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Country Commercial Guides FY 2000: Cyprus Report prepared by U.S. Embassy Nicosia, released July 1999 Note*

II. ECONOMIC TRENDS AND OUTLOOK

Major Trends and Outlook

According to the World Bank's Development Report, Cyprus is ranked 16th in terms of per capita income adjusted for purchasing power parity. In 1998, the Cypriot economy recorded strong growth, declining inflation, and low unemployment. Specifically, growth reached 5.0 percent (from 2.5 percent in 1997), inflation fell to 2.2 percent (from 3.6 percent in 1997), and unemployment remained low at 3.3 percent. As in previous years, services provided the main impetus for growth. Additionally, and in contrast to the previous two years, agriculture and manufacturing performed quite well in 1998.

The Cypriot economy's two most noticeable weak areas in 1998 were a growing fiscal deficit and deteriorating balance of payments. The public finance sector deteriorated further in 1998, with the deficit growing from 5.3 percent of GDP in 1997 to 5.5 percent in 1998 and moving further away from the Maastricht target of 3.0 percent. (Note: Being one of six candidate for EU accession, the Government of Cyprus frequently compares its key economic statistics with the Maastricht criteria.) As a result, public debt continued to rise, causing strong concern, reaching 60.0 percent of GDP from 56.6 percent. A package of fiscal measures designed to increase state revenue and reverse this trend is currently pending before the House of Representatives.

Tourism, the island's engine of growth, generated revenue of USD 1.7 billion in 1998, up 4.2 percent from 1997. Tourist arrivals, 75 percent of which came from the EU, increased by 8.5 percent reaching 2,265,000.

Cyprus' thriving international business and shipping sectors provided another valuable source of foreign exchange in 1997. A total of 4,846 new international business companies registered in 1998 (compared to 5,260 in 1997)(previously known here as "offshore businesses"), raising the total number of international business companies registered here to 36,585, approximately one-half of which are active. About 26.9 percent of new permits were given to companies from the European Union (EU). The number of international business companies operating in Cyprus from fully-fledged and staffed offices recorded a small increase from 1,049 in 1997 to 1,055 in 1998. At least 30 of these fully-staffed international business companies are from the United States. Cyprus also has the sixth-largest ship register in the world, with more than 2,700 ships and 27.0 million Gross Registered Tons (GRTs). Foreign exchange earnings from international business and ship ownership activities recorded a solid increase of 10.0 percent in 1998, reaching USD 386.23 million.

GDP in nominal terms was USD 8.97 billion in 1998 vs. USD 8.40 billion in 1997. GDP per capita reached USD 13,604 in 1998 -- one of the highest in the world. Inflation dropped to 2.2 percent in 1998 from 3.6 percent in 1997 on account of a deceleration in the prices of domestic goods and services. Full employment conditions were maintained in 1998, with unemployment recording a marginal drop, from 3.4 percent of the economically active population to 3.3 percent in 1998.

Productivity, measured as the ratio of real value added to gainful employment, rose by 3.6 percent in 1998, compared with only 2.2 percent the year before. This positive development helped the Cypriot economy regain some of its lost competitiveness, which was undermined in recent years by the fact that productivity gains stayed behind real earnings increases. In 1998 real earnings increased by 2.9 percent. The sector of agriculture recorded the biggest productivity gains (6.9 percent), followed by the broad services sector (4.5 percent).

Total exports declined by 14.1 percent in 1998, while total imports increased by 6.0 percent, causing the trade deficit to reach a record USD 2.5 billion in 1998 (up 17.1 percent from 1997). As a result of this development, and despite a healthy increase in invisible receipts, the current account deficit deteriorated considerably, increasing from 4.0 percent of GDP to 6.7 percent.

Public finances also deteriorated, with the fiscal deficit widening further from 5.3 percent of GDP in 1997 to 5.5 percent in 1998 and moving further away from the Maastricht target of 3.0 percent. (Note: Being one of six candidate for EU accession, the Government of Cyprus frequently compares its key economic statistics with the Maastricht criteria.) As a result, the public debt continued to rise causing strong concern, reaching 60.0 percent of GDP from 56.6 percent. A package of fiscal measures designed to increase state revenue and reverse this trend is currently pending before the House of Representatives.

