D&B Country Report · on any noteworthy austerity measures. − Austerity measures in several of...

D&B Country Report

D&B Country Report Cyprus DB3a (Slight Risk)

2010/11 1 © Dun & Bradstreet Limited

Contents

PART ONE: Executive Summary

Key Information 2

Risk Snapshot 3 Risk Snapshot 3 Outlook Summary 4

PART TWO: Risk Outlook

Political Risk 6 Domestic Politics 6 Policy Agenda 7 International Relations 8

Economic Risk 10 Global Outlook 10 Economic Performance 11 Economic Policy 13 External Economic Risk 16

Commercial Risk 19 Business Performance 19 Credit Risk 20 Financial Sector Risk 21 Other Commercial Risks 22

Data Summary 23

PART THREE: Risk Environment

Political Environment 24 Political Overview 24 Political System 25 Political Forces 26 Security 28 International Environment 28

Economic Environment 30 Economic Overview 30 Economic Framework 30 Trade Profile 32 Long-Term Economic Potential 35

Commercial Environment 36 Overview 36 Physical Environment 36 Legal and Regulatory Environment 37 Corruption 40 Taxation 41 Trade Environment 43 Investment Environment 46

Additional Sources of Information 48

PART FOUR: User Guides

Glossary 49

Country Risk Indicator Definition & Report Guide 50

Country Risk Analyst Markus Kuger Telephone: 01628 492438 Email: [email protected]

Sales Email: [email protected] Telephone UK: +44 (0)1628 492700 US: +1 800 234 3867 Rest of world: contact your local office or call +44 1628 492700

Publisher D&B Marlow International Parkway Marlow Bucks SL7 1AJ United Kingdom Tel: 01628 492000 Fax: 01628 492929 Email: [email protected] While the editors endeavour to ensure the accuracy of all information and data contained in this D&B Country Report, neither they nor Dun & Bradstreet Limited accept responsibility for any loss or damage (whether direct or indirect) whatsoever to the customer or any third party resulting or arising therefrom. © All rights reserved. No part of this publication may be reproduced or used in any form or by any means graphic, electronic or mechanical, including photocopying, recording, taping, or information storage and retrieval systems without permission of the publisher. This D&B Country Report was prepared in September 2010.

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Key Information

Basic Country Information

Surface area (sq km) Capital Nicosia

Country population (m) Population of capital (m)

Official language(s) Greek, Turkish Timezone of capital GMT +2 hours

Political Information

Political system Presidential democracy Ruling coalition AKEL, DIKO

Head of state & govt. President Demetris Christophias Last election

Next election

Trade & Commercial Information

Trade terms Top 3 export goods (% of total exports)

Minimum terms SD Manufactured products 60.0

Recommended terms SD Raw agricultural products 17.4

Usual terms 30-180 days Processed agricultural products 16.7

Transfer situation Top 3 import goods (% of total imports)

Local delays 0-2 months Fuels & lubricants 28.0

FX/bank delays 0-1 months Transport equipment 25.4

Import cover 1.2 months Manufactured products 15.5

Export credit insurance cover Top 3 export markets (% of total exports)

US Eximbank Full cover available Greece 23.8

Atradius Full cover available Other-EU 13.6

ECGD Full cover available Middle East 12.0

International sanctions and trade restrictions Greece 20.0

None known Italy 11.0

UK 9.0

Economic Data

Key country data

GDP (current EURbn)

GDP (current USDbn)

Real GDP growth (%)

Inflation, annual average (%)

Government balance (% of GDP)

Unemployment (% of labour force)

Current account balance (% of GDP)

Global data

World real GDP growth (%)

US real GDP growth (%)

Oil price, Brent Crude (USD/b)

Comparative Market Indicators

Income per capita (USD)

Country population (m)

Internet users (% of population)

Real GDP growth (% p.a., 2010-19) 0.5-1.52.0-3.0 1.5-2.0 1.0-1.5 3.0-3.5

48.8 58.9 48.3

0.9 11.2 59.9 0.4 10.7

49.8 44.5

20,813

72.3 97.9

PortugalMaltaItalyGreeceCyprus

27,023 29,554 35,282

61.8 77.4

19,226

83.2

2.6

1.72.1 0.4 -2.4 2.0

4.2 1.8 -2.0 2.7

-5.8

2007 2008 2009 2010f 2011f

-8.4 -17.1 -8.1 -6.5

-5.2

4.0 3.6 5.3 6.8 7.0

3.4 0.9 -6.1 -5.8

1.7

2.2 4.4 0.2 2.8 3.0

5.1 3.6 -1.7

2,951

0.3

17,248 16,946 17,247 18,059

Top 3 import sources (% of total imports)

2011f2009 2010f

-1.0

0.8

15,879

Euler Hermes UK Full ST cover available

Parliamentary: 2006; Presidential: 2008

Parliamentary: 2011; Presidential: 2012

23,454

2007 2008

21,752 25,364 23,537 22,399

Sources: Central Bank of Cyprus; Eurostat; Statistical Service of Cyprus; World Bank, World Development Indicators; D&B



Risk Snapshot

Country Risk Indicator: DB3a (Slight Risk)

Enough uncertainty over expected returns to warrant close monitoring of country risk. Customers should actively manage their risk exposures.

The DB country risk indicator is a comparative, cross-border assessment of the risk of doing business in a country. The indicator seeks to encapsulate the risk that country-wide factors pose to the predictability of export payments and investment returns over a time horizon of two years.

Risk Snapshot

• Cyprus’ political risk outlook has worsened since Dervish Eroglu was elected

president of the Turkish Republic of Northern Cyprus in April 2010. Reunification

talks have since reached deadlock and prospects for a permanent peace settlement on

the divided island have receded due to unfavourable political conditions on both

sides. We do not expect a reunification agreement in our forecast period.

• The effects of the financial crisis on Cyprus were not as severe as on other

Mediterranean countries, but the economy is only slowly recovering from the

negative shocks of the past two years; the construction and the tourism sectors in

particular are suffering from low demand.

Positive Risk Factors

+ The leaders of the Greek-Cypriots and the Turkish-Cypriots might be able to reach

agreement on some of the disputed topics, like citizenship and government structure,

which would boost the prospects of the reunification talks.

+ The economy showed signs of recovery in 2010 and real GDP growth will return to

positive levels in 2011.

+ The Greek debt crisis did not affect Cyprus as much as other Mediterranean

countries and the government has not yet had problems financing its deficit (owing

to low interest rates and low risk premiums on government bonds).

+ The country’s parliament rejected government proposals to increase corporation tax,

maintaining Cyprus’ position as a very attractive destination for FDI.

Negative Risk Factors

− Political stability decreased further after a junior coalition partner left the

government and a Supreme Court ruling weakened the president’s position.

− The election of Dervish Eroglu (the then party leader of the nationalist opposition)

as president of the Turkish Republic of Northern Cyprus in April 2010 has made

reunification very unlikely in the short term.

− The government has to reduce its high deficit by 2012 but has so far failed to agree

on any noteworthy austerity measures.

− Austerity measures in several of Cyprus’ main trading partners create downside

risks for the tourism- and export-oriented economy.

− Despite the favourable commercial environment, the island’s division is a major

deterrent for investors, hampering investment activity in Cyprus.



Outlook Summary

Cyprus offers a ‘slight risk’ operating environment for businesses, as reflected in its

DB3a rating. The economy is small, but prosperous, and has been significantly

reformed in recent years as a result of its EU accession in 2004 and the introduction of

the euro in 2008. The commercial risk environment is favourable, while its benign

investment climate, preferential corporate tax regime, flexible labour market conditions

and modern infrastructure have helped Cyprus to develop into an important regional and

international business centre. The economy has slowed significantly because of the

global financial crisis and a further deterioration will take place in 2010. However, signs

of a recovery in 2011 are clearly visible.

The still-unsolved political/geographical division of the island will weigh down

investment activity in real estate in the forecast period, and it continues to handicap

economic development. As a result, the key challenge ahead will be to find a

sustainable solution to the island’s division. The current reunification negotiations are

the best chance in many years for finding a workable political settlement and could lead

to an upgrade to Cyprus’ country risk rating, which has not changed July 2009.

However, this chance for reunification has decreased since mid-2009 because of the

presidential election results in the Turkish-Cypriot part of the island and due to several

developments in the Greek-Cypriot political landscape.

Comparative Risk Indicator Histories

1

2

3

4

5

6

72005 2006 2007 2008 2009 Latest

Cyprus Greece Italy

Malta Portugal

Highest

Risk

Lowest

Risk

D&

B R

isk I

nd

icato

r

Source: D&B

Political Risk Outlook

The presidential elections in the Turkish Republic of Northern Cyprus (an entity that is

not internationally recognised) in April 2010 had a significant impact on the outlook of

the ongoing reunification talks between both ethnic groups. The more amenable

President Mehmet Ali Talat was replaced by Dervish Eroglu, the then leader of the

nationalist party in Northern Cyprus. This further reduced the chances of rapid

reunification, as President Eroglu has no interest in making concessions to the Greek-

Cypriot side. Eroglu’s hardline position was reinforced in local elections in July 2010,

making it very unlikely that he will be more conciliatory in the ongoing talks.

Moreover, developments in the Greek-Cypriot part of the island also had a detrimental

effect on the chances of reunification. The social democratic junior coalition partner left

the government because of the compromises President Demetris Christofias made

during the talks, leaving the government with only a single-seat majority in parliament.

