THE EUROPEAN Commission forecast what it called a ‘profound contraction” in economic activity in Cyprus over the next two years as a result of ‘painful adjustments’ the island must endure under its bailout programme.
According to the Spring forecast published yesterday, the island’s economy is expected to contract by 8.7 per cent this year and 3.9 per cent in 2014 mainly as a result of the conditions of the bailout recently agreed with international lenders, the Commission said.
According to the EC’s spring economic forecast, the island’s real GDP is expected to decline sharply by 8.7 per cent this year “affected in particular by the immediate restructuring of the banking sector, which affects net credit growth, fiscal consolidation, and the high degree of economic uncertainty which weighs on domestic demand and investment.”
The situation is worsened by the capital controls put in place to prevent the flight of deposits following the resolution of the island’s second-biggest bank, Laiki, and a haircut on uninsured savings – over €100,000 -- in the Bank of Cyprus, which could ultimately reach 60 per cent.
“Temporary imposition of capital controls and withdrawal restrictions are expected to hamper international capital flows and to reduce business volumes in both domestic and internationally oriented companies,” the EC said. “The bail-in of uninsured depositors implies a loss of wealth, which will also affect private consumption and investment.”
And Cyprus could only look forward to more misery in 2014 as deleveraging
by banks and the tight credit growth conditions will cause the further decline of gross fixed capital formation.
Fiscal consolidation measures and rising unemployment are projected to weigh strongly on private consumption, the EC said.
“Little reprieve could be expected from exports (tourism being most promising) amid uncertain external conditions and a shrinking financial services sector.”
Unemployment was expected to rise further this year and will continue its upward course in 2014 on the back of slowing business activity, spillovers from the bank restructuring, and a hiring freeze in the public sector.
The EC said it expected unemployment in 2013 to reach 15.5 per cent and 16.9 per cent the next year.
The EC said significant downside risks will persist as the implementation of the agreed macroeconomic adjustment programme could have a stronger impact on the economy through domestic demand, exports, business and consumer confidence.
“Also, risks of household and corporate defaults propagating through the economy may lead to further losses in the banking sector and increased unemployment. Upside risks relate to potential investment activity in the energy sector.”
The EC also expected a widening deficit – 6.5 per cent this year and 8.4 per cent in 2014.
The deficit in 2012 was 6.3 per cent.
Revenues were expected to be held back by the slump in economic activity, despite the rise in direct taxation.
“The decline in economic activity is expected to lead to worse revenues in 2013 than in 2012 and to a faster worsening in 2014, as these taxes are collected in the following year,” the EC said. “Indirect tax receipts are also expected to fall in both 2013 and 2014 in line with the reduction of domestic consumption and despite the increases on the VAT rates and on excise duties.”
France, Spain, Italy and the Netherlands - four of the five largest euro zone economies - will be in recession through 2013, the Commission's forecasts showed, with only Germany, the largest euro zone economy, managing to eke out growth.
The Commission said the euro zone economy would shrink 0.4 per cent this year and grow 1.2 per cent next year, revising down its projections from last February of a 0.3 per cent recession and 1.4 per cent growth respectively.
"Fiscal consolidation is continuing, but its pace is slowing down. In parallel, structural reforms must be intensified to unlock growth in Europe, " EU Economic and Monetary Affairs Commissioner Olli Rehn said.
Workmen were spotted refurbishing what used to be Laiki (Popular) Bank branches (Reuters)