Identifier
Created
Classification
Origin
08NICOSIA447
2008-06-13 08:46:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy Nicosia
Cable title:  

CYPRUS: Global Economic Turmoil Takes its Toll

Tags:  ECON EFIN CY 
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DE RUEHNC #0447/01 1650846
ZNR UUUUU ZZH
R 130846Z JUN 08
FM AMEMBASSY NICOSIA
TO RUEHC/SECSTATE WASHDC 8867
INFO RUEHBS/USEU BRUSSELS
RUEHTH/AMEMBASSY ATHENS 4018
RUEHAK/AMEMBASSY ANKARA 5207
RUCPDOC/USDOC WASHDC
UNCLAS NICOSIA 000447 

SENSITIVE

SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN CY
SUBJECT: CYPRUS: Global Economic Turmoil Takes its Toll

REF: 07 NICOSIA 949

(U) This cable is sensitive but unclassified. Please treat
accordingly.

UNCLAS NICOSIA 000447

SENSITIVE

SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN CY
SUBJECT: CYPRUS: Global Economic Turmoil Takes its Toll

REF: 07 NICOSIA 949

(U) This cable is sensitive but unclassified. Please treat
accordingly.


1. (SBU) Summary. Rising oil and food prices and the global
economic turmoil is finally taking its toll on Cyprus. Cyprus is
going to have to live with slower growth rates (albeit, still double
that of the EU average),and to forget about fiscal surpluses.
However, the main threat is inflation, which recorded a five-year
high in May. Faced with a sharp deterioration in the economy and in
its own finances, the government seems to be anxiously pressing all
sorts of economic buttons in a search for additional revenue to fund
the social programs it promised during the election campaign. The
good news is that, thus far, the economy continues to grow, consumer
and business confidence remain robust, and the government's lack of
finesse has been limited to revenue enhancement in ways that do not
affect Cypriot companies or consumers. End Summary.

Inflation on a Five-Year High
--------------


2. (SBU) Less than four months after coming to power (February 24),
the Christofias administration is facing a considerably bleaker
outlook for the Cypriot economy, primarily due to the deteriorating
external environment. As in the rest of the EU, inflation is the
main concern. Year-on-year inflation reached a five-year high for
Cyprus of 4.9 percent in May 2008, against 2.2 percent in May 2007.
Domestic price increases have been particularly strong in housing
and utilities, including electricity (7.3 percent); transportation
(6.5 percent); and foodstuffs 6.4 percent). Depending on how oil
and cereal prices behave over the next few months, year-end (2008)
inflation in Cyprus is expected to be above 4.0 percent.


3. (SBU) According to Eurostat, inflation in the EU 27 for April
(latest month available) averaged 3.6 percent, against 4.3 percent
in Cyprus. One of the main reasons inflation is higher in Cyprus
than in the rest of the EU is Cyprus' complete dependence on
imported oil. Eurostat placed Cyprus at the very top of the list of
EU 27 countries in terms of oil dependency, with an overall
dependency score of 100.7 percent, against an EU average of 52.7
percent. Public transport in Cyprus, whether inter-city or
intra-city is virtually non-existent, so Cypriots rely almost
exclusively on privately-owned vehicles for their transportation
(with a resident population in the south of 780,000 people, Cyprus

has around 600,000 registered motor vehicles). Additionally, Cyprus
has done little to adopt renewable or more environment-friendly
energy sources (like natural gas),falling far short of its Kyoto
commitments to the European Commission.


4. (SBU) Further exacerbating inflation is the legally-mandated
Cost of Living Allowance (COLA). The COLA adjusts wages fully for
inflation twice a year. It covers employees across the board and is
considered a sacred cow by unions, which wield considerable power in
Cyprus, with support from most political parties. Anyone suggesting

that the COLA should be amended gets pilloried immediately, as
Central Bank Governor Orphanides found out recently (reftel). The
result is a wage indexation system that most economists here believe
may be good for the employees' sense of social justice but is bad
for the economy's competitiveness and feeds inflation and the
bloated government payroll.

Construction, Tourism, and Retail Trade Down
--------------


5. (SBU) Building permits issued during the period January-March
2008 recorded a 16.2 percent decrease compared to the corresponding
period of 2007. The total value of these permits decreased by 8.9
percent, and the total area by 11.3 percent. Government tax revenue
from property transactions also took a 17 percent nosedive in the
first four months of 2008 compared to the same period in 2007. Yet,
property prices in Cyprus have risen by 3.3 percent during the first
quarter of 2008, with just a hint of a slow-down in March, defying
the global pattern, at least for the time being. Faced with a
property slowdown, the Central Bank in early June lifted
restrictions on property loans for second homes, imposed a year
earlier when the property market was still booming.