In addition to the loss of the social democratic party (EDEK) as a coalition partner,

there are serious differences between the remaining business-friendly junior coalition

partner and the senior coalition partner (the Communist Party), over further austerity

measures to reduce the public deficit, as well as over the reunification process. The



position of the pro-reunification president weakened in 2010 because of a ruling of the

Supreme Court of Cyprus, which reduced his responsibilities and transferred power to

parliament, necessitating closer co-operation between the president and the coalition

partners in the future. There is a considerable risk that the government will break up in

the forecast period.

Economic Risk Outlook

Cyprus’ navigated through the global and regional financial crises better than

comparable states in the region. Most macroeconomic indicators deteriorated to a lesser

extent than in other Mediterranean countries, although the Cypriot economy contracted

in 2009 and will also shrink in 2010. For 2011, however, we expect real GDP to grow

by 1.7%, based on higher private consumption. That said, the recovery still faces several

downside risks: a slightly appreciated euro and higher domestic inflation rate will lead

to a loss of competitiveness on the European and the global markets; moreover,

austerity measures in Cyprus and its trading partner countries could lead to a decline in

domestic demand (in Cyprus) and import demand (in the trading partner countries) and

therefore to slower economic growth in the second half of 2010; in particular, spending

cuts in Greece, Italy and other Mediterranean countries will have a negative spill-over

effect on the Cypriot economy because of fewer exports to those countries, thus GDP

will decline in Cyprus in 2010 and grow only modestly in 2011.

Nonetheless, the austerity measures will have some positive effects on Cyprus, too.

Owing to reduced investment in the construction sector in China, we expect prices for

steel and cement to decline on world markets; this will help to stimulate investment in

the currently sluggish Cypriot construction sector and real estate market. Indicators for

future investment in the construction sector already improved in Q2 2010, and a slower

downturn in that important sector is very likely for 2011 (albeit at levels still far away

from the boom years in the mid-2000s).

Commercial Risk Outlook

Cyprus offers a favourable commercial environment. A number of wide-ranging

economic and structural reforms were promoted in the lead-up to its accession to the EU

(and since), covering the areas of competition and the financial and business sectors.

The FDI regime has been fully liberalised, tax reform has been implemented, and most

investment restrictions have been lifted. The corporate tax rate remains at 10% (a plan

to increase it by 1 percentage point was rejected by parliament in August 2010). Several

indicators, such as the industrial production index, showed signs of recovery in the first

half of 2010, and we expect them to improve further over the forecast period. The

effects of the financial crisis on the Cypriot financial sector were relatively small

because of its focus on traditional banking activities and conservative lending practices.

The banks’ predominant reliance on more stable retail funding, negligible exposure to

complex securities, high levels of liquidity, and strong supervision helped to shield it

from the global crisis, and recent and ongoing stress tests carried out by the Central

Bank of Cyprus indicate that the system has the capacity to absorb further shocks.

On the negative side, the payments performance of Cypriot firms has worsened since

August 2009, and we fear a further deterioration. Concurrently, bankruptcy rates (both

for companies and individuals) rose significantly in the first six months of 2010, thus

making a further decline in payments performance very likely. The division of the

island creates massive problems for the real estate sector in both the Greek-Cypriot and

the Turkish-Cypriot parts of the island. The ownership of land and houses is often

unclear because of displacement of the former owner, and it is therefore very difficult to

acquire enforceable property rights (including deeds). Recent rulings from several

European courts have increased the danger of investment in real estate that has an

unclear background: this could reduce further investment until a trustworthy solution on

property rights can be found in the reunification talks.



Political Risk

Outlook Summary: The election of Dervish Eroglu as president of the Turkish Republic of Northern Cyprus (an entity that is not internationally recognised) in April 2010 has made make the reunification process between the Greek and the Turkish parts of the divided island even more difficult. Moreover, the willingness to seek reunification is also shrinking on the Greek-Cypriot side: the Social Democratic movement (EDEK) has left the coalition government of President Demetris Christofias because of concessions the president made to the other side in the reunification talks. Consequently, negotiations between the two ethnic groups are in a deadlock at the time of writing, despite international assistance from the UN. It seems very unlikely that an agreement on reunification can be achieved during the forecast period.

Domestic Politics

The unresolved conflict between the Republic of Cyprus and the Turkish Republic of

Northern Cyprus (TRNC, which is not an internationally recognised entity) still

overshadows domestic politics. Since the division of the island in 1974, and even more

so since the North unilaterally declared itself independent in 1983 (a move only

recognised by the Republic of Turkey), the question of reunification has dominated all

aspects of political life on the island. The repercussions of the 2004 ‘Annan Plan’

referendum, a referendum on a UN proposal to settle the Cyprus dispute, were evident

in the last parliamentary election in 2006, influencing the election result such that anti-

reunification parties were victorious in the poll (Political Overview, p24).

Parliamentary Standings

Party House of Representatives

Share of vote (%) Seats

Progressive Party of the Working People (AKEL) 31.2 18

Democratic Rally (DISY) 30.3 18

Democratic Party (DIKO) 17.9 11

Movement of Social Democrats (EDEK) 8.9 5

European Party (EURO.KO) 5.7 3

Ecological - Environmental Movement-Green Party (KEP) 2.0 1

Other Parties 4.0 0

Total 100.0 56 Source: IFES, IFES Election Guide

In contrast, the Annan Plan referendum had almost no effect on the two-round

presidential election in February 2008: the results of the election clarified the

preferences of the Greek-Cypriot community, as over 65% of the electorate supported

pro-unification candidates in the first round. Demetris Christofias, who is highly pro-

reunification, won the second round of the election in a close race against the candidate

of the centre-right DISY party, Ioannis Kassoulides. For the first time since

independence in 1960, Cyprus is governed by a president from the communist party.

Presidential Election Result, February 2008

Candidate Share of vote (%)

1st Round 2nd Round

Demetris Christofias (AKEL) 33.3 53.4

Ioannis Kassoulides (DISY) 33.5 46.6

Tassos Papdopooulos (DIKO) 31.8 - Source: IFES, IFES Election Guide

The reunification

process remains the

most important topic

in domestic politics



In the first months of his presidency, Christofias appointed DIKO and EDEK party

members to his cabinet and convinced the opposition DISY to re-enter the National

Council (the main consultative body on the reunification issue). However, following the

first year of Christofias’ administration, relations between the government coalition

parties have been anything but smooth. Both DIKO and EDEK have strongly objected

or expressed their disagreement over AKEL policies on a number of issues, such as

AKEL’s (and President Christofias’) refusal to apply for accession to NATO’s

Partnership for Peace programme, aspects of the educational reform, a bill on social

security funds, measures to deal with the current economic downturn, as well as aspects

of economic policy. More importantly, they have expressed their strong opposition to

President Christofias’ handling of (and his policies towards) the reunification

negotiation process.

The tensions between the coalition partners led to the withdrawal of EDEK’s ministers

from the government in February 2010. EDEK party officials justified the decision by

citing the too far-reaching concessions that President Christofias made to the Turkish-

Cypriot side in the reunification talks. The pullout by EDEK reduced the government’s

majority in parliament to the smallest possible majority of one seat. Frictions between

AKEL and the remaining coalition partner, the DIKO party, have also increased. Some

DIKO MPs demanded a vote within their party over whether they should leave the

coalition or stay. Although DIKO party chairman Marios Garoyian managed to prevent

the vote taking place, there are still groups in the centre-right party that strongly oppose

President Christofias’ positions in the reunification talks. In July 2010, DIKO voted

unanimously against Christofias’ proposals for the first time since they joined the

government in 2008: the business-friendly party opposed several planned tax raises

suggested by the communist president (see Fiscal Policy, p14). The president’s position

was also damaged by a ruling by the Cypriot constitutional court in December 2009.

President Christofias had appealed to the court because the parliament had reduced

taxes against his will, but the court ruled that parliament had the right to reduce taxes,

thereby shifting budgetary power from the president to the parliament for the first time

since the country gained independence. Parliament can thus block the president’s

budget decisions in the future, forcing President Christofias to co-operate more closely

with AKEL and DIKO MPs.

There is a risk that the government could break up before the next election owing to the

developments mentioned above. AKEL and DIKO disagree on several important topics,

namely the reunification process and economic policy. All political parties (including

those in opposition) are trying to enhance their profiles ahead of the next parliamentary

election in 2011, making it very unlikely that either AKEL or DIKO will be open to

compromise, and thus increasing the risk of the government breaking up. However, it is

relatively unlikely that either AKEL or DIKO will bring about the end of the coalition

such a short time before the election for fear of damaging their public image. On

balance, we expect the government to remain in office until the election in May 2011.

The struggles within the coalition also make a successful outcome to the reunification

talks less likely (the talks restarted in September 2008, after the failed referendum in

2004). President Christofias, who is leading the negotiations for the Greek-Cypriot side,

has to pay more attention to the view of DIKO, which is less unification-friendly than

AKEL. In addition, the parliamentary elections in May 2011 could leave Christofias

without a majority in parliament, making governance very difficult for any new

government because of a deadlock between the president and the parliament.

