The European Commission said in its Autumn Forecast produced on Thursday that it forecast real GDP growth in Cyprus to pick up to 4.0% in 2006 and 4.2% in 2007 on the back of strengthening growth in Europe, after an expected 3.9% in 2005.
The forecast projects a budget deficit of below 3% of GDP in 2005, in line with convergence programme commitments. On an unchanged policy basis, and corrected for one-off (revenue) measures, a similar deficit is projected for 2006, declining somewhat by 2007 to 2.4% of GDP.
“Given these narrow margins, it remains important to keep up fiscal consolidation efforts unabatedly [sic]” says the report.
Public debt is projected to decline from 72% of GDP in 2004 to below 68% by 2007,
reflecting mostly the effects of improved primary balances already from 2005.
The report noted real GDP growth of 3.8% year on year in the first quarter and 3.5% in the second quarter, driven mainly by private sector consumption and investment, including construction. However, it also noted a recovery in tourism and a deceleration of import growth. Surveys indicate a continued positive outlook for tourism arrivals for the remainder of the year, said the report but high energy import price rises will mean that the current account deficit is expected to increase slightly to 5.8% of GDP.
Stronger growth in 2006 and 2007
The forecast projects for 2006 and 2007 a marginal strengthening of GDP growth to 4.0% and 4.2%, respectively.
Private sector consumption is foreseen to increase by about 4% both years, consistent with wage developments and employment growth.
Investment growth is expected to remain strong at 5% by 2007. Public consumption is assumed to increase relatively modestly, by 2-2.7%.
Owing to a moderately positive EU growth outlook, export growth is projected to strengthen somewhat in both years, with similar tourism arrival growth rates as in 2005 and robust growth in non-tourist services.
Import growth is expected to pick up with domestic demand in 2006 and 2007, while high oil prices further push nominal imports.
Altogether, the forecast projects a slight decline in the current account deficit to below 5% of GDP by 2007.
Deficit financing through FDI and portfolio investment is expected to remain unproblematic.
Weaker inflation in 2006-07
In 2006 and 2007 inflation is expected to gradually weaken again to around 2.1% as oil price pressures abate.
The report notes that the real effective exchange rate (taking account of prices and exchange rates among Cyprus’ main trading partners) has tended to appreciate in the wake of mainly one-off inflation pressures, leading to some loss in price competitiveness.
With steady GDP growth, unemployment on an EU-compatible basis is projected to inch down to 4.8% this year, from a peak of 5.1% last year, and to further diminish to 4.5% by 2007.
Fall in unit labour costs
Wage moderation in the public sector and an increasing share of foreign labour (currently about 14% of the total labour force, which includes commuting Turkish Cypriot workers) continue to exert some downward pressure on wages, which are expected to increase between 1.5-2.0% in real terms and unit labour costs are forecast to decrease by 0.4-1.0%.
EU growth to accelerate
Economic activity is set to grow by 1.5% in the European Union in 2005 before rebounding to potential in 2006 at 2.1% and to accelerate further to 2.4% in 2007. The corresponding figures for the euro area are 1.3%, 1.9% and 2.1%.
The main impulse stems from domestic demand, in particular private investment, triggered by a marked recovery in economic sentiment since mid 2005.
Global outlook remains bright, but risks persist
The revival of growth in the EU is supported by a global outlook that remains vibrant. But a disorderly correction of global imbalances and/or an adjustment of US consumer behaviour are one of the main downside risks while further oil price increases cannot be ruled out.
On the positive side, oil-exporting countries might spend a larger share of their additional oil income, which would benefit EU exports.