6. (SBU) Tourism revenue, the life-blood of the Cypriot economy,
recorded a 5.0 percent decrease during the first four months of
2008, largely because of a 12.2 percent decrease in spending per
head by British tourists who constitute Cyprus' main market.
Cyprus' competitiveness in this crucial sector has been eroding over
the last seven years, due to increasing overheads and increasing
competition from such nearby markets as Turkey and Croatia.


7. (SBU) Meanwhile, retail consumer spending also seems to be
slowing down. According to the Cyprus Department of Statistics, the
Value Index of Retail Trade fell from 147.5 points in January 2008
to 145.4 points in February in a reversal from a multi-year upward
trend.

Loans and Foreign Travel Up
--------------


8. (SBU) At the same time, rather incongruously given the apparent
slow-down in the economy, bank lending is at an all-time high.
Credit expansion has been very strong since the beginning of the
year, exceeding 30 percent. By April 2008, total lending surged by
a record 35.4 percent to Euros 44.5 billion in April 2008, compared
to April 2007. The two main components of this increase have been
loans to businesses (non-financial institutions),which rose by 47.3
percent and housing loans, which rose by 38.0 percent. In
particular, lending to businesses reached Euros 21.5 billion in
April 2008, roughly twice the April 2006 level (Euros 12.7 billion).
According to banking sources, increased business lending went
towards financing business development and expansion plans as well
as to provide extra liquidity. Interestingly, Cypriot businesses
are borrowing at an interest rate of 6.63 percent - one of the
highest in the EU, against a Eurozone average of 5.91 percent.
Banks and analysts are warning businesses to be very mindful of the
risks involved in increased borrowing, especially during a period of
economic turmoil. Over the same period, total bank deposits reached
Euros 55.4 billion in April 2008, recording an increase of 24.5
percent.


9. (SBU) Another sign that the Cypriot economy is not in a recession
is that travel abroad by Cyprus residents during the first four
months of 2008 recorded a 15.2 percent increase, and there has been
no increase in unemployment.

Growth Down, Fiscal Surplus Vanishing Quickly
--------------


10. (SBU) Against this backdrop, the Ministry of Finance recently
revised downwards its economic performance targets for 2008. The
rate of growth, estimated at 4.0 percent in February, is now
anticipated to reach only 3.5 percent. This is still about twice
the EU average but it marks a considerable deceleration from last
year's 4.3 percent growth.


11. (SBU) Just a few months ago, the government was expecting a
fiscal surplus of 0.5 percent for 2008, following last year's
surplus of 3.3 percent. In early June, Finance Minister Stavrakis
said that ending 2008 with a surplus would be challenging.
Government revenue from the once-booming property market, was down
17 percent in the first four months of 2008. On the expenditure
side, the government paid out Euro 33 million to pensioners as an
Easter bonus, as soon as it come to power. The government will also
need to spend Euro 30 million on a civil service pay increase and
another Euro 40 million for the importation of water via tankers
from Greece to deal with the current severe drought.


12. (SBU) In an effort to stay in the black, the government has
turned its attention to past-due taxes amounting to Euros 480
million. However, up to a third of this is probably not recoverable
since the businesses owing the taxes are now bankrupt. The biggest
debtor to the government, at least from the government's point of
view, is the Church of Cyprus.

Government Confronts Church Over Taxes
--------------


13. (SBU) In early June, the government and the Church had a very
public confrontation over whether or not the Church owes the state
any taxes. The Ministry of Finance claims that the Church owes
Euros 111 million in taxes (Euros 58 million property tax, Euros
10.2 capital gains, and Euros 42.7 million in past taxes).
Archbishop Chrysostomos stridently denied that the Church was a tax
dodger, pointing to an agreement with the previous administration
dated December 27, 2005, which, according to the Archbishop, settled
this matter once and for all. Chrysostomos concluded: "They are not
getting a single Euro out of us; we do not owe them anything."
During the exchange, both sides exchanged some rather pointed
comments, including the Archbishop blasting the government for
populist antics. Previous administrations have also tried to get
the Church to pay taxes, but this is the first time the
confrontation between them has been so acrimonious.


14. (SBU) As a result of the confrontation, the Church felt
compelled to call a press conference and disclose, for the first
time ever, the full picture of its finances. According to this
disclosure, at the end of 2007, the Church had fixed assets of Euros
1.1 billion, including Euros 600 million in property holdings; Euros
58 million in hotels, and Euros 383 million in shares and other
investments. By the Archbishop's own admission, the property figure
is based on older valuations; a more current valuation would raise
the property figure to "billions of Cyprus Pounds." Comment: The
issue seems to revolve around whether property taxes are payable by
the Church on its vast (for Cyprus) unutilized property holdings.
The Church had previously agreed to pay taxes on income earned from
its holdings in brewery, hotel, winery, and banking operations on
the island. End Comment.