Policy Agenda

The reunification issue will remain the most important problem for Cypriot policy

makers. Since his election in 2008, pro-unification President Christofias has tried to

speed up negotiations with his Turkish-Cypriot counterpart, and Christofias has already

said that he will not run for a second term in 2012 if a reunification is not achieved

before then. Talks between Christofias and the then president of the TRNC, Mehmet Ali

Talat, started in March 2008, the first attempt to achieve the reunification of the divided

island since the failed referendum on the Annan-Plan in 2004. Six working groups and

The government

coalition parties

disagree about the

reunification

process

The president’s

position has

weakened…

…and there is a risk

that the government

could break up

The reunification

process has lost

momentum



seven technical committees were established to facilitate the fully-fledged direct talks,

which began officially in September 2008. Since then, meetings have been held, during

which the chapters regarding governance and power sharing, property issues, EU and

economic matters have been discussed. The talks ended without agreement shortly

before the presidential elections in the TRNC in April 2010. In the elections, Talat was

defeated and replaced by Dervish Eroglu, the then prime minister (he is from the

nationalist National Unionist Party). Since then, the talks have been postponed or even

cancelled several times and no substantial progress has been made in the few meetings

that have been held. In addition, public opinion in the Greek part of the island has

shifted towards a more reunification-sceptic point of view.

As mentioned above, the biggest problems in the reunification talks are the different

positions on property rights (see Other Commercial Risks, p22), the organisation of the

government and security guarantees. Those problems have increased since Eroglu has

headed the delegation of the TRNC, as he does not feel committed to agreements his

predecessor Talat achieved with the Greek-Cypriot side. After his election, Eroglu tried

to set up a deadline for the negotiations, possibly with the covert agenda that no

agreement on highly controversial topics could be reached such a short time. President

Eroglu has stated that, should the talks fail, the international community should finally

accept the division of the country and recognise the TRNC as an official state.

However, thanks to Greek-Cypriot lobbyism a UN Security Council resolution of June

2010 was diluted, only saying that it is ‘desirable’ that the talks should come to an end

by the end of 2010. Although there is no explicit deadline for the UN-monitored talks,

there are signs that the UN is losing patience: the pressure on both sides was increased

recently by a warning about the possible withdrawal of the UN peacekeeping force in

Cyprus, which has controlled the buffer zone between the Greek and the Turkish parts

of the island since 1964. With both sides unwilling to give up their positions on the

crucial topics of property rights and security, it seems highly unlikely that an agreement

can be reached within our two-year forecast period.

Another key priority is cutting back the costs of the policy measures that had been taken

to mitigate the negative effects of the global financial and economic crisis on the

Cypriot economy. To this end, the government has announced a package of measures

that should reduce the fiscal deficit (which stood at 6.1% of GDP at the end of 2009; see

Fiscal Policy, p14). For example, the government decided to raise fuel taxes, eliminate

preferential VAT rates, and cut social transfers to those with household incomes above

EUR60,000 per year. Those measures were carried by both coalition partners (the

notionally communist AKEL and the more business-friendly DIKO). Despite the tax

rises already announced, further measures still have to be taken, but there are

disagreements between the coalition partners about the focus of such measures. AKEL

prefers tax rises, especially in the business sector and for well-off Cypriots, whereas

DIKO prefers to reduce social transfer payments, as well as job and wage cuts in the

public sector (a traditional AKEL stronghold). As such, these plans are heavily

disputed. In July 2010, AKEL unilaterally tried to raise corporate and property taxes,

although DIKO decided to vote with the opposition against that proposal. As a result,

AKEL’s proposal was short of a majority in the parliament and failed, causing more

trouble for the already stressed government coalition.

International Relations

Cyprus’ international relations are friendly with almost every country, except Turkey.

The Cypriot-Russian friendship is particularly deep, but relations with the US are also

good. Cyprus makes efforts to secure support from its powerful allies for its position on

the reunification process.

Reunification

within the next two

years is highly

unlikely, despite UN

pressure

Reducing the

government deficit

is another potential

trouble spot



Relations with Russia

We expect the warm relations between Russia and Cyprus to improve further over the

forecast period. Russian tourists are becoming more and more important for the Cypriot

tourist industry and Cyprus has become the most important haven for Russian capital in

the EU; however, some sources of Russian FDI are dubious and the Cypriot authorities

fear money-laundering activities. Cyprus is officially the third-largest foreign investor

in the Russian economy and Cyprus is used by a large number of large Russian

businesses to create offshore firms. In 2009, the two countries signed a protocol on

economic co-operation and a double-taxation avoidance agreement, thus removing

Cyprus from the Russian tax blacklist (see Taxation, p41). Consequently, Cyprus will

attract even more investments from Russia in the near future, thus increasing the

island’s economic growth potential.

Relations with the US

Relations with the US deteriorated in June 2010, when a Russian spy escaped from the

US and was later arrested by Cypriot police. Although US officials warned the Cypriot

side in due time, the arrested person disappeared after he was released from prison on

bail. US government officials accused the Cypriot side of favouring Russia by allowing

the spy to escape. However, the incident was minor and D&B expects the relations

between both states to improve again, as Cyprus needs the support of the US in the

reunifications talks and in the UN Security Council, while the US is interested in a high

degree of political stability in the broader Middle East region. Cyprus can thus still rely

on US pro-Cypriot lobbyism in the reunification talks. Furthermore, the US can

positively (from a Greek-Cypriot point of view) influence the opinion of their ally,

Turkey, and, via Turkey, the TRNC on the reunification topic. This strengthens the

Greek-Cypriot side’s position in the talks.

Relations with Turkey

Relations between Turkey and the Republic of Cyprus are traditionally troubled. This is

because of the Turkish invasion of the north of the island in 1974 (see Political

Overview, p24). The Turkish government is still the only government that recognises

the TRNC (established in 1983) instead of the (Greek-Cypriot) Republic of Cyprus. The

future of the relations is uncertain. On the one hand, the parliamentary elections in

Turkey in April 2011 are likely to lead to a more nationalistic tone in the official

statements of the Turkish government: Turkish Prime Minister Recep Erdogan will try

to secure votes from the nationalist opposition parties and will therefore reject any

settlement in the reunification talks. On the other hand, a referendum in Turkey in

September 2010 reduced the influence of the army (a stronghold of nationalist and anti-

reunification forces) in Turkish politics. If Prime Minister Erdogan wins the elections in

April 2011, we expect his return to a more generous position in the reunification talks,

thus leading to a higher likelihood of reunification. However, if the nationalist

opposition wins the election (unlikely at the time of writing, but not impossible), D&B

sees almost no chance for a positive settlement.

Cyprus’ economy

benefits from

Russian tourists and

capital inflows

Relations between

Cyprus and the US

deteriorated in June

2010 but should

recover

The April 2011

elections in Turkey

could worsen

bilateral relations



Economic Risk

Outlook Summary: The austerity measures in Cyprus’ trading partner countries will lead to a decline in foreign demand and to slower economic growth in the second half of 2010. In particular, the spending cuts in Greece, Italy and the UK will have a negative spill-over effect on the Cypriot economy because of fewer exports to those countries, meaning that the economy will continue to contract in 2010 and grow only modestly in 2011. However, the austerity measures will also have some positive effects on Cyprus: owing to a reduction in investment in the construction sector in China, prices for steel and cement are expected to decline on world markets, which could help to stimulate investment in the sluggish Cypriot construction sector and real estate market.

Global Outlook

China’s policy tightening, European fiscal austerity and the slow and fragile recovery in

the US could result in a renewed slowdown of the world economy in the latter half of

2010. While we still expect 2.7% global real GDP growth, downside risks are elevated

for the OECD as the fiscal orthodoxy needed to stem debt costs in Europe takes effect,

and, in the US, as consumer retrenchment, a new downturn in housing and severe

budgetary problems in the states are set to curtail demand. Meanwhile, policymakers in

China are determined to deflate the property sector and rationalise the steel sector. All

these factors will weigh on commodity prices in the next two quarters. We expect that

the new financial stresses in Europe will result in increased funding costs as interbank

margins increase, cutting credit and investment, and that growth in Europe and the US

will remain mediocre at best.

Global Forecast Summary

2007 2008 2009 2010f 2011f

Real GDP growth (%)

World 4.2 1.8 -2.0 2.7 2.6

US 2.1 0.4 -2.4 2.0 1.7

Euroland 2.8 0.6 -4.1 0.8 1.1

Financial indicators

US interest rate (Federal Funds, year-end, %) 4.25 0-0.25 0-0.25 0.50 0.75

Euroland interest rate (Refinancing, year-end, %) 4.00 2.50 1.00 1.00 2.00

EUR:USD exchange rate (annual average) 0.73 0.68 0.72 0.77 0.79

Commodity prices

Oil price (Brent dated, USD/b, annual average) 72.3 97.9 61.8 77.4 83.2 Sources: IMF, International Financial Statistics; World Bank, World Development Indicators; D&B

Drastic fiscal consolidation measures (such as sharp tax rises and reductions in public

spending) across many developed countries remain a key downside risk to the global

recovery. In their meeting in Toronto in June 2010, G20 leaders agreed to pursue

‘growth-friendly’ fiscal cuts, aiming to halve budget deficits by 2013 (Japan is exempt

from this goal, although it has also made debt reduction a top priority). EU countries

will see particularly sharp cuts amid the Greek debt crisis. Planned cuts in France, Italy

and the UK will amount to around USD75bn (1.1% of their combined GDP) in 2010-

11. Outside the G20, the most vulnerable euro area members (Greece, Ireland, Portugal

and Spain) plan to reduce their deficits by a sizeable USD82bn (4.5% of their combined

GDP) by 2011. These cuts risk undermining demand in developed countries and,

eventually, global growth prospects.

For Cyprus, the planned spending cuts in Greece and the UK in particular will create

multiple downside risks because of the importance of both economies as key

destinations for Cypriot exports. Additionally, European fiscal austerity will reduce

tourist arrivals from European states (see Trade Profile, p32).

