EIU maintains Cyprus growth forecast

The Economy Intelligence Unit (EIU) maintained its Cyprus GDP growth forecast at 3.6% and 3.8% for 2007 and 2008 respectively. The EIU says that with slowing demand in both the Euro area and the UK in 2007-08, tourism is likely to recover only slowly, and real GDP growth in Cyprus will continue to be driven largely by domestic demand.

According to EIU the construction sector will be boosted by civil engineering projects (upgrade of airports and highways) and demand for holiday homes. The construction of new marinas and golf courses could also begin in 2008.

Furthermore, financial services should get an extra boost as the adoption of the Euro leads to a further fall of commercial lending rates and expands opportunities for outward investment. The British agency believes that government consumption growth will remain fairly buoyant in 2007-08 as the presidential election approaches. EIU sees the strict airline security alerts in the UK as the main risk to the Cyprus GDP growth forecast, as they might put off UK travelers, while cruise tourism will remain vulnerable to any bursts of violence in the region.

Regarding inflation the EIU says that the risk that Cyprus will miss its inflation target for adopting the Euro appears to bereceding, as inflation is beginning to ease. It also expects that the easing of international oil prices will lead to a fall of inflation rates in 2007-08. The EIU forecasts inflation (EU Harmonized CPI measure) at 2.0% for both 2007 and 2008.Regarding interest rates, the EIU says that the Central Bank of Cyprus will probably keep rates on hold, allowing the spread with the EU rates to fall to 75bps, given that ECB is expected to raise its rates by another 25bps in March 2007.

This means that Cyprus rates will converge rapidly towards ECB rates after mid-2007 and as previous experience suggests this will happen in the last two months before the

adoption of the Euro.

The British agency observed that the Cyprus currency has consistently traded closed to, but stronger than the central parity rate and it expects that this is the rate which is going to be used when the irrevocable fixing of exchange rates takes place. This will imply a mild depreciation from the current rate. In 2007-2008 the Euro is forecast to strengthen against the sterling but weaken against the dollar in 2007, after appreciating strongly in 2007.

EIU believes that government targets with regard to the budget are broadly realistic and while the budget deficit is expected to increase in 2007, since it is a pre-election year, it expects the deficit to remain below 2.0% of GDP in 2007-08. While EIU expects the 2006 public debt/GDP ratio to exceed the 60% of GDP threshold, a large primary surplus will allow the ratio to fall compared with 2005 and therefore probably meet the requirement that it is falling rapidly enough towards that threshold. It also says that although the sharp increase in euro-denominated borrowing is indicating higher external debt forecast, Cyprus will continue to find easy access to finance. EIU forecasts a current account deficit of 5.6% of GDP in 2007, falling to 5.5% of GDP in 2008.