According to a macroeconomic imbalances review published by the European Commission on Monday as part of the European Semester, Cyprus’ economy remains on a solid foundation. The country anticipates growth and a decrease in inflation. However, connections with economies within and outside the EU pose a non-negligible risk due to geopolitical and commercial tensions.

The Commission issued in-depth reviews (IDRs) for six member states, including Cyprus, the Netherlands, Romania, Slovakia, Spain, and Sweden.

The Cyprus report analyzes the country's vulnerabilities related to high private, public, and external debt, as well as emerging risks. It evaluates the persistence or alleviation of vulnerabilities identified in previous years, potential emerging risks, policy implementation progress, and future policy options.

Countries were selected through the Alert Mechanism Report, based on specific economic indicators to identify states needing potential risk analysis. Reports for an additional six countries, including France, Germany, Greece, Hungary, Italy, and Portugal, are forthcoming.

The reports are being published ahead of the spring package to allow for thorough discussion before the Commission presents its country-specific recommendations in the European Semester process.

The introduction of the Cyprus report highlights stable economic growth combined with decreasing inflation, positioning the Cypriot economy on a healthy foundation. The GDP growth rate moderated to 2.4% in 2023, down from 5.1% in 2022, mainly due to weaker external demand for financial and business services affected by Russia's invasion of Ukraine.

The European Commission's interim winter forecast predicts economic growth will rebound to around 3% in 2024 and 2025. This growth acceleration is expected to be aided by significant planned investments in energy, education, healthcare, and tourism sectors, partly supported by the Recovery and Resilience Facility.

Inflation began to decline in 2023, falling to 3.9%, with core inflation slightly higher at 4.4%, down from 8.1% and 5.3%, respectively, in 2022. Inflation is expected to continue decreasing in 2024 and 2025.

The Cypriot labor market remains robust, with employment continuing to rise and unemployment expected to fall below 6% by 2025, the lowest in the last decade. Real wages are forecasted to record moderate increases during 2024-2025, following a significant decrease in 2022.

According to the Commission's Cyprus report, the fiscal position remains strong with a significant surplus in 2023, expected to be maintained in 2024 and 2025. Risks to economic prospects are generally balanced.

Cyprus' high integration with EU and non-EU economies makes it susceptible to secondary impacts from economic developments in these countries. The Cypriot economy heavily relies on Greek and Italian products and services, with Greece and the UK being key export partners.

For external demand, the largest shares of Cyprus' total value-added production cater to domestic demand in Germany, the US, and China, while Cyprus' domestic demand is primarily met by value-added production in the UK, Greece, and Germany.

Given Cyprus' high exposure to non-EU partners, geopolitical and commercial tensions present a significant risk to its economy.