Policy measures

could slow down the

economic recovery

Spending cuts in

Greece and the UK

will reduce Cypriot

exports



Economic Performance

More than a decade of sustained and strong economic growth in Cyprus came to an end

in the second half of 2008, and real GDP fell by 1.7% in 2009.The downturn in gross

fixed capital formation and exports, which both declined at around 12%, were the key

factors behind the decline in GDP, but private consumption also fell considerably.

Latest available data from the Cypriot statistics office show that the economy is still

shrinking: real GDP fell by 1.5% in Q1 2010 and by 0.2% in Q2 year on year (y/y).

However, the pace of the economic downturn has slowed: in Q4 2009, real GDP had

fallen by 2.7% y/y.

Real GDP Growth

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

2002 2003 2004 2005 2006 2007 2008 2009 2010f 2011f

% Cyprus Malta

Portugal Greece

Sources: Eurostat; D&B

We expect real GDP growth to decline modestly in the second half of 2010 because of

lower public and private consumption, leading to an overall decline of real GDP of 1%

in 2010. Because of a recovery in household consumption and increased exports, we

expect the economy to grow modestly by 1.7% in 2011, which is in line with the

recovery in other Mediterranean countries.

Economic Activity

Real % change 2007 2008 2009 2010f 2011f

Private consumption 9.4 8.4 -3.0 -1.6 2.0

Government consumption 0.3 6.2 5.8 -1.2 -3.4

Gross fixed capital formation 13.4 8.6 -12.0 -9.9 -3.6

Exports 6.1 -2.1 -11.8 0.5 1.6

Imports 13.3 8.0 -19.8 -1.7 2.8

GDP 5.1 3.6 -1.7 -1.0 1.7

Consumer prices (year-average, % change) 2.2 4.4 0.2 2.8 3.0

Unemployment (% of labour force) 4.0 3.6 5.3 6.8 7.0 Sources: Eurostat; D&B

Household Consumption

Private consumption made up almost 70% of demand-side GDP in 2009 and has been

the main driver of economic growth in recent years, growing by double-digit rates from

Q4 2007 until Q3 2008. This was supported by low levels of unemployment and low

borrowing costs, as well as buoyant property and equity prices. However, since then,

private consumption has been losing momentum, growing by only 1.9% and 4.5% y/y

in Q4 2008 and Q1 2009. It has declined sharply since Q2 2009, with the latest data for

Q1 2010 showing a dip of 10.8% y/y; this mainly reflects a deterioration in the labour

market (see Industrial Relations and the Labour Market, p30). Furthermore,

households increased their savings because of the uncertain economic situation after

The slowdown will

ease in the second

half of 2010

Increased savings

and decreased

lending by the

financial

institutions have

reduced household

consumption



mid-2009. For example, deposits by households held with monetary financial

institutions increased by 13.6% y/y in June 2010, compared with 4.3% in June 2009.

The increased savings rate goes hand in hand with a lower household consumption rate,

as it also reduces disposable income.

We expect private consumption to decline considerably in 2010 because of persisting

uncertainty, tighter credit conditions and the still-rising unemployment rate. For 2010,

we expect private consumption to shrink by 1.6%, but for 2011 we forecast a modest

recovery because of increased consumer confidence (which returned over the first eight

months of 2010 and will increase spending after some delay), increased wages and

improved lending conditions; private consumption will rise by 2.0% in 2011.

Gross Fixed Capital Formation

Gross fixed capital formation grew by high single-digit or even low double-digit figures

from Q3 2003 until Q3 2008. This trend came to an end during the financial crisis.

Since Q4 2008, gross fixed capital formation has shrunk markedly; latest data for Q1

2010 show a decline by 13.4% y/y. Investment in equipment (including machinery)

deteriorated particularly fast: data for Q1 2010 show a decrease of 24.8% y/y. The

construction sector, representing a sizeable 66.3% of total investment, did not perform

well in 2009 and the first half of 2010 either; Q1 2010 data show a decline in

investment in housing and other construction by a further 8.5% y/y.

However, there are signs that the downturn in investment in real estate and construction

will be lower in the near term. Reduced investment levels in China will lower prices for

raw materials like steel and cement, thus lowering the costs for investment in

construction. Additionally, the number of building permits, which is a significant

indicator for future investment in construction, developed favourably in the first five

months of 2010. During that period, 3,827 building permits were issued, registering an

increase of 3.5% compared with the corresponding period of the previous year. The

total value of these permits increased by 8.5% and the total area grew by 7.6%. Overall,

D&B expects grossed fixed capital formation to shrink again in 2010 and 2011; we

forecast a decrease of 9.9% in 2010, while for 2011 we forecast a further decrease of

3.6%. Thus gross fixed capital formation will not make a positive contribution to real

GDP growth (although the negative impact will diminish significantly).

Net Exports

Reflecting a slowdown in private consumption and investment, import of goods and

services declined by almost 20% in 2009, after having grown by 8%% in 2008. Data for

Q1 2010 show that import growth had returned to a positive level, growing by 0.5% y/y.

In addition, the deteriorating external environment had an adverse effect on exports,

which declined by almost 12% in 2009 and 6.2% in Q1 2010 y/y. In 2008, exports had

shrunk by only 2.1%. According to our estimates for 2010, imports will decrease by

1.7% because of sluggish private and public demand. Exports will grow slowly (by

0.5%), mainly because of higher revenues from tourism (especially during the summer

holiday season) and also due to base effects. For 2011, D&B expects both imports and

exports to grow modestly. We expect the effect of the improved tourism infrastructure

to lead to a growth in exports of 1.6%. Nonetheless, austerity measures in many

European countries (especially in Greece and the UK, which are important export

markets for Cyprus, see Trade Profile, p32) and a slightly appreciated euro will prevent

a higher increase of exports. D&B expects imports to grow by 2.8% in 2011, due to a

modest pick-up in global oil prices and because of an increase in private consumption,

leading to a higher import demand.

Investment declined

sharply in 2009 and

will not pick up

until 2011



Inflation

Latest available data from Cystat, the Cypriot statistics office, show that the

Harmonised Index of Consumer Prices increased by 3.3% y/y in August 2010. This is

significantly higher than the inflation rate in August 2009, when the CPI decreased by

1.0%. The inflation rate increased over the first eight months of 2010, rising from 2.0%

y/y in December 2009. The relatively sharp hike in Q1 and Q2 2010 resulted mainly

from base effects (lower oil prices and a stronger euro in 2009 both put downward

pressure on inflation in 2009). Changes in oil prices have a big effect on the Cypriot

inflation rate because the country is heavily dependent on oil imports (it does not have

any natural crude oil resources). For example, in April 2010 energy prices increased by

22.7% y/y, whereas in April 2009 they declined by 19.2% y/y. The prices for food

remained pretty much stable in the first half of 2010; data for Q2 2010 show a decrease

of 2.2% y/y. Prices for services also declined modestly in Q1 and Q2 2010. As a result,

core inflation, which excludes the prices for energy and unprocessed food, showed a

downward trend in the first six months of 2010, but this was nullified by the increase of

the energy prices, leading to an increase in the CPI.

Inflation

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

2002 2003 2004 2005 2006 2007 2008 2009 2010f 2011f

% Cyprus Greece

Malta Portugal

Sources: Eurostat, D&B

For the second half of 2010 and for 2011, we expect the inflation rate to rise further

because of further increasing oil prices and a general recovery of the economy,

including rising nominal wages. For 2010, D&B expects an inflation rate of 2.8%, and

for 2011 we forecast 3.0%. This is higher than the inflation target of the European

Central Bank (see Monetary Regime, p32) and will undermine Cyprus’

competitiveness in the euro-zone export markets. Additionally, higher inflation rates

lead automatically to higher wages in Cyprus because of the ‘cost of living allowance’

(COLA) scheme, which pegs wage developments to the inflation rate (see Industrial

Relations and the Labour Market, p30). The rising inflation rate (in conjunction with

the COLA scheme) could therefore lead to a wage-price spiral, leading to higher labour

costs for companies, potentially creating negative effects on the Cypriot labour market

and the profitability of companies at a time when the weak economic recovery is

already squeezing company profits.

Economic Policy

By entering the euro-zone in 2008, Cyprus gave up all monetary policy instruments:

monetary policy is managed and interest rates are now set by the ECB. Economic policy

is therefore limited to fiscal policy and structural economic reforms, which also have to

be in line with EU regulations. Compared with other Mediterranean states such as

Greece, Spain (and to a lesser extent, Italy), Cyprus was not too severely hit by the

financial crisis. The financial supervision system in Cyprus performed well and avoided

a collapse of the banking sector without the need for government aid for suffering banks

(see Financial Sector Risk, p21). However, the government deficit rose sharply in

Inflation increased

in the first half of

2010 because of

higher energy prices



2008-09, reaching unsustainable levels of around 6% of GDP at the end of 2009. The

consolidation of public finances will therefore remain the overall policy target for fiscal

policy in the medium and long term, with a view to reducing public debt and thus

ensuring the sustainability of public finances.

Fiscal Policy

To counteract the effects of the financial crisis, the Cypriot government introduced a

series of economic stimulus measures in 2009, with a big direct budgetary impact. Thus,

the fiscal deficit increased to 6.1% of GDP by the end of 2009. Since the economic

recovery is in sight, the EU, which put Cyprus under an excessive deficit procedure in

July 2010, has called for corrective measures to reduce the deficit to the 3% of GDP

benchmark stipulated in the Stability and Growth Pact (see Fiscal Framework, p31).

According to the EU time schedule, the fiscal retrenchment has to be achieved by the

end of 2012, but several measures will need to be taken in the second half of 2010.

