Growth is expected to slow down in 2023 but gradually pick up pace over the next years, while inflation is expected to subside, according to the Autumn 2023 Economic Forecast presented by European Commissioner for the Economy, Paolo Gentiloni, on Wednesday. On an EU level, economic dynamism is expected to suffer due to the high cost of living, but gradual recovery is expected by 2025, along with a continued drop in inflation.

More specifically for Cyprus, the Commission projects a shift from the 5.1% growth of 2022 to 2.2% in 2023, attributing this change to global uncertainty. However, the labour market shows promising signs, with unemployment projected to decrease from 6.8% in 2022 to 5.9% by 2025.

The Commission also highlights Cyprus's fiscal health, noting a continued surplus in the country's GDP: 2.4% in 2022, and expected surpluses of 2.3% in 2023, 2.1% in 2024, and 2.5% in 2025. Key contributing factors include the gradual phasing out of energy-related measures and the expected conclusion of the mortgage-to-rent scheme, positively impacting the budget balance by 2025.

However, risks loom for the Cypriot economy, primarily due to its heavy reliance on oil imports and the sensitivity of critical sectors like construction, tourism, and trade to higher interest rates.

Following a growth rate of 5.1% in 2022, Cyprus's economic activity is forecasted to moderate to 2.2% in 2023 amid ongoing global economic uncertainty and rising interest rates. However, a gradual recovery is expected in the following years, with inflation, peaking at 8.1% in 2022, anticipated to subside as global energy prices stabilize.

The labour market is buoyed by this dynamic growth, and the general government balance is projected to maintain its surplus through 2024 and 2025. Public debt-to-GDP ratio is also expected to decrease, reaching 66.3% by 2025.

2023: A Year of Slowdown

Real GDP growth in Cyprus is estimated at 2.2% for 2023, primarily driven by domestic demand. Private consumption has seen robust growth, supported by dynamic employment and wage growth, with the partial wage indexation providing a buffer against the impact of high prices. Investments in residential and commercial construction are thriving, bolstered by government incentives and an influx of foreign companies. Tourism has bounced back from pandemic lows and the impacts of the Ukraine conflict, although it has adversely affected exports of financial and professional services.

Moderate Growth Projected

The forecast anticipates a gradual increase in economic activity, with growth rates of 2.6% and 2.9% for 2024 and 2025, respectively. Government measures to curb inflation and wage indexation are expected to sustain consumption growth, albeit at a slower pace. Rising interest rates may dampen the housing market, but foreign investments and the Cypriot Recovery and Resilience Plan should stimulate infrastructure development, particularly in green and digital sectors, as well as healthcare, education, and tourism. However, external sectors like tourism may experience a slowdown due to weakened growth momentum in Cyprus's trading partners.

Labour Market Trends

The labour market is showing positive signs, with employment increasing by 1.8% in the first half of 2023. Growth in labor-intensive sectors like tourism and ICT is projected to continue, reducing unemployment from 6.8% in 2022 to 6.4% in 2023, and further to 5.9% by 2025, marking a decade low.

Inflation Outlook

Inflation, measured by the harmonised index of consumer prices (HICP), is expected to decrease to 4.1% in 2023 from a peak of 8.1% in 2022, and continue its downward trend in the following years. This is largely due to falling energy prices and government intervention, although the HICP, excluding energy and unprocessed food, remains high due to the wage indexation effects.

Fiscal Position

The general government balance achieved a significant surplus of 2.4% of GDP in 2022. For 2023, a surplus of 2.3% of GDP is anticipated, supported by strong VAT revenue from inflation and consumption growth, as well as increased income taxation revenue. Expenditure is also expected to rise due to adjustments in wage indexation and new fiscal measures. However, the budget balance is forecasted to remain in surplus, reaching 2.1% in 2024 and 2.5% in 2025. The debt-to-GDP ratio is projected to decline significantly, hitting 66.3% in 2025, thanks to nominal GDP growth and primary surpluses.

Country-specific risks, including potential budget overruns in new government initiatives, may negatively impact the fiscal outlook, underscoring the need for cautious fiscal management.