The forecast for 1999 calls for satisfactory growth, based on an anticipated improvement in external demand for goods and services. Tourism prospects, in particular, appear excellent, with arrivals are expected to grow by 7.1 percent. With this backdrop, real GDP growth is forecast to reach 4.0 percent in 1999, slightly below the 1998 rate.

Principal Growth Sectors

The share of the tertiary sector (services) to GDP has been growing rapidly in recent years -- from 54.4 percent in 1992 to 60.2 percent of GDP in 1998, in constant 1990 terms -- reflecting the fact that Cyprus is rich in human capital (large numbers of Greek Cypriots have advanced degrees from U.K. and U.S. institutions of higher learning). Within the broad services sector, the principal growth sub-sectors were services other than tourism. In particular, finance, insurance, real estate and business services recorded healthy gains (from 16.6 percent of GDP in 1992 to 19.8 percent in 1998) and community and personal services (from 6.3 percent of GDP to 8.0 percent over the same period). The subsector of restaurants and hotels contributed 9.4 percent of GDP, compared with 10.2 percent in 1992. (Tourism as a whole, which benefits from spill-over effects from many other sub-sectors, generated a little over 18.0 percent of GDP in 1998, compared with 21.0 percent in 1992. This reflects the relative shrinking of importance of tourism compared to other services.)

Value added in the primary sector (agriculture and mining) shrank from 7.1 percent of GDP in 1992 to 5.8 percent of GDP in 1998 and, similarly, the secondary sector (including manufacturing, electricity and construction) has declined from 25.9 percent to 20.6 percent over the same period. Efforts to revive the manufacturing sector have not been successful in recent years for many industries. The island's advantageous position in the Mediterranean, its rich history and friendly people give Cyprus a natural comparative advantage in tourism and services, while the relative shortage of blue-collar workers and rising labor costs make it progressively harder for labor-intensive manufacturing operations to flourish.

Government Role in the Economy

The role of the government is still significant by U.S. standards but is declining. Substantial assets remain in government hands in the form of Semi-Government Organizations (SGOs), such as the Cyprus Telecommunications Authority (CyTA), the Electricity Authority of Cyprus (EAC), etc.

In 1996, the Central Bank of Cyprus spearheaded a campaign to liberalize and reform Cyprus' financial sector, achieving substantial progress. Monetary policy is now successfully conducted through a new monetary policy framework, using market-based instruments. Repurchase transactions between the Central Bank and financial institutions constitute the primary tool of liquidity management and the use of the minimum liquidity requirement has been totally abandoned. The new monetary policy framework also includes a lower minimum reserve requirement and two standing facilities, aimed at providing and absorbing overnight liquidity. The new operational set-up of monetary policy is fully in line with EU practices.

The most important structural impediment to full liberalization of Cyprus' financial sector is the continued existence of an obsolete interest rate regime. An antiquated law (first introduced in 1944) fixing an interest rate ceiling of 9.0 percent is still in effect, even though the maximum interest rates applicable at the present time (after some recent adjustments by the Central Bank) are 6.5 percent for deposits and 8.0 percent for loans. A bill for the liberalization of interest rates is currently being hotly debated by interested parties. The bill could pass before the end of 1999, although the government will have a hard time convincing the unions and communist party AKEL.

Despite certain recent relaxations concerning the amounts involved, residents of Cyprus are still subject to exchange control restrictions, covering the holding of foreign currency accounts, investing abroad, travel allowance, etc. Once interest rates are liberalized, or, at any rate, prior to EU accession, the abolition of foreign exchange controls will follow (first, for inflowing capital and then for outflowing capital). (Non-residents are exempt from these restrictions. Non-residents may hold and manage assets and liabilities in any foreign currency and in any foreign country, including freely convertible and transferable balances with banks on the island.)

