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Ernst&Young : Cyprus economy to contract 4% in 2014, return to growth in 2016

21 March, 2014

Cyprus’ GDP is expected to contract by 4% this year and by 0.5% in 2015, before a return to growth in 2016, a year earlier than expected, according to the spring Ernst&Young Eurozone Forecast (EEF).

While Cyprus’ economy continues to suffer, activity has not slowed as much as it was initially expected, it says.

The main risk to the outlook is a slide into deflation, which would have an adverse impact on the growth outlook

The forecast says that consumption is still under pressure from rising unemployment, fiscal consolidation and falling wages. The EEF expects consumer spending to return to growth by 2016, by which time it will be more than 15% lower than its pre-crisis peak.

Moreover, it notes that investment is also suffering from fiscal consolidation efforts. Sharp cuts in public capital expenditure alongside restricted access to credit due to a fragile financial system caused investment to drop by an estimated 20% in 2013, with a further 8% decline expected in 2014.

EEF says the fiscal consolidation program remains on track, with the authorities receiving positive comments from the major credit agencies and even an upgrade from Standard & Poor’s in November.

The forecast notes, however, that against the backdrop of sharply declining economic activity, that implementation risks to the program remain, particularly if Cyprus experiences the levels of social unrest seen in other countries that have undergone painful adjustments.

“While the prospects are not as bleak as initially thought, the outlook remains highly uncertain” the forecast says. In particular, it points out that the financial system is still vulnerable, due to the high level of non-performing loans and says that banks’ continuing efforts to shrink their balance sheets could also delay the fragile recovery.

On the situation in the Eurozone, the EEF expects Euro area countries to lag well behind other major economies during the recovery, with their GDP in 2018 to be only about 5% above pre-financial crisis peak in the first quarter of 2008.

After two years of decline, the forecast predicts growth of 1% in the Eurozone in 2014, followed by a pickup to 1.4% in 2015, and then only slightly faster growth of about 1.6% a year in 2016-18.

However, it is added that there are reasons for cautious optimism as there will be a gradual recovery in consumer spending and business investment.

The forecast also predicts a variable pace of recovery across different member states, noting that the divide is no longer simply between the core and peripheral countries. It is noted that some of the peripheral countries that have implemented painful reforms in recent years, notably Spain and Ireland, are benefiting as world trade picks up. By contrast, GDP growth in France is forecast at only 0.7%, below the Eurozone average.

EEF forecasts Eurozone inflation of just 1.1% on average in 2014, with a modest uptick to 1.5% in 2015.

The forecast predicts moreover unemployment in the Eurozone to average 12% in 2014, slightly lower than 2013, before edging down gradually to 11% in 2018.