Cyprus' economic and financial stability was reaffirmed during the 17th post-memorandum surveillance mission conducted by the European Commission and the European Central Bank (ECB), with participation from the European Stability Mechanism (ESM), from September 30 to October 7, 2024. However, the report, published on Tuesday, underscores significant risks in specific sectors and from geopolitical uncertainties, calling for vigilance.

The report highlights that Cyprus' economic foundations remain robust, bolstered by strict fiscal discipline and a resilient banking sector. Nevertheless, challenges persist in energy, tourism, and the country’s investment model, exacerbated by geopolitical tensions and uncertainties linked to climate change.

Economic growth accelerated to 3.7% year-on-year in the first half of 2024, driven by strong investments and a recovery in net exports. Household purchasing power and savings rates continue to improve, supporting private consumption. Inflation is projected to stabilize around 2% in the medium term, aligning with the ECB's price stability target, while unemployment has reached its lowest level in a decade.

The report identifies geopolitical tensions as a major economic risk. Disruptions in supply chains and rising production costs could impact critical sectors such as tourism, which is recovering from past crises. Moreover, Cyprus’ reliance on fossil fuels and its limited integration into the European electricity market leave it vulnerable to energy price fluctuations.

Cyprus maintains a strong fiscal profile, with a surplus of 3.5% of GDP projected for 2024 and public debt expected to decline to 56.7% of GDP by 2026. However, delays in major infrastructure projects, such as the Vasilikos liquefied natural gas terminal, could strain the budget by up to 1% of GDP. Rising public expenditures, driven by wages, pensions, and healthcare costs, add pressure to public finances.

Cyprus’ banking sector demonstrates resilience, with steady profitability and a reduction in non-performing loans (NPLs). However, smaller financial institutions (LSIs) struggle with high NPL levels, averaging 21% as of June 2024, unchanged since December.

Structural barriers, including limited appetite for new lending, remain a concern. Notably, Cypriot banks hold 32% of their assets in central bank deposits and 42% in loans and advances, compared to EU averages of 12% and 63%, respectively. Rising interest rates have led to loan renegotiations, though repayment capacity remains strong.

The current account deficit remains high, reflecting dependence on imports and significant profit outflows by foreign companies. While foreign direct investment (FDI) inflows are strong, a large proportion involves Special Purpose Entities with limited contributions to domestic production and employment.

The report raises concerns about the sustainability of Cyprus' economic model, emphasizing vulnerabilities related to aggressive tax planning. Risks from geopolitical tensions, climate change, and cyberattacks are also intensifying. Banks are investing heavily in infrastructure to address cyber threats, while closely monitoring climate-related risks.

The report concludes that Cyprus maintains a strong debt servicing capacity. However, geopolitical uncertainties and sectoral vulnerabilities require continuous attention to sustain investor confidence. The first ESM repayment is scheduled for 2025, with annual repayments averaging €0.99 billion until 2031.