Government Balance

-15.0

-12.0

-9.0

-6.0

-3.0

0.0

3.0

6.0

9.0

2002 2003 2004 2005 2006 2007 2008 2009 2010f 2011f

% of GDP Cyprus Greece

Malta Portugal

Sources: Eurostat, D&B

In this context, the government and the parliament approved a rise in VAT on

previously zero-rated goods, like pharmaceuticals and certain food, to 5% by 1 January

2011 (while retaining the standard VAT rate at a low 15%). They also decided to

introduce a petrol duty of EUR0.055 per litre. However, the main element of the

austerity measures will be focused on the public sector payroll, which amounts to

EUR2.24bn, or almost one-third of the budget. From 2011 until 2014, 4,000 jobs will be

cut and senior government officials (including MPs, ministers and the president) agreed

on a 10% pay cut.

These measures will reduce government expenditure by EUR60m in 2010 and EUR90m

in 2011, but are not sufficient to cut the deficit to the level requested by the EU.

Consequently, the senior government coalition partner tried to increase corporate tax by

1 percentage point to 11%, but parliament rejected the plan in July 2010 (see Policy

Agenda, p7). Thus, other austerity measures have to be taken to fulfil the requirements

of the EU, otherwise Cyprus will not be able to achieve the EU targets, which demand a

maximum public deficit of 3% of GDP per year. If the government cannot agree on

spending cuts (or revenue increases), fear would grow of a sovereign default by Cyprus

on the financial markets in the medium term. However, after the next parliamentary

election in May 2011, another attempt to increase corporate tax could be made if the

centre-left parties win the election and form a government (at the time of writing, polls

indicate that this is unlikely). D&B does not expect an increase in corporate tax until the

elections in May 2011, but other taxes could rise and there could be further public

spending cuts. Hence, investors and traders with Cyprus should be aware of potential

tax increases that could increase the risk of trading with/investing in Cyprus.

Measures will have

to be taken to

reduce the deficit to

3% by end-2012



Public Debt

In light of the so-far ineffectual austerity measures, D&B expects public debt to rise

throughout the forecast period, breaking the 60% of GDP threshold that is set out in EU

law. We forecast a public debt of 60.1% of GDP at the end of 2010, while for 2011 we

predict a public debt of 63.7%. However, although the public debt is rising, the

government as yet has no problems in financing its debt: government bonds are still

massively oversubscribed and risk premiums remain at a low level. In the latest issue of

government bonds (52-week Treasury bills, worth EUR250m) in July 2010, the interest

rate was 1.7%. It is noteworthy that the interest rate has risen in the recent past; in

January, before the Greek debt crisis, interest rates for Cypriot government treasury

bills amounted to only 1.5%. However, risk premiums and therefore interest rates could

rise in the second half of 2010 and in 2011, as fears of a government default still exist

because the danger of a contagion from the Greek debt crisis is not yet over (although

the IMF and the EU have announced assistance programmes in May 2010). Rating

agency S&P put Cyprus on a negative credit watch outlook in July 2010 after the failed

corporate tax rate increase (see Policy Agenda, p7). Cyprus’ government bonds could

be downgraded by the end of November 2010 if no corrective actions to reduce the

public debt are taken.

Monetary Policy

Cyprus has ceded monetary policy-making to the ECB, which aims primarily to

safeguard price stability in the euro-zone (see Monetary Regime, p32). The ECB’s

monetary policy will focus on two key areas in 2010-11: striking a balance between the

risks to the economic recovery in the euro-zone (which has been boosted by low interest

rates) and inflationary risks; and the role of the ECB’s non-standard lending measures in

boosting liquidity in the financial system, especially in light of the Greek debt crisis.

As far as inflationary risks are concerned, the ECB continues to regard inflation

prospects as moderate, with higher global price pressures (in light of higher commodity

prices) mitigated by weaker domestic inflation (amid a fragile recovery). In July 2010,

the euro-zone’s average inflation rate reached 1.7%, still well below the bank’s target of

‘close to, but below 2%’. We expect the average to remain below 2% in 2010-11, thus

providing little reason for the ECB to raise its key interest rate substantially (from its

current record low of 1.00%). Our forecast is that the ECB will not start raising the rate

until the second half of 2011, possibly taking it to 1.50% by end-2011 when inflationary

expectations might have strengthened slightly on the back of stronger economic activity

in the euro-area.

With regard to financial stability, the ECB’s non-standard measures to ease liquidity

constraints in the economy in the wake of the global financial crisis have included: the

provision of unlimited liquidity at fixed interest rates at its one-week auctions; the

provision of emergency lending at a reduced penalty rate; and the purchase of covered

bonds. These measures have supported bank lending by pushing down overnight and

longer-term market interest rates. This, in turn, has supported the onset of a recovery in

Euroland since mid-2009. That said, the ECB’s bank lending survey for Q2 2010 shows

that banks continued to tighten credit standards to firms and households.

In December 2009 the ECB started to withdraw its credit easing measures. The Bank is

concerned about the risk of rising inflation and the development of asset price bubbles if

monetary stimulus measures are kept in place for too long. However, in response to the

Greek debt crisis that has threatened to spread to other peripheral euro-zone countries,

the ECB introduced further non-conventional measures in May 2010. First, the bank

decided to help ease liquidity risks by lifting the collateral requirement for Greek debt

so that it can still be used by financial institutions to access ECB liquidity. This decision

has been a relief for Greek and other European banks (especially those that hold a large

share of Greek government debt). Second, the ECB reintroduced unlimited offers of

three-month and six-month liquidity. Third, the bank decided to reactivate FX liquidity

swaps, particularly by buying US dollars in exchange for euros; this measure could help

European banks access dollar funding more easily through the ECB. Finally, the ECB

We expect the ECB

to increase its key

interest rate only

modestly, starting in

the second half of

2011

The ECB’s non-

conventional

measures have

supported bank

lending in the euro-

zone…

…with further wide-

reaching measures

announced in May

2010



announced that it would start buying sovereign bonds (in particular those of Greece,

Ireland, Italy, Portugal and Spain) to ease liquidity risks further. This measure is

controversial as it could compromise the ECB’s perceived political neutrality.

Interest Rates

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Jan-0

7

Apr

Jul

Oct

Jan-0

8

Apr

Jul

Oct

Jan-0

9

Apr

Jul

Oct

Jan-1

0

Apr

Jul

% p.a. ECB refinancing rate

Three-month inter-bank rate (EURIBOR, average)

Ten-year euro area government benchmark bond yield (average)

Source: ECB

Overall, the ECB’s credit-easing measures have demonstrated that the bank has at its

disposal a comprehensive toolkit to ease liquidity constraints in the euro-zone. Without

the ECB’s measures, it is likely that the current volatility in equity, credit and money

markets would be even higher. We expect the ECB to withdraw its non-conventional

measures only slowly and gradually, and it could even extend them until signs emerge

of a firm return to financial stability. This means monetary policy will remain broadly

supportive of financial sector stability in 2010-11.

External Economic Risk

External Accounts

Cyprus’ balance of payments structure is characterised by a large trade deficit. This

mostly reflects the county’s heavy dependence on imports, particularly on capital and

consumer goods and energy (see Trade Profile, p32). Large surpluses in the services

sector have only partially offset the merchandise trade deficits; as a result, net direct

investment inflows have been the main source of financing of the current account

imbalances in recent years.

During the financial crisis, the current account deficit declined from 17.1% of GDP in

2008 to 8.1% in 2009, mainly as a result of the substantial improvement of the trade

account. This development was mainly due to the strong decline in imports of goods

owing to a significant fall in the value of oil imports (reflecting lower international oil

prices) and declining domestic demand (leading to a reduction in imports of consumer

and intermediate goods). Meanwhile, exports of goods have remained stable since 2008

and are projected not to change in the forecast period; therefore they will not have any

impact on the trade account. The surplus in the services account, which has historically

played an important role in reducing the current account deficit, recorded a decline from

2008 to 2009, owing to the decrease in tourism revenues and receipts from financial

services, as well as the increase in the expenditure of residents travelling abroad. But

revenues from tourism are picking up again and the services account surplus is expected

to widen moderately from EUR5.8bn in 2009 to EUR6.0bn in 2010.

Overall, we forecast the current account deficit to decrease to 6.5% of GDP in 2010,

reflecting the incline in consumer demand and the increase in imports. The rising real

effective exchange rate (because of a higher inflation rate and a modest euro

appreciation) and the austerity measures in Cyprus’ trading partners will reduce exports

in 2010. However, this will be counteracted by higher revenues from the tourism sector,

Monetary policy will

remain broadly

supportive of

financial sector

stability in 2010-11

The current account

deficit has increased

gradually in recent

years

Modest import

growth will increase

the current account

deficit slightly



attributed to the improved infrastructure (we expect this effect to last into 2011 as well),

thereby enlarging the services account surplus. Because of higher oil prices and

increased household consumption, imports of goods will rise in 2011. The projected

decline of the current account deficit (as a percentage of GDP) in 2011 is mainly caused

by higher GDP and a higher services account surplus (counteracting the increased trade

account deficit).