Additionally, the Central Bank has put in effect a more liberal policy on foreign direct investment since February 1997. Under this new policy, foreign participation of up to 100.0 percent will generally be allowed in the manufacturing and services sectors and up to 49.0 percent in agricultural activities. In some sensitive areas like banking, insurance and other financial services, as well as publishing and distribution of newspapers and magazines, applications will be examined on a case-by-case basis. In "saturated" activities, such as real estate development, tertiary education and the provision of public utility services, non-residents will be discouraged from investing.

Since June 1996, the maximum limit on foreign participation in public companies (traded on the stock exchange) was raised from 24.0 percent to 49.0 percent. The limit on foreign participation in public companies has been abolished completely, for non-residents of Cypriot origin. Public companies in the banking sector are exempted: the limit on total non-resident participation (Cypriot and non-Cypriot) in Cypriot banks is now 15.0 percent of their total share capital (compared to 8.0 percent before 1996). (For additional information on the Cyprus Stock Exchange please refer to paragraph A1 of Section VII)

The relatively large role of government in the economy of Cyprus is being reconsidered in many areas. For example, the government's monopoly of telecommunications services is being reviewed, while the liberalization of air transport in Europe is exerting an increasingly strong pressure on Cyprus Airways, the national airline, to restructure. Additionally, in view of increasing competitive pressures and low productivity gains, more people in Cyprus are questioning the wisdom of practices such as fixed shopping hours, and the Cost of Living Allowance (COLA) wage indexation system. Another, long-lasting practice in Cyprus used to be fixed sales periods, which was abolished about a year ago on a trial basis despite protests from small shop keepers.

Balance of Payments Situation

The Balance of Payments recorded significant deterioration in 1998, displaying an overall deficit of USD 342.8 million, compared with a deficit of USD 229.9 million in 1997. Despite a small increase in the invisibles surplus, the current account deficit increased considerably, from USD 337.9 million or 4.0 percent of GDP in 1997 to USD 603.9 million or 6.7 percent in 1998, because of a disproportionate increase in the trade deficit.

The trade deficit rose by 17.1 percent from 1997, reaching a record USD 2.5 billion. Total exports (FOB, including re-exports) declined by 13.9 percent due to a substantial fall in re-exports. In particular, re-exports of cigarettes from the United States recorded a sharp fall of 36.7 percent with the two main re-export markets -- Russia and Bulgaria -- suffering the largest drops. Total imports rose by 6.0 percent to USD 3.9 billion in 1998, fueled by a significant increase in imports of intermediate inputs and also by an increase in capital goods imports.

The surplus in the invisibles account-- the lifeblood of the Cypriot economy -- registered a 5.2 percent increase, from USD 1.79 billion in 1997 to USD 1.88 billion in 1998, reflecting the increase in net earnings from tourism and international business companies.

Capital transactions resulted in a net inflow of USD 341.4 million in 1998, after a net inflow of USD 183.1 million in 1997, reflecting an upsurge in net long-term loans and credits extended by government and financial institutions. Gross foreign exchange reserves decreased by USD 563.0 million in 1998, reaching USD 4.47 billion, mainly because of an increase in foreign currency lending by deposit banks and a decrease in foreign currency deposits.

Infrastructure Situation

Infrastructure in general is commensurate with European standards and is considered efficient. Semi-state organizations handle power generation, telecommunications, management of ports, marketing of agricultural products and several other areas of economic life.

The Cyprus Telecommunications Authority (CYTA) provides modern telecommunications services. Installation of telephones, telexes and telefax usually takes one week. Direct dialing is available to the majority of countries in the world. Postal and courier services are highly efficient and there are many courier companies in Cyprus, including DHL and Federal Express. Internet service including ISDN has been available from a number of providers in recent years and the number of internet users is growing rapidly.

Several roads connecting the main cities have recently been constructed as dual-way highways. Land transport in this small island is performed by vehicles only (private or company vehicles and taxis). There is no train, and bus service is limited but the easy availability of taxis makes up for this.

The Government of Cyprus and the larger Cypriot firms are very much aware of the Year 2000 (Y2K) problem and have taken steps to address it. Most large organizations have already set up their own task forces to deal with this problem or have their personnel attend special seminars (some of them organized by the Embassy). Some of Cyprus' smaller companies, however, may not be adequately prepared.