Cyprus faces deceleration amid inflation and rising rates

Cyprus' economy experienced a slowdown in the second quarter of 2023, prompting inquiries about the situation. According to the preliminary estimate provided by the Statistical Service, the growth rate of the economy in Q2 2023 is calculated at 2.3%, as compared to the corresponding quarter of 2022, and at -0.4% in comparison to the previous quarter. To delve further, official statistics indicate a downward revision of the growth rate for Q1 2023, now estimated at 3.2% in contrast to the previous estimate of 3.4%. Throughout the first half of 2023, the growth rate reached 2.75% in comparison to the corresponding half of 2022.

In response to the official announcements from the Cyprus Statistical Service, former Finance Minister Constantinos Petrides shared observations on Twitter, wherein he emphasized that the 0.4% contraction in GDP compared to the 1st quarter is a cause for concern. Petrides elucidated that seeing negative GDP, beyond the pandemic period, has not occurred since 2014 when stability returned after the financial restructuring. He pointed out that negative GDP, or a significant slowdown, historically precedes crises, as was evident in the cases of 2003 (the stock market crisis leading to wealth redistribution) and 2009. Petrides, in his five-point analysis, remarked that negative GDP will influence government revenues, which, in his viewpoint, will profoundly impact public finances, government debt, and ratings.

Turning to the matter of public finances, the former Finance Minister expounded that Q2's fiscal performance displays a deeply concerning deterioration, with the accumulated surplus stemming from a strong surplus in Q1. He cautioned that this situation should raise concerns for both the government and the opposition—both responsible and otherwise—who have favored increased spending, often inflexible and recurring, to cater to the client-state model they present as a success. He articulated this in his post evaluating the Q2 GDP growth rate.

Addressing the Fiscal Council's perspective, as conveyed in their interim report of July 2023, the fiscal landscape, despite significant spending increases, currently maintains stability. Acknowledging that a new government tends to raise spending, the Council underscored that this can strain public finances despite ongoing revenue growth. The Council suggested factoring in planned expenditures associated with political and other commitments not yet reflected in official figures. Additionally, the Council advised maintaining surpluses to safeguard the fiscal space required for social initiatives, physical security, energy security, and the green and digital transformation of the public sector and the broader economy. While the Council recognized potential pressures for further fiscal expansion, it stressed that the Ministry of Finance presently maintains control over public finances, with no imminent high primary risks of fiscal instability.

Conversely, data from the Ministry of Finance for January to May 2023 indicates a fiscal balance of 344 million, as opposed to 140.8 million for the same period in 2022. Public debt as a percentage of GDP in January-May 2023 decreased to 83.6% from 90% in the corresponding period of 2022. The growth rate of revenues stands at 15%, while expenditures have grown at a rate of 9.7%. Notably, Cyprus' GDP growth rate for the first half of 2023 remains the third highest among the EU Member States, surpassing the Eurozone and EU averages of 0.9% and 0.8% respectively.

Moving on to the European Commission's projections, the spring forecasts released in mid-May 2023 anticipated a deceleration in economic activity for Cyprus in 2023 and 2024, attributed to ongoing inflationary pressures and increasing interest rates. The Commission highlighted that this slowdown commenced in the final quarter of 2022 and is projected to persist throughout 2023. Cyprus' economy is expected to be buffered by persistent inflation impacting household purchasing power, higher interest rates dampening investment, and the waning growth of trading partners influencing external demand. The partial wage indexation implemented in January 2023 is anticipated to mitigate the negative impact on consumption. The implementation of the Recovery and Resilience Plan (RSP) is poised to bolster investment in the forecasted period. Despite the moderation in growth, the Commission forecasts real GDP to expand by 2.3% in 2023 and further to 2.7% in 2024.

In a final note, the European Commission has revised its 2023 real GDP forecast upward by 1.3 percentage points from its autumn projections (2.3% from 1.0%), with a similar increase of 0.8 percentage points for 2024 (2.7% from 1.9%), aligning closely with the Treasury's projections (2.8% for 2023 and 3.0% for 2024).