The forecast is slightly more optimistic than the growth rate projected by the Central Bank of Cyprus (2.8%) and the European Commission (2.5%) in December and November, respectively.
“The expansion of real economic activity in Cyprus is expected to continue in 2017 at rates similar to those registered in 2016,” said the report for January, explaining that the main drivers for the forecasts include a robust GDP and employment growth that continued in the third quarter of 2016 and many leading indicators with respect to domestic activity that improved further during the final quarter of 2016.
The UCy-RTC report also attributed the improvement to “moderate growth in the euro area and the EU, stronger-than-expected growth in the UK (in spite of the June 2016 Brexit vote) and the moderation of the recession in Russia,” as well as, “further strengthening of economic sentiment in Cyprus and in the EU.”
Other favourable factors included improved performance of foreign stock markets, reflecting less adverse external economic conditions now vis-à-vis the conditions in the first half of 2016; the prolonged period of declining energy prices and the subdued non-energy commodity prices; the ongoing normalisation of the domestic banking sector marked by increases in deposits, deleveraging and low lending interest rates; and the improved general government balance and primary balance in January – November 2016, relative to the same period in 2015.
“The low levels of European interest rates have been supportive of the recovery in Cyprus; however, the protracted period of low interest rates also reflects uncertainties about the growth momentum in the euro area which could weigh on the strength of the recovery in Cyprus in subsequent quarters,” the UCy-ERC report warned as it listed the downside risks to the growth forecasts.
A considerable slowdown in the UK and further depreciation of the pound against the euro, as a result of increased political and economic uncertainty following the Brexit vote, are expected to directly affect the Cypriot economy, primarily through weaker exports of services, it said, adding weaker-than-expected growth in the EU and the euro area as a result of (i) the Brexit vote - impacting activity through e.g. trade and confidence channels - and (ii) worsening growth prospects in emerging market economies.
“The high private indebtedness levels that have led to deleveraging and increased default rates continue to pose significant risks to the stability of the domestic banking system and to the outlook for the economy, especially in conditions of subdued property prices,” the report said.
“The high public debt-to-GDP ratio renders Cyprus vulnerable to external negative shocks; thus delays in the advancement of structural reforms may create risks to public finances, Cyprus’s credibility and market borrowing costs.”
Thus, a protracted period of elevated unemployment could undermine the growth prospects of the Cypriot economy, the UCy-ERC report said.
Upside risks to the outlook include (i) improved economic conditions in Russia as oil prices are rebounding, and (ii) new investment projects linked to tourism, energy and public infrastructure.
Looking ahead in 2017, the UCy-ERC January outlook concluded that inflation is projected to turn positive; CPI inflation is forecasted to reach 1.5% as activity growth is anticipated to continue and energy prices are expected to increase.