EIU maintains Cyprus GDP growth targets

The Economist 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 continuing but slowing demand for holiday homes.

The construction of new marinas and golf courses could also begin in 2008, although progress in implementation appears to be slow. 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 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 be receding, 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 an average of 2.0% in 2007-2008.

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 50bps, given that ECB is expected to raise its rates by two further 25bps rises by mid 2007 to 4.0%. 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 EIU observed that the Cyprus currency has consistently traded closed to the central parity rate for about 14 years, without recession or other crisis. This suggests that the parity rate is appropriate, and therefore no devaluation is expected. In 2007-2008 the euro is forecast to strengthen against the US dollar on average in 2007-2008, but to weaken against sterling in 2007, before appreciating again in 2008.

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. Although strong import demand for ongoing large construction projects suggests that the current account deficit will remain above 5.0% of GDP, current account deficit will be reduced and EIU forecasts a current account deficit of 5.4% of GDP in 2007, falling to 5.3% of GDP in 2008. Cyprus’s expected adoption of the euro in 2008 should ensure that it continues to find easy access to finance.