European Commission flags trade risks for Cyprus economy

The Cypriot economy is on a sound footing due to solid economic growth and declining inflation, but its high integration with EU and non-EU economies make geopolitical and trade tensions a non-negligible risks, according to a macroeconomic imbalances review published by the European Commission on Monday as part of its European Semester process.

The Commission has today published six in-depth reviews (IDRs) for Cyprus, the Netherlands, Romania, Slovakia, Spain, and Sweden, assessing whether they are experiencing macroeconomic imbalances. Reports for another six member states are expected in the coming weeks. The report on Cyprus is posted on https://economy-finance.ec.europa.eu/publications/depth-review-2024-cyprus_en .

As noted in the introduction of the report, the review analyses the evolution of Cyprus’s vulnerabilities related to high private, government and external debt, and possibly newly emerging risks.

This year’s report assesses the persistence or unwinding of the vulnerabilities identified in previous years, potential emerging risks, and relevant policy progress and policy options that could be considered for the future.

The countries for which reports were published were selected through the Alert Mechanism Report which identifies Member States for which IDRs should be undertaken to assess whether they are experiencing macroeconomic imbalances.

The 2024 Alert Mechanism Report (AMR) adopted in November 2023 as part of the European Semester Autumn package selected 12 Member States for which an IDR should be prepared. The remaining six IDRs for France, Germany, Greece, Hungary, Italy, and Portugal will be published in the coming weeks.

This year, the IDRs are being presented in advance of the European Semester Spring Package to allow for more in-depth multilateral discussions with Member States ahead of the Commission's proposals for country-specific recommendations, in the context of the European Semester (the EU’s framework for the coordination and surveillance of economic and social policies).

Summary of the report on Cyprus

As noted in the introduction to the report on Cyprus, solid economic growth, combined with declining inflation, are helping to put the Cypriot economy on a sound footing.

The GDP growth rate moderated to 2.4% in 2023 from a very buoyant 5.1% in 2022. This slowdown in growth was mainly due to weaker external demand for financial and business services, affected by Russia’s war of aggression against Ukraine.

According to the Commission’s winter 2024 interim forecast, in 2024 and 2025, economic growth is expected to pick up again to reach around 3%. This acceleration in growth is expected to be helped by sizeable planned investments in the areas of energy, education, healthcare and tourism, in part supported by the Recovery and Resilience Facility.

Headline inflation started to moderate in 2023, dropping to 3.9% with core inflation slightly higher at 4.4%, down from 8.1% and 5.3% respectively in 2022. In 2024 and 2025, inflation is expected to continue declining.

The Cypriot labour market remains robust, with employment continuing to increase and unemployment expected to fall below 6% by 2025, its lowest level in over a decade.

At the same time, real wages are forecast to grow only moderately over 2024- 2025, as in 2023, after having declined substantially in 2022.

The fiscal position remains strong with a sizeable surplus in 2023, which is expected to be maintained in 2024 and 2025. The risks to the economic outlook are broadly balanced.

High integration with EU and non-EU economies makes Cyprus prone to spillovers resulting from economic developments in these economies.

The Cypriot economy is highly dependent on Greek and Italian goods and services, while Greece and the UK are significant export partners.

On external demand, the largest shares of total value added in the Cypriot economy are generated to satisfy domestic demand in Germany, the US and China, while Cypriot domestic demand is mostly satisfied by value added generated in the UK, Greece and Germany.

Because Cyprus has high exposure, both direct and indirect, to non-EU partners, geopolitical and trade tensions appear to pose a non-negligible risk to its economy.