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By Michael Sarris,
Minister of Finance
of the Republic of Cyprus
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The economy of Cyprus has performed well during the last decade, in spite of a challenging external environment. The positive macroeconomic performance during the recent years enabled Cyprus to join the European Union as a full member on 1 May 2004 and subsequently the Exchange Rate Mechanism II (ERM II) on 2 May 2005. The successful participation of Cyprus in ERM II led to the decision of the European Council, on 21 June 2007, to allow Cyprus to join the euro area as of 1 January 2008. These achievements were possible because the government implemented sound economic fundamentals and prudent macroeconomic policies.
Cyprus is well placed to benefit from the adoption of the euro. The euro area is Cyprus’s largest trading partner and trade relationships with euro area member states are expected to enhance even further with the introduction of the euro. Profitable business opportunities will expand, as transaction costs and exchange rate risks will be reduced. Moreover, economic activity can benefit from the boost provided by low interest rates. Indeed, our efforts to adopt the euro have already benefited the economy, through reduced interest rates and increased FDI and other capital inflows.
The adoption of the euro on 1 January 2008 is expected to strengthen economic growth and foreign investment, through the improvement of entrepreneurial environment and the strengthening of confidence that international markets and investors place in the Cypriot economy.
More specifically, the benefits that will arise for business firms from the adoption of the euro are:
• Favourable conditions of borrowing due to the convergence of interest-rates at the levels of the eurozone.
• Elimination of exchange rate risks and costs in transactions in euro.
• Facilitation of the access in the capital markets of the eurozone.
• Greater transparency regarding prices.
• Intensified competition leading to better quality and lower prices.
• Reinforcement of investment activities and further improvement of the business climate, due to the embedment of price stability as well as the strengthening of confidence that international markets and investors will now place in the Cypriot economy.
The prospects for 2008/9 appear to be favourable. The improvement of the macroeconomic indicators is expected to continue, reflecting the course of convergence with the EU economy. Macroeconomic stability enables us to implement our development and social visions.
The basic fiscal targets of the Government are included in the recent Stability Programme 2007-2011. The national medium-term objective of a small deficit of ½% of GDP is now revised to a balanced budget, a very positive development which will further contribute towards reducing the public debt. Public debt is expected to continue following a downward trend to below 50% by 2009.
The elimination of fiscal deficit in 2007 is expected to contribute to keeping inflation at low levels, leading to higher growth and investment activity, more and better jobs and maintaining the purchasing power of employee’s wages. The rate of inflation is expected to fluctuate around 2,5% in 2008.
The sectors of services will continue to be the main fuel for growth and for the creation of new jobs. In the labour market, the unemployment rate is estimated to remain at low levels than maintaining near full employment conditions. The rapidly rising number of foreign and Turkish-Cypriot workers is expected to address any labour shortages and exert a dampening effect on wages.
Growth is projected to remain close at around 4% in the next years due to: (a) the expansion of private consumption and continued demand for new homes among non-residents, (b) the satisfactory investment of capital goods and (c) the expected further increase in export of services.
However, the growth outlook remains subject to a number of risks. Most important are: (a) the potential effects of higher oil prices, with Cyprus dependent on oil imports for its energy needs, (b) the possibility of a slow down of growth in the rest of the EU, the primary market for Cypriot exports of goods and services, and (c) the effect on competitiveness of the continued appreciation of the euro against most major currencies. Tourism, which accounts for around 15% of GDP, is vulnerable to regional geopolitical events and increasing competition from cheaper Mediterranean destinations.
Over the longer term and with the adoption of the euro, the primary challenge is to maintain economic competitiveness. The absence of national interest and exchange rate policies, following the adoption of the euro, underscores the need to strengthen the role of sound macroeconomic policies to provide conditions of price stability. Key to addressing the competitiveness issue will be the implementation of structural reforms associated with the EU’s Lisbon Agenda.
The envisaged reforms are expected to safeguard both the continuation of high growth and financial sustainability of the social insurance and health care systems as well as social cohesion. In this respect, the introduction of income criteria on social policy measures will allow the targeting of higher grants to vulnerable social groups.
This section is sponsored by the government of Cyprus.