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Projected at double that of euro area, The European Commission expects the Cyprus economy to continue to grow solidly by 3.7% in 2008 and 2009, despite an adverse external environment.
This is below the 4% initially forecast by the government but twice that of the rest of the euro area where growth forecasts are put at 1.7%.

In its spring economic forecasts, the European Commission is generally upbeat about Cyprus’s prospects.

Finance Minister Charilaos Stavrakis welcomed the report, saying Nicosia would manage to retain a growth rate more than double that of the Eurozone.

"The Cyprus economy has received praise because it is continuing to grow at a rate more than double that of the rest of the euro area.

"This is a significant achievement for which we must all be proud," he said.

EU Economic and Monetary Affairs Commissioner Joaquin Almunia had projected a euro zone growth rate of 1.7% – down from an earlier forecast of 2.2%.

Almunia sees inflation rising by 3.6% – up from the initial forecast of 2.3% because of costlier fuel and grain. For Cyprus, inflation is seen at 3.75% – compared to the initial 2.5%.

"Cyprus is nevertheless one of the few European economies with conditions of full employment. At a time when large countries have significant unemployment rtes, we import manpower," Stavrakis said.

Demand

In its report on Cyprus, the Commission notes that accelerated economic activity of 2007, led to real GDP growth rate of 4.5% after attaining 4% in 2006.

Growth was underpinned by dynamic domestic demand. In particular, private consumption accelerated due to historically low interest rates, sustained credit expansion and continued employment and wage gains. A personal income tax cut also supported disposable income.
A reform reducing car tax, introduced in November 2006, also added extra dynamism to private consumption, by stimulating demand for cars. In parallel, sustained buoyant private investment in construction, especially housing, supported investment growth.

Export-oriented services continued to benefit from the positive outlook in the main export markets, while revenue growth from tourism accelerated compared with the past two years.
In 2008 and 2009, economic growth is projected to decelerate from the exceptionally high rate of 2007, yet to grow solidly at 3.7%, against an adverse external environment, it said.
Economic activity will be exclusively driven by domestic demand while the external sector will continue to weigh negatively on GDP growth.

Disposable income, supported not only by sustained wage and employment growth but also by the second phase of the enacted personal income tax reform, will keep private consumption growing robustly, although at a slower pace than in 2007 on account of tighter credit conditions, it added.

Housing

Construction investment though should decelerate throughout the forecast period, compared to the exceptionally high levels of the last years.
Investment in equipment, the bulk of which takes in the construction sector, is projected to follow suit. The main reasons for the deceleration in construction are the softening of demand for dwellings by non-residents and some policy measures aiming at cooling the housing market.
Albeit decelerating, exports of services should remain dynamic, also on the back of positive prospects for tourism. Exports of goods, which consist mainly of re-exports, are projected to post some positive growth after the adoption of measures to boost the sector, such as the agreement with a global shipping corporation to use Cyprus as a regional hub, as well as the deepening of the port so as to serve larger vessels.

Labour market conditions remained close to full employment in 2007. In line with buoyant economic activity, employment should continue growing at around 1.5% per year also in 2009. High participation, particularly by foreign workers, should ensure that wage pressures remain contained despite the tight labour market conditions.
Since productivity growth is expected to rise by about 2.25% by 2009, unit labour costs will rise but at lower rates than in the recent past.

Average HICP inflation was 2.2% in 2007. Due to the hike of commodity prices, especially oil and food prices, overall HICP inflation is expected to accelerate to 3.75% in 2008. In 2009, it is set to decline to 2.5%, against a background of moderating oil prices and domestic demand.

Turnaround in public finances

Last year marked a turnaround in public finances as the general government balance reached a surplus of 3.25% of GDP, almost 4 percentage points better than the 1.5% deficit target of the budget.

The turnaround in 2007 was attributed to an exceptional rise in revenues, due to especially high
tax receipts resulting from strong profitability in the financial sector and booming real estate investment. Consequently, part of the increase in tax bases and in the associated revenues does not appear to be permanent. The official target for 2008 is for a surplus of about 1%.
No one-off measures are planned. In 2009, on a no-policy-change basis, the surplus is projected to inch up, due to interest payment savings. The debt-to-GDP ratio is projected to remain on a decreasing path, reaching about 43% by 2009, driven by the planned reduction of deposits with the central bank.