will create a climate of fear and restraint. Then there are the new property taxes to be paid. On top of this, the civil service, a large and traditionally secure employer, will cut back about 5k jobs. Civil service salary cuts are expected as well as higher pension contributions and lower pensions. Another chunk off 2013 GDP?.

The EC commission fantasy of 3.5% negative GDP in 2013 is looking a little over optimistic. As for -1.3% in 2014, you must be having a laugh! A 15% drop in 2013 looks not improbable and another 7.5% in 2014. The impact on government revenue will be devastating so the public sector budget balance is clearly going to be well north of -4.5% of GDP. The cumulative effect of these economic outcomes on GDP and borrowing will last for many years. The 10 billion euro that the troika may lend Cyprus (still not approved) is not going to be enough to cover the shortfall. Cyprus will need to be ‘rescued’ again. So how does this package put Cyprus back on a sustainable debt path Christine? The EC and IMF are blowing smoke. They must know the situation and can make better estimates than my back-of-envelope doodles. The Cyprus government economic service must also know the situation. They can add up. So what is going to happen when the second ‘rescue’ becomes necessary?

At this juncture, it is not even certain the IMF will agree to participate in the 10 billion rescue and without them there may no rescue. To do so would be disingenuous as they must know it does not lead to a sustainable debt path. So I am afraid I am unconvinced that this Greek tragedy is yet even through the first act. I can see a scenario in which Cyprus is denied the 10 billion and drops out of the eurozone. I can perceive a scenario in which Cyprus receives the 10 billion but only if it promises even more austerity. It will then drop out when the need for a second ‘rescue’ becomes evident even to the old lady in Ledra street and there is no more economy to which to apply austerity. I have worn out my worry beads in the last two weeks.

It is worth comparing the IIF estimates ( These are the only post ‘rescue’ estimates I have found. They are grim but not nearly grim enough in my view.