Cyprus is hoping that its recent adoption of the euro will help it better survive—and perhaps even thrive—during the coming global turbulence.
Cyprus is hoping that its recent adoption of the euro will help it better survive -and perhaps even thrive- during the coming global turbulence.
Nearly all local economists agree that joining the eurozone should bring about huge benefits to local businesses—including inward investment and lower transaction and borrowing costs—and to consumers in the form of lower costs for borrowing money, traveling and studying abroad. Membership of the single currency also imposes increased discipline on the country’s fiscal management and will in the long run be beneficial to growth.
“The framework of the eurozone is strong and will help Cyprus prepare for addressing important challenges such as the aging population and long-term fiscal sustainability,” says Zenon Kontolemis, an economist at Cyprus’ ministry of finance.
Cyprus’ finance ministry certainly paints a rosy picture for the island’s future economic development. According to figures released by the ministry, tourist arrivals will increase by 2% and per capita tourist spending by around 1% a year in real terms. The total number of tourist arrivals could reach 2.5 million by 2009, but despite the growth, tourism’s share of GDP is expected to fall to some 11.6% of GDP, compared with 12.8% in 2005 and 17.6% in 2002.
The decline in tourism’s contribution to GDP is a healthy sign, illustrating the fact that the Cypriot economy is becoming more balanced. The value of exports of services other than tourism will rise at an annual average rate of 7.6%. The share of the services sector as a whole to GDP is anticipated to reach 79.6% in 2011, as compared with 78.4% in 2006.
The finance ministry is predicting that Cyprus’ GDP will grow by an average 4% per year until 2011. This is due in part to an increase of 4% per year in private consumption and to an anticipated increase in wages and employment. Lower interest rates should also help promote growth in the economy as a whole.
Economic growth is contributing to an improving employment outlook, too. Unemployment is predicted to fall to 3.6% within three years despite the fact that the overall number of workers in the economy will expand by 1.7% each year until 2011. The increase in workers is due chiefly to an influx of Turkish Cypriots working in the southern part of the island. The number of public sector employees is set to grow by 1% annually.
A Push Toward High-Tech
Analysts expect the overall structure of the Cypriot economy to remain the same but the balance within individual sectors to change as the effects of joining the euro become more deeply ingrained. “We see no fundamental change in the structure of Cyprus’ economy over the next few years,” says Kontolemis. “The economy is already mainly services based. What hopefully will happen in the medium- to long-term is a move to more high-tech activities and high-value-added production. This will be achieved by a program of increased R&D;—by private and public sector—and by enhancing education and training.”
The corporate sector in Cyprus is already in a steady growth phase. While the early part of the 21st century was tough on Cypriot equities, the past three years have seen a marked improvement, evidenced by impressive growth of the valuations on the Cyprus Stock Exchange (CSE). There are 140 companies listed on the CSE—representing a market cap of approximately $25 billion. Last year was the third consecutive year in which the CSE general index recorded profits after five consecutive years of losses, which began with the bursting of the equity bubble in 2000. In 2007 the CSE general index was up 23.6% against 128.8% in 2006 and 68.4% in 2005.
Banking sector share prices have been the main driver of this rally. Marfin Popular Bank was up 25.6%, Bank of Cyprus gained 20.7%, and Hellenic Bank leaped by 38.6%. There is heavy dependence on the banking sector on the CSE, with the three banks listed on the main market accounting for 91% of its capitalization or 74% of all listed companies’ capitalization.
Market analyst John Pitsillos of Sharelink Financial Services, a major investment bank in the capital city of Nicosia, points out that the main factor driving this performance is the improvement of the local fundamentals. This is indicated by the market’s earnings recovery. In 2005 earnings jumped by 92.6%, and in 2006 CSE main market constituent companies posted a whopping 128.7% year-on-year increase in profitability.
The CSE main market continued its dramatic earnings recovery in 2007. According to Sharelink, the earnings growth for these firms last year is estimated to be around 110%-120%. Further improvement is also expected in 2008. Because of the anticipated slower GDP growth rate, however, corporate earnings growth is likely to slip to an estimated 12%-15% for 2008. The expected improvement in profitability in 2007 will arise mainly from the continuation of the earnings recovery of the heavyweight banking sector, derived from revenue growth, cost containment and lower provision charges. “The earnings growth reported in the banking sector in the last couple of years has been an extended one, with the high levels of margins and profitability, containing an element of cyclicality,” says Pitsillos.
The performance of the local equity market last year was positively affected by the improved equity market conditions that resulted from the introduction of the Common Trading Platform between the Athens Stock Exchange (ASE) and the CSE on October 30, 2006. Sharelink predicts the platform will further improve the market visibility, while liquidity is expected to remain at acceptable levels. The growth in liquidity has been a welcome change because many investors had deserted the market after the bubble burst in 2000, leading to extremely low trading volumes on the CSE from 2002 to 2005.
Although the CSE is expected to post continued gains this year, Pitsillos expects the local market will be volatile, reflecting the anticipated significant correlation between the local and international markets. Equity markets are expected to be dominated in 2008 by fears related to global economic growth, possible “earnings scare” related to the anticipated slowing in earnings growth, possible change in risk perceptions, inflation fears, as well as the outlook on interest rates.
“We believe that a volatile sideways move on the local equity market is the most likely scenario for 2008, with sharp moves providing attractive investment opportunities,” Pitsillos points out. “We also think that 2008 will be the year for attractively valued companies, with resilient business models, earnings quality and defensive characteristics.”
If the recent global financial crisis lasts beyond the first half of 2008, significantly affecting global equity markets, Pitsillos predicts that the CSE will again outperform its European counterparts. “Cyprus may represent a less risky investment choice, as the subprime-fired financial crisis, which is blamed for a potential market downturn internationally, seems to have no obvious victims among the Cypriot listed companies,” he adds.
Alongside the dramatic recovery in the local stock market has been the boom in the real estate market, especially in the residential sector, which has been one of the engines of growth in the past few years. In 2007 home prices rose 8.02%, following a 6.5% rise in 2006 and a 2.2% rise in 2005.
Property analyst Michelle Kari says price increases in Cyprus have been fueled by a combination of factors, including the liberalization of the financial sector, a decrease in interest rates and increased demand for higher-quality housing and second homes.
Cyprus’ joining the eurozone is expected to further boost the growth of the market as buyers take advantage of the anticipated lower borrowing costs and as purchasers from elsewhere in Europe start to look for second homes in Cyprus. Kari says tumbling interest rates on savings accounts will further encourage real estate investments and acquisitions with positive effects on property values. Some observers are less confident that Cyprus’ membership of the euro will bring a flood of new homebuyers to the island. The bulk of foreign demand for Cyprus real estate currently comes from Britain and Russia, neither of which are members of the euro.
Cyprus’ long-term plan is to serve as a bridge for economic cooperation. Already, many European companies use Cyprus as their base to expand their activities to the Middle East, Africa and even further to Asia, attracted to Cyprus by its political and economic stability, the favorable taxation system and business environment, advanced infrastructure and qualified labor force. Using this as a platform, Cyprus’ strategic aim is to become a regional service center that European companies can use as a stepping stone to secure access to the Middle East and emerging neighboring markets of more than 350 million people.