Current Account

EURbn 2007 2008 2009 2010f 2011f

Goods -6.5 -8.9 -5.9 -6.0 -6.4

Exports 1.5 2.1 2.1 2.0 2.0

Imports -8.0 -11.1 -8.0 -8.1 -8.4

Services 5.0 7.1 5.8 6.3 6.8

Credit 8.8 12.0 9.9 10.3 10.8

Debit -3.8 -5.0 -4.1 -3.9 -4.0

Income -0.4 -2.4 -1.5 -1.6 -1.6

Credit 4.2 4.1 3.4 3.4 3.5

Debit -4.5 -6.4 -4.9 -5.0 -5.1

Current transfers 0.0 -0.1 -0.3 -0.2 -0.1

Credit 0.8 0.9 0.6 0.7 0.8

Debit -0.8 -1.1 -0.9 -0.9 -1.0

Current account -1.8 -4.3 -1.9 -1.5 -1.4

Current account (% of GDP) -8.4 -17.1 -8.1 -6.5 -5.8 Sources: Central Bank of Cyprus; D&B

External Debt and Default Risk

The latest data show that total external debt rose from USD43.2bn in Q1 2009 to

USD49.5bn in Q1 2010. While the external debt of the private non-banking sector

decreased modestly over that period, it grew significantly in the public sector (22.0%)

and even more in the banking sector (62.9%), increasing the Cypriot economy’s

vulnerability to spill-over effects from external shocks. More positively, the

composition of Cyprus’ external debt is still more favourable than before the financial

crisis, making the economy more resilient against a credit crunch in foreign countries.

The share of long-term external debt (defined as debt with a maturity of over two years)

has increased significantly since the financial crisis. Between Q2 2008 and Q1 2010, it

grew from 34.9% to 43.5% of total external debt, while short-term external debt (with a

maturity of less than one year) has decreased from 56.1% to 48.7%. However, the

second half of 2009 showed an increase of short-term external debt and a decrease of

long-term external debt (albeit with levels still far away from those seen in the pre-crisis

period).

Cyprus’ net foreign debts (based on the country’s international investment position)

have also improved since the outbreak of the financial crisis. At the end of Q1 2010,

Cyprus’ net international investment position amounted to EUR6740m (up from a

negative position of EUR40.6m before the crisis in Q2 2008). Although Cyprus’ public

debt rose sharply after mid-2008 because of the costs of the financial crisis, it still has

one of the smallest public debt stocks in the EU. The majority of the public debt is

domestic: liabilities are long term and practically exclusively euro-denominated, which

means that they are not subject to currency fluctuations. Overall, despite external

financing difficulties as a result of the global crisis, the risk of a public sector (or large-

scale private sector) default on Cypriot foreign debt is low. Cyprus’ government bonds

are still rated with ‘A+’ by S&P and ‘AA-’ by Fitch, while risk premiums are still at a

low level.

External liquidity

risks are very low as

most foreign debt is

euro-denominated



Exchange Rate Risk

Cyprus adopted the euro (see Exchange Rate Regime, p32) in 2008. Since late 2009

and early 2010 mounting concerns over the public finances of Greece and other

countries on the periphery of the euro-zone have led to a marked, broad-based

depreciation of the euro, particularly against the US dollar and the Japanese yen. The

key risks to exchange rate stability in 2010-11 derive from the uncertain outlook for the

economic recovery in the euro-zone as well as the risk of further contagion from the

Greek debt crisis and its impact on the euro. With regard to the recovery in Euroland,

we only expect meagre growth of 1.3% in 2010 and 1.2% in 2011. The recovery in the

US and many emerging markets in Asia, for example, will be much stronger, according

to our forecasts. Hence, interest rates in the euro-zone will remain subdued (see

Monetary Policy, p15). These factors mean that the economic outlook and monetary

policy will provide little boost for the euro.

As to the Greek debt crisis, exchange rate volatility has remained a source of concern

despite the adoption of a large rescue package by the EU, ECB and IMF (worth around

EUR750bn) in May 2010 to help alleviate debt financing risks in the euro-zone. The

euro could continue the tentative appreciation trend seen since June 2010 if concerns

about public finances in the euro-area ease further. However, the euro might also

depreciate again in the near term if fears about sovereign debt and financial sector

stability re-emerge. A large part of Euroland’s banking system remains under-

capitalised and liquidity risks remain a source of concern; many banks still rely heavily

on cheap ECB liquidity as they struggle to raise funds on the international capital

markets. On balance, we expect the exchange rate to average EUR0.77:USD in both

2010 and 2011; the euro had been much stronger in 2008 (EUR0.68:USD) and 2009

(EUR0.72:USD). The elevated risk of volatility in the short term weakens predictability

in trade and investment dealings with businesses in the euro-zone. Currency hedging

might be a useful strategy for companies to protect against rising volatility.

Exchange Rates

0.60

0.65

0.70

0.75

0.80

0.85

Jan

-07

Apr

Jul

Oct

Jan

-08

Apr

Jul

Oct

Jan

-09

Apr

Jul

Oct

Jan

-10

Apr

Jul

EUR:USD

92

94

96

98

100

102

104

106

108

110

Index: 2005=100EUR:USD FX rate (left-hand axis, inverted)

Nominal effective exchange rate (right-hand axis)

Real effective exchange rate (right-hand axis)

Source: IMF

Cyprus’ real effective exchange rate (REER), which accounts for the country’s currency

relative to a basket of currencies of major trade partners, depreciated steadily during the

first half of 2010 due to lower inflation recorded in Cyprus, as well as to the weakening

of the euro against the US dollar. We expect the euro to appreciate slightly once more

against several other currencies, namely the US dollar and the pound sterling; therefore

Cyprus’ REER will increase again in the near future, leading to a loss of

competitiveness in global markets. Additionally, a higher inflation rate in Cyprus

compared with other euro-area countries will negatively effect Cyprus’ position and

competitiveness in intra-euro-area trade.

The weaker euro

will continue to ease

pressure on euro-

zone exporters

Cyprus will suffer

due to euro

appreciation and

higher inflation

rates



Commercial Risk

Outlook Summary: Stress tests carried out by European and domestic institutions in mid-2010 show that the domestic financial sector is healthy, sound and adequately supervised. In addition to the sound banking system, company failures are low, although the payment performance of Cypriot companies is less favourable that their European peers, and we expect it to worsen further. Moreover, the absence of a political settlement and the ongoing division of the island pose inherent risks for businesses, especially for those interested in investing in real estate. Recent rulings from several European courts have increased that risk significantly.

Business Performance

Cyprus’ industrial sector started showing signs of sluggishness in 2008 as a result of the

international financial and credit crisis; since the beginning of 2009 it has experienced a

more pronounced downturn, which is continuing. In particular, after growing by 9%

year on year (y/y) in the second half of 2007, the construction sector has been

decelerating sharply. Latest data for Q1 2010 show a decline of value added to real

GDP of 9.1% y/y. The number of building permits (which is an indicator for future

investment in housing and non-residential buildings) decreased too, especially in Q4

2009, when it fell by 33% y/y. Not even a 2% decrease in the input materials price

index in 2009 could counteract the downturn in the construction sector.

Like the construction sector, industrial production is showing signs of a sharp

deceleration (despite strong growth of 3.2% in 2008). The general index of industrial

production shrank by 9.6% in 2009 but then slowed, albeit still declining by 5.0% y/y in

Q1 2010. The industrial confidence indicator also worsened in 2009, shrinking by 24%

in that year. In addition, the industrial turnover index for 2009 recorded a decrease of

10.8% y/y, including a fall by 20% in consumer durables turnover.

The outlook for the construction sector is reasonable. Residential property prices are

falling and the number of building permits picked up by almost 3% y/y in the first five

months of 2010. In particular, the outlook for the construction of office buildings

improved sharply: in Q1 2010, the number of permits in this category grew by more

than 80% y/y. Further decreases in prices for raw materials like steel and cement

(because of lower investment in emerging Asian markets) could lead to further

investment in Cyprus’ construction sector in the forecast period (although still far below

the pre-crisis levels seen in the mid-2000s). The outlook for the manufacturing sector is

ambiguous. Industrial production is still shrinking, but at a slower pace than in 2009. In

Q1 2010, it shrank by 2.3% y/y, compared with 9.6% in 2009. The industrial confidence

indicator is also improving: in the first six months of 2010 it improved by 3.8% y/y,

compared with a decline of 28% in the first half of 2009. That said, the manufacturing

sector will face some difficulties in coming quarters: austerity measures in several

economies and the appreciation of the real effective exchange rate (see Exchange Rate

Risk, p18) will lead to a lower industrial production growth. Overall, we expect it to

grow moderately in the next two years because of base effects and further investment in

infrastructure projects to boost the Cypriot tourism industry.

The construction

and industrial

sectors experienced

a pronounced

downturn in 2009…

…but there will be

an improvement

during 2010 and

2011



Credit Risk

Business Failures

One of the basic characteristics of the Cypriot economy is the large number of small and

medium-sized enterprises (SMEs) as a proportion of all enterprises: there are almost 52

SMEs per 1,000 inhabitants in the country, well above the EU average of 40, while

micro-enterprises (five employees or less) account for 92.3% of total SMEs. As a result,

insolvency legislation is divided into two parts: the insolvency legislation for companies

and the insolvency legislation for natural persons.

The Official Receiver conducts bankruptcy proceedings, while the law provides for a

second start-up in the case of bankrupt persons. Nevertheless, the number of individual

bankruptcies has been steadily rising since 2003, reaching a record high of 1,329 in

2009. In contrast, company failures remain very low: in 2009, 159 business failures

were recorded, up from 135 in 2008. By end-May 2010, 81 companies had gone

bankrupt, compared with 51 during the corresponding period in 2009. Although this is

still low in absolute terms, it constitutes a considerable increase and we believe that the

number of company bankruptcies will continue to rise at a faster pace in the remainder

of 2010, very likely reaching a higher level than in 2009 due to the effects of the

financial crisis (i.e. worse payments performance, less access to finance, and sluggish

real GDP growth).

