EC projects 3.8% GDP growth in 2007 The forecast issued by the European Commission on the Cyprus economy data are set to pave the way for the entry of the country into the Eurozone as planned on January 1, 2008.Based on the forecast for 2007 and 2008 coupled by the fact that Cyprus meets the Maastricht criteria, it is safe to assume that the EC report due on May 16 will be positive and pave the way for a positive decision by the ECOFIN on June 21, 2007 for Cyprus’ entry into the Euro-zone club. Malta is also set to join the Eurozone, increasing the number of member states to 15 out of 27.Prospects for 2007 and 2008 GDP is projected to continue growing solidly at 3.8% in 2007 and 3.9% in 2008, still driven by domestic demand, which would contribute around 4 percentage points to GDP growth. Increasing disposable income, supported by sustained wage and employment growth, will keep private consumption growing at still high rates, albeit lower than this year on account of rising interest rate expectations. Investment should remain robust and continue growing just below 5% per year until 2008. This expansion of investment will be mainly driven by construction, underpinned by a strong demand for dwellings by non-residents and by other large infrastructure projects. Furthermore, confidence effects linked to the prospects of joining the Euro area should also sustain total investment through higher investment in machinery and equipment. Although the projected deceleration in private consumption should have a moderating impact on imports, higher investment in equipment should keep imports growing at high rates until 2008. Labour market, costs and prices Labour market conditions remained tight, at nearly full employment, with unemployment at around 4¾%. In line with buoyant economic activity, employment will continue growing at around 1½% per year until 2008. However, higher participation would keep the unemployment rate around its current level. Higher participation by foreign workers, combined with moderate wage growth in the public sector, should also keep wage pressures relatively contained, in spite of tight labour market conditions. Since productivity growth is expected to rise by just above 2½% by 2008, unit labour costs will rise, but at lower rates than in the recent past. Public finances The general government deficit for 2006 is estimated at 1½% of GDP, about ½ percentage point of GDP lower than the target in the Budget Law. The initially budgeted ¼% of GDP from temporary revenues from building permits has not materialised, but this was more than compensated by higher-than-expected tax revenues associated with the buoyant performance of the real estate sector as well as improved tax administration and collection. The structural balance (the cyclically-adjusted balance net of one-offs) improved by around 1¾% of GDP in 2006. The 2007 Budget Law targets a deficit of just above 1½% of GDP. No one-off measures are planned. The fiscal adjustment is still mainly driven by tax revenues, partially offset by the reduction of EU funds. Total revenues are projected to rise by almost ¼% of GDP. However, expenditures will remain unchanged in terms of GDP, as the reduction in the interest payments is offset by higher social transfers. The Commission services project an almost unchanged deficit (1½% of GDP), despite the better-than anticipated outturn for 2006, to account for the announced package of social transfers amounting to about ¼% of GDP. In structural terms, the fiscal adjustment in 2007 is expected to be marginal, which would correspond to a broadly neutral fiscal stance.
This also reflects the deterioration of Cyprus’ net position vis-à-vis the EU budget as temporary compensating grants associated with EU accession came to an end in 2006, and are only partially compensated in the 2007 budget. In 2008, on a no policy- change basis, the deficit is projected to inch down to slightly below 1½% of GDP. The debt-to- GDP ratio is projected to keep on a decreasing path, attaining about 55% by 2008, driven by the planned reduction of deposits with the central bank.
