Cyprus on track for strong economic recovery

As a small economy that is heavily reliant on tourism, Cyprus was hit hard by the Covid-19 pandemic, with economic activity shrinking by just over 5% in 2020. However, the economy rebounded strongly in 2021, helped by the re-opening of international travel, with real gross domestic product (GDP) growth forecast at around 5%, regaining the lost economic output from the year before.

“Cyprus performed relatively well compared to peers, and GDP contracted less than originally anticipated, by 5.1% compared to 2019,” says Sebastien Boreux, an associate director and sovereign analyst at S&P Global Ratings. “Notably, the measures implemented by health authorities contained infections and casualties at levels below those of peers. Furthermore, the implementation by the authorities of targeted measures to shield economic agents from the negative fallout of the pandemic softened the hit to private consumption while public consumption increased significantly. This led to a moderate rise in unemployment after years of steady decline, with government support measures preventing a more significant rise.”

Kit Yeung, an associate director in the sovereign team at Fitch Ratings, says: “Last year, the economy benefited from a recovery in tourism that helped it to perform a little better than expected. Our expectations continue to be strong on the back of a continued recovery in tourism.” 

Covid response

Cyprus has ramped up its borrowing to help offset the initial impact of the pandemic.

“During the pandemic period, borrowing increased significantly in order to deal with both the actual effects of the crisis and the significant uncertainty that was created, especially in 2020,” says Stelios Leonidou, head of front office at Cyprus’s Public Debt Management Office (PDMO). “So, the aim of increased funding was twofold — to meet the increased fiscal needs and at the same time to enhance the cash buffer.

“However, this increase has proven to be more than necessary, as the economy fared better than expected during the crisis. This resulted in the building up of significant cash buffers during 2020 and the first half of 2021 — the partial use of which has led to a significant reduction in debt in 2021. This reducing trend is expected to continue further in 2022, as these buffers are being reduced even more.”

The PDMO borrowed €6.3bn in 2020, but this was significantly reduced to €1.7bn in 2021, with €1.6bn of cash reserves used. In 2022, the PDMO is expected to borrow €2bn, with the use of €400m of reserves.

Debt sustainability 

As with all countries in Europe that increased their borrowing during the pandemic, particularly those in the eurozone periphery, the question of debt sustainability has often come up.

“[This] is something that always concerns a debt manager and a fiscal policy-maker,” says Mr Leonidou. “However, at this particular moment, considering the balanced maturity profile of [Cyprus’s] public debt, the relatively low average cost of funding, the comfortable access to the international capital markets, the strong rebound of the economy in 2021 and the projected reducing trend of public debt in 2021–2022, we are very confident that the public debt is sustainable.”

Ms Yeung concurs that Cyprus’s debt is sustainable, at least for now. “Despite the high debt-to-GDP ratio, there continues to be favourable financing conditions,” he says. “The average maturity of debt is long, at around eight years, and the government has outlined a good medium-term fiscal strategy.”

Other credit rating agencies hold a similar view. Last July, Moody’s upgraded Cyprus’s long-term ratings from Ba2 to Ba1 with a stable outlook, leaving it just one notch below investment-grade status.

The question, therefore, is how far away Cyprus is from reclaiming investment-grade status with Moody’s. Such an upgrade would take Cyprus into investment-grade status with all three of the major credit rating agencies, and result in a significant reduction in Cyprus’s cost of funding and boost demand for its debt.

“What we would need to see for a potential upgrade is progress on potential growth-enhancing structural reform,” says Heiko Peters, a sovereign analyst at Moody’s Investors Service. “A sustained, more rapid reduction of the debt burden to pre-pandemic levels than currently expected would also put upward pressure on the rating. Moreover, a further material reduction in the sovereign’s exposure to banking sector risks would also be rating positive.”

Mr Leonidou adds that this would also open new liquidity pockets for the country, thus providing more demand in both the primary and secondary market for Cyprus bonds, for investors whose mandates demand that a country is rated by all credit rating agencies at investment grade.

Next Gen boost

Cyprus’s strong economic recovery is expected to continue, helped by the NextGenerationEU (NGEU) funds, in which Cyprus will receive €1bn in grants and €200.3m in loans between 2022 and 2026. Cyprus’s GDP growth forecast at 4.2% and 3.5% in 2022 and 2023, respectively, according to a forecast by the European Commission.

“Going forward, we expect economic growth will remain strong, at a rate of 3.7% on average over 2022–2024,” says Mr Boreux. Disbursements from the EU’s Recovery and Resilience Facility and the implementation of the related structural reforms included in the country’s recovery plan should strongly support economic activity, he adds.

“According to our analysis, the full absorption of EU grants from this facility could boost growth by 3.3–8.1% during 2021–2026. This estimate does not include the positive impact structural reforms related to the plan would have on economic growth, nor does it include potential use of EU loans that the facility makes available to the EU members. The overall impact could therefore be even more positive.”

Cyprus will put more than 60% of the NGEU funds towards investments for its green and digital transition. Along with the implementation of structural reforms, this will provide a huge boost for Cyprus’s economy. However, this will need to be implemented effectively to maximise the economic benefit.

As with other tourism-dependent economies, much of Cyprus’s growth in the coming years is reliant on how the pandemic plays out.

“In the short term, the uncertainty related to the evolution of Covid-19 and its variants continue to pose a risk and could slow the pace of recovery,” says Mr Boreux. “Once the pandemic’s negative effects on the economy abate, we anticipate that authorities will focus on shoring up its resilience, restoring the budget surplus, pursuing government debt reduction, and aiding the banking sector’s recovery.

“Like in other countries with a large tourism sector, Cyprus’s tourist arrivals and related receipts have collapsed. Before the pandemic, tourism accounted for an estimated 12% of employment, and about 20% of total exports. In 2020, tourist arrivals were about 85% lower than in 2019 and revenues went from about €2.7bn to around €400m. While the sector has recovered faster than expected in 2021, it is still way below its pre-pandemic level.”