Payments Experience

Payments performance worsened in 2009 because of lower profitability of companies

due to the effects of the financial crisis. According to the 2010 Intrum Justitia Payment

Risks Survey, the payment performance of Cypriot companies compares unfavourably

with that of their European peers. Payment delays have developed ambiguously. On the

one hand, the payment loss (receivables that were not paid) in Q1 2010 remained at 3%

and amounted to the same as the year before. Some 29% of the receivables were paid

within 30 days and 31% between 31 and 90 days, compared with 30% and 37%

respectively one year before. On the other hand, the part of receivables that were paid

after 90 days increased sharply from 33% (2009) to 40% (2010). Additionally, the

central bank’s 2009 annual report shows a year-on-year (y/y) increase of 100% for

bounced cheques, indicating bigger payments delays and even payment loss in the

future. Bankruptcy rates also increased significantly compared with the previous 12

months, worsening the payments performance of Cypriot firms (and individuals). In

addition, credit conditions became more stringent in Q1 2010. As a consequence,

traders with Cyprus should be wary of increased payment loss and a further

deterioration in payments performance.

Trade Terms: D&B recommends SD terms on business dealings with Cyprus, while

usual terms currently run at 30-180 days. In accordance with the 2000 EU directive on

combating late payments implemented into national law on July 2003, the payment of

penalty interest starts automatically in the event of payment delay. The penalty interest

rate charged is the ECB’s main refinancing rate plus at least 7 percentage points.

Export Payment Indicators

Trade terms Transfer situation

Minimum terms SD Local delays 0-2 months

Recommended terms SD FX/bank delays 0-1 months

Usual terms 30-180 days Import cover 1.2 months Source: D&B

Transfer Situation: Transfer risk is minimal owing to Cyprus’ membership of the euro-

zone. For vendors requiring payment in euros, no transfer risk exists. Import cover in

the euro-zone is low at an estimated 1.2 months, but is largely immaterial within the

currency union. In general, export credit agencies offer full cover on trade with Cyprus.

Company

bankruptcy levels

will rise during

2010

Indicators show a

further

deterioration of

payments

performance



Export Credit Agencies

US Eximbank Full cover available

Atradius Full cover available

ECGD Full cover available

Euler Hermes UK Full ST cover available Sources: Export credit agencies

Financial Sector Risk

Prompted by EU accession and, more broadly, by developments in financial markets

worldwide, the financial sector has been undergoing substantial transformation in recent

years. The banking sector plays the most significant role in the financial sector,

representing approximately 80% of total financial sector assets; its assets represented

875% of GDP in 2009. The sector is very concentrated: three large banking groups

active in all three sectors (banking, insurance, and securities) dominate the system,

controlling around 63% of total assets. The soundness of the banking sector has

improved since 2003: the banks’ asset quality has continued to progress, with the ratio

of non-performing loans (NPLs) to total loans to non-financial corporate sector steadily

decreasing over recent years. The most recent data (for September 2009) show a ratio

for NPLs of 6.9% (compared with 7.2% in March 2009 and levels around 13% in 2006).

Although the loan loss provisions as a percentage of NPLs shrank from 60.9% in

September 2008 to 53.6% in September 2009, levels of provision are still sufficient.

However, during 2009 global economic conditions deteriorated as a consequence of the

financial crisis that erupted in the US in 2007. The adverse effects of the crisis on the

Cypriot economy had a significant negative impact on the profitability of the banks

supervised by the Central Bank of Cyprus (CBC), reducing the return on equity of the

consolidated banking sector from 15.2% in 2008 to 13.4% in 2009. The unfavourable

economic conditions led to a significant increase in the provisions for doubtful debts,

while the low level of interest rates in the euro-area and the US, the sharp increase in

the cost of deposits and the sharp deceleration in the growth of credit restricted higher

profits in the banking sector.

However, the banking sector remains sound, helped by its focus on traditional and

conservative banking activities. The banks’ predominant reliance on more stable retail

funding, negligible exposure to complex securities, high levels of liquidity, and strong

supervision helped to shield it from the global crisis, and recent and ongoing stress tests

carried out by the national central bank indicate that the system has the capacity to

absorb further shocks if any occur. In the latest stress test conducted by the EU, in co-

operation with the national supervisors, in July 2010, both Cypriot banks that were

involved in the test (Marfin Popular and Bank of Cyprus) fulfilled the criteria. Deposits

have continued to grow thanks to confidence in the banking system and its strength

relative to the rest of the region. Banks and supervisors responded appropriately to the

recent slowdown in economic activity and higher spill-over risks from Greece and other

Mediterranean countries. Furthermore, banks are taking steps to strengthen capital and

liquidity. Data from December 2009 show that capital buffers rose from 3.0% in 2008

to 4.4% in 2009, while banks’ Tier 1 capital ratio (defined as common stock plus

disclosed reserves) increased from 8.3% to 9.6% over the same period.

Additionally, supervisors have stepped up their vigilance and taken steps to strengthen

the regulatory framework since 2008. There has been significant progress in

implementing EU directives and recommendations from the IMF’s 2008 Financial

Sector Assessment Programme. The forthcoming introduction of a legal framework for

covered bonds will improve banks’ access to liquidity from the markets and the ECB

and will reduce financial sector risk further.

The banking system

has improved in

recent years

Bank profitability

and capital

adequacy remain at

satisfactory levels



Given the large size of the banking sector relative to the economy and the

comparatively high concentration ratios, if problems emerge in the financial sector they

could quickly escalate to systemic proportions, with serious spill-over potential for the

rest of the economy and for the public finances, creating higher risks for the Cypriot

economy as a whole. Therefore, Cyprus (and the EU) plans several reforms to

strengthen financial supervision in addition to the already implemented measures (see

Financial Sector Oversight, p40). For example, co-operation with Greece and other

Southeastern European supervisory authorities will be increased because of Cyprus’

extensive financial linkages.

Other Commercial Risks

Property issues are closely linked to the political situation. As a result, the absence of a

political settlement poses an inherent risk for foreign investors interested in buying or

leasing property in the Greek-Cypriot South, in the Turkish-Cypriot North and across

the buffer zone (see Policy Agenda, p7). Investors are well-advised to consider the

practical, financial and legal implications of investing in real estate, taking into account

the possible consequences for property of a future settlement, and the many thousands

of claims to ownership from people displaced in 1974. In addition, there is a risk that

purchasers would face legal proceedings in the courts, as buying, selling, renting,

promoting or mortgaging a property without the permission of the owner is a criminal

offence (see Judicial Environment, p38). A UK court of appeal ruling in February

2010 stated that British buyers had to demolish their house, which stands on the

property of a Greek-Cypriot in north Cyprus, return the land and pay compensation and

legal costs. Although the demolition and the handover could not be executed (because

the Turkish-Cypriot government refused to take any action), it established a new

precedent, whereby any Greek-Cypriot who owned land in the northern part of Cyprus

can now seek financial redress through international European courts; the EU will

enforce those rulings. The once-booming property market plunged after the ruling,

having already been hit by the wider economic crisis.

There are plans to

improve the

financial

supervision system

Investment in real

estate is risky

because of unclear

property rights



Data Summary

2002 2003 2004 2005 2006 2007 2008 2009 2010f 2011f

Gross domestic product

Nominal GDP (EURm) 10,980 11,761 12,654 13,462 14,435 15,879 17,248 16,946 17,247 18,059

Nominal GDP (USDm) 10,358 13,215 15,622 16,828 18,044 21,752 25,364 23,537 22,399 23,454

GDP per capita (USD) 12,835 16,175 18,890 20,129 21,354 25,471 29,425 27,023 25,453 26,382

Population (year-end, m) 0.8 0.8 0.8 0.8 0.8 0.9 0.9 0.9 0.9 0.9

Components of demand (real % change)

Private consumption 1.3 2.1 6.5 4.2 4.7 9.4 8.4 -3.0 -1.6 2.0

Government consumption 6.9 6.0 -5.5 3.4 7.4 0.3 6.2 5.8 -1.2 -3.4

Gross fixed capital formation 8.6 2.4 11.6 4.1 10.2 13.4 8.6 -12.0 -9.9 -3.6

Exports -4.9 -0.5 5.5 4.9 3.5 6.1 -2.1 -11.8 0.5 1.6

Imports -0.2 -0.3 10.3 3.7 6.7 13.3 8.0 -19.8 -1.7 2.8

GDP 2.1 1.9 4.2 3.9 4.1 5.1 3.6 -1.7 -1.0 1.7

Components of demand (% of GDP)

Private consumption 64.6 64.1 64.5 64.6 64.4 66.4 69.5 68.7 68.4 68.5

Government consumption 18.2 19.7 17.8 18.0 18.6 17.4 17.9 19.9 19.8 18.8

Gross fixed capital formation 18.1 17.6 19.0 19.3 20.6 22.0 23.3 20.4 18.7 17.7

Change in inventories 0.7 -0.2 1.2 0.6 0.2 0.4 0.8 -3.2 -2.0 0.3

Exports 50.8 47.0 47.8 48.3 48.0 47.9 44.8 39.4 39.9 39.9

Imports 52.3 48.2 50.2 50.9 51.8 54.2 56.2 45.2 44.8 45.3

Contributions to real GDP growth (percentage point)

