by Ioannis Tirkidis
Cyprus is a small country with a large export sector of services, which makes it vulnerable to its external environment. An external shock is felt faster and more intensely. Recovery then depends on the flexibility, adaptability and resilience of the economy. Over the years, and especially after the 2012-14 domestic financial crisis, Cyprus has reduced its vulnerabilities, consolidated its public finances and significantly strengthened its banking system. But the business environment continues to be hampered by a host of unresolved issues. The unresolved national problem, for example, hides uncertainty and increases political risk. Long bureaucratic procedures and a slow judicial system hinder development. Overall, our score is not particularly high or low, but it must be improved in distinct ways and we must seek to raise our country's credit ratings one or two more steps. We know this very well.
It is important to get out of this crisis at the end of the road, with the economy strengthened. This can only be done through reforms and quality investment, and inclusive growth measures.
The pandemic, the war and the sanctions, have created an unprecedented shock to the global economy with severe shortages of energy, goods, food and some industrial goods. This is essentially a big shock to trade terms. That is, as the cost of imports increases, mainly due to the cost of energy, trade conditions deteriorate and more domestic exports are needed to cover the same imports. There are no easy ways to bypass this problem. A traditional monetary policy can not offset the impact of a trade shock, especially of this magnitude, without causing a recession. Thus, inflation rises above the target and remains high for a significant period of time, reducing incomes and their real purchasing power.
This state of affairs will inevitably slow down growth and demand in all affected countries, including our own. Mainly from the second quarter of the year onwards.
Cyprus will be affected by the reversal of the external environment and will be particularly affected by sanctions against Russia. In terms of exports of services, our interconnections with the Russian economy remain significant, at about 5% of GDP in 2021, of which about 40% is related to tourism with the rest mainly related to shipping and financial and professional services. . Sanctions will have a significant impact on much of this trade, and growth forecasts for this year have been revised down to 2-3%. We can respond to mitigate the effects by expanding public spending, to help households and businesses as much as possible, knowing that this increase in spending will have budgetary costs, and this immediately after the pandemic which has already worsened the debt burden of our country. The same goes for all governments in the EU.
Monetary policy is more complicated. The slowdown in growth and the increase in inflation deepens the dilemma of the European Central Bank because an increase in interest rates to reduce inflation will also reduce growth.
Looking further into the long term, this is an external crisis and we can only partially mitigate its effects with a targeted fiscal policy. It is important to get out of this crisis at the end of the road, with the economy strengthened. This can only be done through reforms and quality investment, and inclusive growth measures. The EU Recovery and Sustainability Fund provides significant funds for economic transition and enhancing potential growth. We must not deviate from this and we do not need to do so. We need to be guided by what we want at the end of this process, in 2026 and beyond. Better business environment. Best electricity generation mix. A public sector that will better balance its spending. A private sector with higher productivity and resilience. Better growth without exclusions.
Mr. Ioannis Tirkidis is the Director of Financial Research at the Bank of Cyprus and the President of the Cyprus Economic Studies Company.