Recession in the Cyprus economy is expected to deepen this year and the next, with the European Commission’s Autumn European Economic Forecast expecting to see growth again in 2015.
According to the quarterly report based on data up to July, the economy “will continue to face several headwinds.”
Domestic demand will continue to fall, amid declining credit and wage growth alongside further fiscal consolidation. On the back of further shrinking of import in 2013-14, a positive contribution to growth is expected from net trade, and the current-account balance is forecast to improve significantly, the report said.
Amid high uncertainty, real GDP in 2013 and 2014 is expected to profoundly contract, to broadly the same extent cumulatively as expected in the Spring Forecast.
But the good news will be forthcoming later.
“In 2015, the recession is expected to come to an end and growth is foreseen to resume gradually, as private domestic demand regains strength,” the quarterly forecast said, adding that the ongoing deleveraging of both households and corporates will remove impediments to a more balanced growth over time. At the same time, the restoration of a sound and well-capitalised banking sector is expected to gradually loosen the tight credit conditions, supporting domestic demand.
The rebound in domestic demand is expected to support imports, therefore limiting the positive contribution of net export to GDP and negatively impacting the current-account balance.
Consumer confidence and business sentiment indicators hit historically low levels in the first half of 2013, as uncertainty about future business prospects led firms to accelerate their destocking, weighing further on growth. On the other hand, on the back of a sharp contraction in import, net trade contributed positively to growth.
“Although some improvement in the indicators has been observed since, they continue to point to further contraction in activity for the coming quarters,” the Commission’s quarterly forecast said.
UNEMPLOYMENT HIGH
The profound contraction in economic activity in 2013 and 2014 is expected to weigh on employment and push unemployment to unprecedented levels.
Subdued domestic cost pressure and sizeable spare capacity are projected to contain inflation in 2013 and 2014 despite higher indirect taxes. As domestic demand picks up in 2015, inflation is projected to accelerate, albeit remaining below 2%.
Despite the significant consolidation effort undertaken in line with the programme requirements, the general government deficit is expected to increase in 2013. This is largely due to a one-off compensation of provident and retirement funds in Popular Bank, which amounts to 1.8% of GDP. The deficit is projected to stay flat in 2014 and to decline in 2015, in line with the annual targets set out in the context of the programme.
Developments in 2014 are expected to be largely driven by the continuation of the deep recession and the sizeable consolidation measures undertaken. This is likely to result in a decrease of broadly the same magnitude of both total revenue and total expenditure.
On the revenue side, falling wages and employment in the private and public sectors as well as declining profits are forecast to lower revenues from direct taxes, while the measures undertaken to raise revenues from indirect taxes are unlikely to be sufficient to cushion the negative effect stemming from the drop in private consumption and imports. On the expenditure side, further restraint is expected from measures to reduce the public sector wage bill, continued compression in public investment, intermediate consumption and other current expenditure.
Overall, expenditure-reducing measures are projected to outweigh the increase in social transfers connected to the adverse labour market developments.
In 2015, total revenue is expected to recover in line with the improving macroeconomic situation, while total expenditure is projected to decrease further on the back of better labour market conditions.
Debt is expected to sharply increase in 2013, mainly as a result of the participation of the government in the recapitalisation of the banking sector. The debt-to-GDP ratio is projected to further increase in 2014 and 2015, reflecting the weak GDP growth.
DOWNSIDE RISKS
The Commission report concluded that risks “are tilted to the downside.”
On the domestic front, a more protracted period of disruptions to efficient credit intermediation alongside tighter credit supply conditions and a further deterioration in the confidence in the banking sector could pose considerable risks to the real economy.
Moreover, a further worsening of labour market conditions may lead to a more prolonged weakness of business and consumer confidence. On the fiscal front, weaker-than-expected growth could lead to revenue shortfalls.
SEE ALSO:
EU economy starts growing again; Eurozone turns corner, but pace slows
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