It is easy to see why Cyprus is sometimes wrongly perceived as a mono-economy dependent on sun, sea and sand. After all, according to the World Travel & Tourism Council (WTTC), tourism’s total contribution to the economy will rise from 19.3% in 2015 to 22.9% by 2026. In 2015, according to the same source, the industry accounted for 20.1% of total employment; this, too, will climb to 22.9% in 2026. The government recognises that it would be hazardous to rely on tourism for several reasons. The first is that although the island’s tourism industry has clearly been a beneficiary of the regional geopolitical climate in recent years, Cyprus potentially remains exposed to external events well beyond its control. A reminder of this came last June when the shock outcome to the UK’s EU referendum and subsequent fall in sterling prompted concerns that the industry would be impacted by reduced demand from British tourists.
Perhaps surprisingly, demand from the UK has remained strong, contributing alongside a surge in Russian visitors to a 26% rise in arrivals in the first two months of this year. Nevertheless, given that the UK accounted for 37% of all arrivals in 2016, Brexit is an uncomfortable reminder of the potential vulnerability of the industry to events over which Cyprus has no control.
The second is that capacity constraints, twinned with the seasonality of the tourism industry, mean that its expansion potential is not inexhaustible. “Tourism will continue to grow, but the rate of growth will inevitably slow down unless we can find new markets and extend the tourism season,” says Ioannis Tirkides, head of economic research at Bank of Cyprus.
Third and most important, to over-emphasise the role of tourism in the Cyprus economy is to belittle the contribution played by other sectors. After all, as Tirkides says, although it has an indirect impact on virtually every sub-sector of the economy, the tourism sector itself — defined as accommodation and food — accounts for only about 7% of total gross value-added (GVA).
That, according to Tirkides, means that tourism is smaller than professional services, the importance of which should not be overlooked. He points to accountancy as one example of a flourishing area of the professional services sector, which accounts for about 8% of GVA. “Increasingly, we are seeing the Cypriot offices of major international firms providing accounting services to companies overseas,” he says.
Knowledge-based franchises such as accountancy, law and financial services, Tirkides adds, are all good examples of sectors that are helping Cyprus to rebalance its economy towards high value-added drivers of growth. “Between the early 1980s and the eve of the crisis, the three pillars of growth were tourism, trade and construction, all of which are labour-intensive, low value-added sectors,” he says. “The challenge is to change this model and move towards areas of enhanced productivity and value-added.”
Growing agriculture
One area where improved productivity is urgently needed is the agricultural sector, which still accounts for no more than about 2% of GDP. “Agriculture is the most unproductive sector of the Cypriot economy, because farmers’ plots are fragmented into small holdings which keeps the profit margins on their production very low,” says Tirkides. “We’re starting to see farmers looking at ways of pooling and mechanising their production, which would help them to increase their margins and lift their output. Given that about 15% of Cyprus’s imports are food, it would also help to replace some imports.”
The recovery in the Cypriot economy over the last 12-24 months has by no means been restricted to tourism and professional services. “We’re seeing increased activity in real estate and property development, which is a sector that was dead and buried a couple of years ago,” says Nicholas Hadjiyiannis, CEO of the Cooperative Central Bank (CCB). “We’re now seeing companies investing in refurbishment and expansion of their facilities.”
Others agree. “Even in construction, which was the sector that was most severely hit by the recession, there has been encouraging evidence of a recovery,” says Andreas Charalambous, director of financial stability at the finance ministry in Nicosia. The numbers speak for themselves. According to research published by Bank of Cyprus, local sales of cement rose by 25.5% in 2016, compared with a rise of just 2.4% in 2015, while the volume of building permits rose by 18.8% last year, up from 12.3% in 2015. Cement sales continued to grow in early 2017, rising by almost 25% in the three months to February.
“Aside from contributing to economic growth and job creation, this is important because it will help to preserve and enhance the value of banks’ collateral and help them to take more real estate assets off their balance sheets,” says Charalambous (see box).
This should help banks to support growth in a range of sectors, in turn promoting increased economic diversity. So too should the expansion in the banks’ deposit base, which have been recovering steadily since their dramatic decline during the crisis.
For now, however, as Bank of Cyprus comments in its most recent update, net deleveraging continues to be the dominant feature within the industry. Total loans outstanding fell by 12% in 2016, with lending to financial companies plummeting by almost 50%. Loans to non-financial corporate borrowers fell by a much lower 8.7%, while declines in personal and household lending were in the low single digits.
“Deleveraging is continuing,” says Hadjiyiannis at CCB. “But the banks are becoming more active in trying to limit the effects of deleveraging and finding new areas of business to deploy the significant level of liquidity in the system.”
Some local bankers argue that rebuilding loan books will be a challenge, given a shortage of lending opportunities in the domestic market. This is an argument that is given short shrift by John Hourican, who has overseen the turnaround at Bank of Cyprus since his appointment in 2013. “Some of the banks have been unable to deploy surplus liquidity,” he says. “I think there are plenty of lending opportunities in the domestic market, but these have to be priced appropriately.”
Sorting the Cyprus problem
New lending opportunities would arise if a solution is found to the so-called Cyprus problem that has divided the island since 1974. “Normalising our economic relations with Turkey would be a game-changer both for the country and for the banking industry,” says Irena Georgiadou, chairwoman at Hellenic Bank in Nicosia.
Few industries would be more positively impacted by a speedy resolution to the Cyprus problem than the shipping sector, which accounts for about 7% of the island’s GDP and employs 4,500 people ashore. “Shipping would be the first beneficiary of a settlement, because since 1987 Turkey has imposed a unilateral restriction on Cypriot flagships calling at Turkish ports,” says Thomas Kazakos, director general of the Cyprus Shipping Chamber. “Should there be a settlement, this ban would be lifted immediately, which would lead to a substantial growth in our fleet and a noticeable expansion in the use of Cypriot ports.”
The numbers are eye-catching. Kazakos says that a fleet of about 2,500 ocean-going vessels with 56m gross tonnes is under Cypriot control today. Of these, 1,000 sail under the Cypriot flag, making it the 11th largest fleet in the world. “If all our non-Cyprus flag carrying vessels were put under the Cyprus flag, this would become the world’s fourth largest fleet overnight,” says Kazakos.
Even in the absence of a reunification agreement, Kazakos says there are plenty of reasons why the prospects for the Cypriot shipping sector remain compelling. One of these is the interlinkage between shipping and the energy sector. “We always say that shipping is the first cousin of the energy sector because it is such an important provider of maritime services to the offshore industry,” says Kazakos. “On top of that, if substantial natural gas reserves are discovered in the eastern Mediterranean, the Cypriot shipping sector will play an important role in transportation, because you can’t build a pipeline from here to Taiwan.”
Another of the shipping industry’s trump cards is a highly attractive tonnage tax (TT) regime which has been approved by the EU and applies to ship owners, charterers and managers. “Whereas other EU countries tend to specialise in one of these areas, we offer all three, which makes Cyprus very attractive to ship-owning, chartering and ship management companies,” says Kazakos.