Central Bank staff assessments put Cypriot growth roughly on a par with Finance Ministry projections of the island’s economy expanding by 3.6 per cent this year. However it said that a slowdown in state revenues for the first five months of 2008, coupled with what it said appeared to be higher spending, suggested a “significant deterioration” of fiscal indicators for 2008.
“Based on the first data of the year, the Cypriot economy appears to be experiencing a small slowdown in activity, while inflation and public finances have displayed a worrying trend because of domestic and external factors,” the Central Bank said.
It made the comments in a biannual report released yesterday.
Noting a European Commission forecast of a 1.7 per cent fiscal surplus this year despite a decrease in revenue, the Central Bank said that forecast appeared to be based on the assumption the island will not use a surplus windfall in 2007 to finance more public spending.
“The government must adopt measures which will limit on a permanent basis public spending, taking into account its priorities on social policy. Temporary increases of public benefits should not be used to increase spending, and particularly not without being socially targeted ones,” it said.
Cyprus recorded a 3.3 per cent surplus in 2007 on the back of a buoyant real estate sector, which has since shown signs of tapering off.
“A restraint in spending is necessary to safeguard the long term viability of public finances,” the Central Bank said, highlighting European Commission forecasts that an ageing population will put pressure on the island’s pensions system in years to come.
In the first quarter of 2008, the surplus stood at 0.5 per cent of GDP – the level authorities expect for the whole year – though government revenue grew 2.6 per cent compared to the corresponding 2007 period where inflows were 24.3 per cent higher, the Central Bank said.
However, figures in the report did suggest the government had tightened its belts; government spending over the first quarter of 2008 was 2.6 per cent higher year on year, compared to a 15.5 per cent increase in 2007.
“It is generally recommended that unexpected increases in revenues, such as those of 2007, be utilized to strengthen fiscal consolidation instead of being used to finance spending, (to sectors) which are permanent in nature and not easily reversed,” the Central Bank said.
The government must also adopt measures which will permanently reduce public spending. It said authorities could look at ways of regulating its welfare and benefits system through the introduction of income thresholds.
“The government must adopt measures which will limit on a permanent basis public spending, taking into account its priorities on social policy. Temporary increases of public benefits should not be used to increase spending, and particularly not without being socially targetted ones,” it said.
Based on May data, the Central Bank said it expected domestic inflation to reach 4.2 per cent in 2008, and moderate to 2.4 per cent in 2009.
The survey also offered a glimpse into households’ borrowing patterns. Housing loans represented 43 per cent of lending exposure and consumer loans 19.6 per cent as of March 31 this year.
The overwhelming majority of mortgages, some 97 per cent, were with floating interest rates; meaning that most will be affected by the European Central Bank’s decision to up its key refinancing rate by 25 basis points last week.
“Based on the large percentage of loans which contain a floating rate clause, it can be concluded that households are vulnerable to oscillations which could possibly occur by a sudden or significant increase in interest rates,” the Central Bank report said. Recent turmoil on international financial markets has also led to a liquidity squeeze in international money markets and an increase in short-term rates on the Interbank market, the mechanism banks use to borrow or lend money to one another.
Banks in Cyprus could transfer part of the additional borrowing costs on the Euribor or Libor money markets to their clients, adding to the cost of borrowing, the Central Bank said.
Strong competition among banks to lure deposits – offering high returns – can also manifest as additional costs for banks which could at some point spur them to transfer the additional cost onto borrowers.
Domestic banks this year raised their base rates for new loans twice, citing conditions on the Interbank market.
Cyprus Mail 10/07/2008