Government Eyes Central Bank Gold
--------------


15. (SBU) On June 7, Finance Minister Stavrakis met with officials
from several parties regarding the economy. Stavrakis warned 2009
would be a hard year for the economy. He explained that a fiscal
surplus would be unlikely for 2009, and the government was focusing
on keeping the deficit to a minimum. Stavrakis noted further that,
based on current conditions, the government would be in a position
to undertake only about 40 percent of the development programs it
had pledged to carry out for the next five years.


16. (SBU) Stavrakis used this as an introduction to recruit
cross-party support to the government's effort to require the
Central Bank to sell off its gold reserves, which amount to Euros
250 million. According to the press, the government has been trying
for the past two months (initially behind the scenes, but publicly
since the story was leaked to the press on June 8) to convince the
CB to sell off its gold reserves to "realize a profit." Existing
legislation stipulates that, if the CB sells off reserves, the
proceeds are to be divided as follows: 80 percent to the
government's consolidated fund, and 20 percent to the CB's reserves.
Based on this provision, the press speculated that the government
intended to keep Euros 200 million for itself, and give the CB the
remaining Euros 50 million. The government quickly responded that
this was not its intention at all and that it wanted to sell the
gold in order to help pay off the public debt to alleviate the
burden on the economy. (Comment: This excuse is probably nothing
but an afterthought on the part of the government. At Euros 8.6
billion or 52.5 percent of GDP, Cypriot public debt is quite
manageable and on its way down without any extra help. It is also
within the Maastricht ceiling of 60 percent. End Comment.)


17. (SBU) The CB has resisted this effort. (Some have even
suggested that this refusal was the real reason behind the recent
tension between the government and CB Governor Orphanides, and not
his suggestion to amend the COLA.) With the exception of the ruling
AKEL party and its coalition partner DIKO party, none of the parties
expressed support for selling off gold reserves. Opposition party
DISY, in particular, launched severe criticism against the
government's intention. Challenged to comment on why the government
was pursuing this issue at this point in time, Stavrakis responded,
"We are a new government; we have every right to start with a clean
slate and examine things critically."


18. (SBU) We asked a senior CB contact for comment. He responded
that the CB's main policy guideline when it came to managing its
reserves, vis-`-vis the European Central Bank, was that the CB
maintained "adequate" reserves to conduct its business and meet its
obligations. He stressed further that the CB was not a speculative
institution - it manages Cyprus' reserves with a view to hedge
against risk and to keep enough for a rainy day, in case of a real
catastrophe. (Cyprus' official international reserves were around
Euros 4.0 billion at the end of 2007; gold makes up only about 6.0
percent of this.) He described the government's suggestion to sell
off gold now to realize a "profit" as "misguided" at best, given
that the government is not facing an immediate or dire fiscal
deficit. He also commented that the debate over the gold reserves
should have been kept away from the public domain. If nothing else,
the media are often not sufficiently informed about these issues.
Furthermore, he noted, to even call this a "profit" (given that gold
now sells for USD 900 an ounce, compared to USD 40 an ounce when
acquired in 1963) - as the papers have done quoting AKEL sources --
betrays a basic lack of understanding of the CB's role.


19. (SBU) Comment: When this administration won the February 24
election, the Cypriot economy was in a clearly enviable state. Less
than four months later, this is true only in relative terms: high
inflation, a quickly-vanishing fiscal surplus, restrained
consumption, and a rapidly-slowing growth rate make up the present
picture. It may be tempting to blame the present administration for
the significant deterioration in the economy since the February 24
Presidential elections. However, the truth is that the government
took over just at a time when the Cypriot economy was already poised
to decelerate due to the deteriorating external circumstances.



20. (SBU) Comment Continued. Far from being in a recession, the
Cypriot economy continues to grow at a satisfactory level,
especially compared to the rest of the EU. So the real issue here
is not so much how bad the economy is but rather with what confusion
the government seems to be reacting to its first unfolding economic
crisis. By most people's reckoning, its reaction so far can only be
described as "clumsy." Simultaneously pressing the hot buttons of
both the Church and the Central Bank has unified those from a very
broad political spectrum to question the new government's economic
management skills. Most disturbingly, the Finance Minister, who as a
senior banker was brought in to lend his economic credentials to the
nominally communist regime, is seen by many as failing to restrain
the non-orthodox economic tendencies of his government. End
Comment.

SCHLICHER