Cyprus Business Forecast Report Q1 2009

A Difficult Year Ahead In 2009

Like most countries in Europe, Cyprus will be negatively affected by the global financial crisis. The government has stressed that the banking system is sound, and that it will step in to protect deposits and restore confidence in the sector. While we agree that Cypriot banks do not seem to have the same balance sheet problems evident in countries like the US and UK, this does not make it immune from frozen credit markets in the slightest. Stocks have tumbled (particularly local banks) in recent weeks, and we see further stress on local financial markets. This will also feed through into the real economy. We expect the main effects to be in the housing market, while domestic demand and tourism are also likely to moderate in the coming year.

Politically speaking, the issues and risks are unchanged in Cyprus. Reunification talks between the ethnic Greek and ethnic Turkish communities are underway, but have barely made any progress so far. We remain encouraged by the return to dialogue from both sides, and expect negotiations to continue under the auspices of the international community. However, we do not see any great upside to Cyprus political risk ratings unless symbolic breakthroughs are supported by concrete and practical steps towards a lasting settlement. Deteriorating economic conditions will increase both the risk that public opinion turns against peace talks and the urgency with which a settlement needs to be reached for business purposes.

We have downwardly revised our economic growth targets for 2009 and 2010, based on the growing threats in the external environment. We now anticipate growth slowing from 3.6% this year to 3.0% next year, before recovering slightly to 3.4% in 2010. This is in line with a region-wide adjustment in our growth targets, as the effects of the financial market crisis seep into the real economy. We anticipate some economic stimulus from both the governments fiscal stance and European Central Bank (ECB) rate cuts in 2009, though these will not prevent domestic demand for moderating in the short term. One silver lining of the global slowdown is the impact on commodity prices, which had threatened to send Cypriot inflation to alarming levels. As food and fuel costs moderate, we expect inflation risks to ease.

Cyprus business environment has been given a boost by accession into the eurozone this year, due to the removal of many transaction costs. However, investment activity will continue to be weighed down by the islands political problems, which are a major deterrent for investors. In addition, the traditionally important sector of tourism is suffering from a decline in competitiveness relative to other popular destinations, which will be increasingly important as the global economic climate worsens. The banking sector - which has been developing rapidly in recent years - will also come under strain from external risks.