The Cypriot economy is expected to slow down towards the end of 2022 after growing steadily during the first half of the year, according to the chapter on Cyprus from the European Commission’s Autumn 2022 Economic Forecast which was presented on Friday by Commissioner for the Economy Paolo Gentiloni.
The country’s public finances are expected to remain sound, but an overall slowdown of the economy is expected due to the continuing effects of the Russian invasion of Ukraine and the increase in energy prices.
The predictions include reduced unemployment to 7.2% in 2022. Unemployment is expected to remain stable in 2023 and fall to 6.9% in 2024.
Inflation is expected to increase from 2.3% in 2021 to 8% in 2022, and slow down to 4.2% in 2023 and 2.5% in 2024.
The chapter on Cyprus
Following solid growth in the first half of 2022, economic activity is expected to slow down considerably towards the end of the year due to global headwinds and persistent inflationary pressures. Public finances are projected to remain sound, but the headline surplus is set to grow at a slower pace than before.
Strong GDP growth in 2022
According to the forecast, real GDP increased by 6.3% in the first half of 2022, compared to the same period of 2021, driven mainly by domestic demand. Buoyant private consumption growth was supported by increased employment and savings accumulated during the pandemic.
It is also stated that investment has increased as a result of the Recovery and Resilience Plan's implementation (RRP). However, high material prices and tightening financing conditions have hampered construction investment.
The tourism sector performed well with arrivals and revenues from tourism reaching almost 80%, and 90% of the pre-pandemic levels, respectively in the first three quarters of the year.
Exports of Information Communication and Technology (ICT) and of financial and transport services continued to expand in the first half of 2022.
Headwinds to weigh on growth
Starting from the last quarter of 2022, growth is expected to significantly decelerate due to the global economic slowdown, rising interest rates and upward price pressures, in particular for energy.
Low purchasing power in Cyprus’ trading partners is set to weigh on exports of services, notably tourism, it is noted.
Moreover, weakening consumer and business confidence in Cyprus and increasing interest rates are negatively affecting private consumption and household investments. This is expected to intensify in 2023.
Targeted government measures to mitigate the impact of high energy prices and the partial indexation of wages to be implemented in January 2023 are expected to support purchasing power. The wage indexation concerns around 50% of employees covered by collective agreements, limiting somewhat the negative impact on private consumption.
Furthermore, the implementation of the Cypriot RRP is expected to support investment over the forecast horizon. Overall, real GDP is forecast to grow by 5.6% in 2022 and to decelerate to 1% in 2023, before slightly picking up in 2024 by 1.9%.
Significant uncertainty and downside risks to the growth outlook remain, as the tourism sector and other export-oriented services sectors are particularly vulnerable to external shocks.
Unemployment is set to decline, but slowly
The unemployment rate is projected to reach 7.2% in 2022 slightly down from 7.5% in 2021, the forecast says. Employment and vacancies were on the rise in the first half of 2022, whereas the slowdown of economic activity is set to put brakes on the labor market's positive performance later this year.
In 2023, the unemployment rate is forecast to remain stable, before declining to 6.9% in 2024.
Inflation will be moderate in 2023
Headline inflation is expected to increase to 8% in 2022, up from 2.3% in 2021. This, it is noted, is mainly due to the exceptionally high oil prices, as Cyprus depends heavily on oil products.
The prices of non-energy industrial products and food have also increased as a result of supply chain disruptions and the secondary impact of higher energy prices.
In 2023, oil prices are projected to moderate, but the partial indexation of wages is set to have some upward second-round effects on core inflation. Overall, inflation is projected to decelerate to 4.2% in 2023 and to 2.5% in 2024.
Public finances continue to be sound
Moreover, according to the forecast, the fiscal performance has been stronger than expected over 2021 and 2022, supported by the economic rebound. In 2022, the government headline balance is forecast to turn into a surplus, reaching 1.1% of GDP.
It is added that government revenues are set to grow strongly in 2022 by 10.2%, supported by high inflation. This is only marginally offset by an increase in public spending of 3.1%. Public expenditure growth remains low due to the phasing out of the COVID-19-related support measures granted to corporations and employees.
The costs of measures to mitigate the impact of high energy prices, mainly the reduction of indirect taxation and subsidies on energy bills, is estimated at 0.7% of GDP in 2022.
For 2023, government revenues are projected to increase at a slower pace, reflecting the slowdown in economic activity. Nevertheless, the budget surplus is forecast to reach around 1.1% of GDP in 2023, and 1.6% in 2024.
The broadly unchanged budget surplus in 2023 in spite of the economic slowdown is driven by the projected reduction of the cost of measures to mitigate the impact of high energy prices to 0.1% of GDP, as many of them are set to expire by the end of 2022.
The debt-to-GDP ratio is expected to decrease over the coming years on the back of expected nominal GDP growth (including due to the high GDP deflator) and primary surpluses. It is set to reach 89.6% by the end of 2022, and further decline to 84.0% and 77.7% in 2023 and 2024 respectively.