Private consumption 0.8 1.3 4.1 2.7 3.0 6.1 5.7 -2.1 -1.1 1.4

Government consumption 1.3 1.2 -1.1 0.6 1.3 0.1 1.1 1.0 -0.2 -0.7

Gross fixed capital formation 1.5 0.4 2.1 0.8 2.0 2.7 1.9 -2.8 -2.0 -0.7

Change in inventories 1.0 -0.9 1.5 -0.6 -0.5 0.3 0.4 -4.0 1.3 2.4

Net exports -2.5 -0.1 -2.4 0.5 -1.7 -4.0 -5.5 6.2 1.0 -0.7

Labour market

Working age population (m) 0.4 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5

Activity rate (% of working age population) 72.9 74.4 74.6 74.4 74.8 75.9 75.9 76.2 76.2 76.2

Employment rate (% of working age population) 73.4 74.3 74.4 74.2 74.5 74.3 75.4 74.3 75.7 75.7

Unemployment rate (% of labour force) 3.6 4.1 4.7 5.3 4.6 4.0 3.6 5.3 6.8 7.0

Fiscal and monetary indicators

General government balance (% of GDP) -4.4 -6.5 -4.1 -2.4 -1.2 3.4 0.9 -6.1 -5.8 -5.2

General government debt (year-end, % of GDP) 64.6 68.9 70.2 69.1 64.6 58.3 48.4 56.2 60.1 63.7

Consumer prices (year-average, % change) 2.8 4.0 1.9 2.0 2.3 2.2 4.4 0.2 2.8 3.0

Official interest rate (year-end, % p.a.) 2.75 2.00 2.00 2.25 3.50 4.00 2.50 1.00 1.00 1.50

Three-month inter-bank rate (year-average, % p.a.) 3.32 2.33 2.11 2.18 3.08 4.28 4.63 1.23 0.80 1.55

Ten-year government bond yield (year-average, % p.a.) 5.70 4.74 5.80 5.16 4.13 4.48 4.60 4.60 4.80 4.95

Exchange rate (year-average, EUR:USD) 1.06 0.89 0.81 0.80 0.80 0.73 0.68 0.72 0.77 0.77

Current account

Merchandise trade account (USDm) -2,883 -3,183 -4,049 -4,247 -4,942 -6,474 -8,933 -5,908 -6,029 -6,371

Services account (USDm) 2,789 3,135 3,591 3,796 4,221 5,039 7,052 5,814 6,331 6,766

Income account (USDm) -401 -390 -537 -612 -765 -383 -2,359 -1,543 -1,566 -1,613

Net current transfers (USDm) 117 144 168 92 206 -14 -108 -278 -201 -143

Current account (USDm) -378 -294 -827 -971 -1,280 -1,832 -4,348 -1,915 -1,465 -1,361

Current account (% of GDP) -3.6 -2.2 -5.3 -5.8 -7.1 -8.4 -17.1 -8.1 -6.5 -5.8

External liquidity

FX reserves (year-end, USDm) 247 224 212 185 197 215 219 284 295 305

Import cover (months) 2.5 1.9 1.5 1.2 1.1 1.0 0.9 1.4 1.2 1.0 Sources: Central Bank of Cyprus; Eurostat; IMF; Statistical Service of Cyprus; D&B



Political Environment

Political Overview

The Establishment and Breakdown of the Bi-communal State

Cyprus gained its independence from British colonial rule in 1960, after a five-year

struggle by the Greek-Cypriot EOKA (National Organisation of Cypriot Fighters), a

guerrilla group that desired political union (enosis) with Greece. The Zurich-London

Agreements, signed by the UK, Greece, Turkey and the Cypriot communities’ leaders,

provided the legal framework (along with the Cypriot constitution) for the function of a

bi-communal state. Shortly after the founding of the republic, serious differences arose

between the two communities about the implementation and interpretation of the

constitution: the Greek-Cypriots argued that the complex mechanisms introduced to

protect Turkish-Cypriot interests acted as obstacles to efficient government.

For this reason, in November 1963 Archbishop Makarios, the country’s first president,

advanced a series of constitutional amendments designed to eliminate some of the

special provisions for the Turkish-Cypriots that he considered impediments to the

functioning of the government. The Turkish-Cypriots reacted strongly to these changes

and the confrontation prompted widespread inter-communal fighting in December 1963,

after which Turkish-Cypriots ceased to participate in the government. As a result of the

violence, many Turkish-Cypriots and Greek-Cypriots living in mixed villages began to

move into enclaves, and a UN peacekeeping force was deployed on the island in 1964.

Following another outbreak of inter-communal violence in 1967-68, a Turkish-Cypriot

provisional administration was formed, while inter-communal talks for a solution to the

constitutional crisis during the ten-year period from 1964 to 1974 were all unsuccessful.

The 1974 Crisis and the Division of the Island

In July 1974, the military junta in Greece sponsored a coup, led by EOKA, against the

government of President Makarios, citing his alleged pro-communist leanings and his

perceived abandonment of enosis. Following Makarios’ overthrow, Turkey, asserting its

right to protect the Turkish-Cypriot minority under the Zurich-London Agreements,

intervened militarily in the island, occupying 37% of its territory in the northeast. The

operations led to the widespread displacement of Cyprus’ ethnic communities, dividing

the island between a Turkish-Cypriot North and a Greek-Cypriot South. In the

aftermath, the Turkish-Cypriots’ leadership declared a separate political entity in the

form of the Turkish Federative State of Cyprus and by 1983 had made a unilateral

declaration of independence as the Turkish Republic of Northern Cyprus (TRNC),

which was recognised only by Turkey. The ceasefire lines achieved after the 1974

events formed the basis for a buffer zone separating the two communities, manned by

the UN Peacekeeping Force in Cyprus (UNFICYP), which has been in place since 1964.

In Search of a New Political Formula

In the immediate aftermath of the 1974 crisis, UN-led inter-communal talks were held,

initially limited to humanitarian issues, such as the exchange of population between the

two sides of the island. However, attempts to make progress on the substantive issues,

such as territory and the nature of the central government, failed to produce results.

Negotiations for a settlement through the creation of a new federal republic continued in

the late 1980s and in the 1990s, but none were successful.

The EU’s decision to open up accession negotiations with Cyprus in 1997 created a new

catalyst for a settlement. In January 2002, direct talks between the leaders of the two

communities started under UN auspices, with the goal of reaching a settlement before

Cyprus’ entry into the EU. UN Secretary-General Kofi Annan released a comprehensive

settlement proposal, the ‘Annan Plan’. Under its final revision, the ‘United Republic of

Cyprus’ would be created, a loose confederation of two component states, the Greek-

The constitutional

crisis that broke out

in 1963 led to the

breakdown of the

newly established

state

The island was

effectively divided

following Turkey’s

military intervention

All negotiations for

a settlement of the

political problem

since the 1980s have

failed



Cypriot state and the Turkish-Cypriot state, joined together by a minimal federal

government apparatus. In April 2004, dual referendums were held, with the Greek-

Cypriot side overwhelmingly rejecting the plan and the Turkish-Cypriot side voting in

favour. On 1 May 2004, a week after the referendum, Cyprus joined the EU.

For more than two years following the Annan Plan referendums, the island saw little

progress towards reunification. However, a change in leadership in both communities

generated a new momentum for the resumption of negotiations. In September 2008,

fully-fledged reunification talks began between the Greek-Cypriot president, Demetris

Christofias, and his then Turkish-Cypriot counterpart, Mehmet Ali Talat. However,

since Dervish Eroglu (the former leader of the nationalist party in Northern Cyprus)

took over the presidency in April 2010, the chances for a reunification have diminished

because of Eroglu’s position on the property issue (see Domestic Politics, p6).

Political System

Constitutional Arrangements

The constitutional structure of Cyprus comprises the constitution itself, together with

two Annexes (the Treaty of Guarantee and the Treaty of Alliance), as laid out by the

Zurich-London Agreements (see The Establishment and Breakdown of the Bi-

communal State, p24). The 1960 constitution, amended in 1964, remains in force

despite the island’s 1974 division and provides for a presidential system of government

with a strict segregation of powers between the executive, legislative and judicial

branches. It is very rigid, detailed and complicated, as it was designed to protect the

interests of both Greek- and Turkish-Cypriots through a system of checks and balances,

procedural and substantive safeguards, guarantees and prohibitions. The House of

Representative (parliament) has the right to amend the constitution, except its basic

articles, i.e. those provisions that determine the form of government as a presidential

republic, as well as all those provisions ensuring the bi-communal character of the state

and the principle of separation of powers; the remaining articles can be amended by a

law passed by a majority vote comprising at least two-thirds of the total number of MPs.

The Legislature

Legislative power is exercised by the House of Representatives, the unicameral

legislature of Cyprus. Following a constitutional amendment in 1985, the House has 80

seats, of which 56 are assigned to Greek-Cypriots and 24 to Turkish-Cypriots; the seats

that correspond to Turkish-Cypriots remain vacant because of the political situation (see

Political Overview, p24). The religious groups of Maronites, Armenians and Latins are

also represented: each group elects one member who attends meetings, though without a

right of participation in the deliberations. The deputies are elected for a five-year term

by universal, direct suffrage via a simple proportional representation system. Under the

electoral law Cyprus is divided into six constituencies; the distribution of parliamentary

seats for each constituency is determined by law. The electoral system is designed to

give smaller parties the potential to be represented in the House of Representatives: a

party must gain 1.8% of the vote to qualify for entry into parliament.

The legislature is a strong check on the executive’s authority. The House of

Representatives’ legislative power is exercised by voting on the bills put before it by the

government and proposals for laws put forward by members, as well as the approval of

regulative administrative acts tabled by the executive. The government must secure a

simple majority vote to pass legislation, except in the case of modification of the

electoral law, the adoption of any law relating to the municipalities or of any law

imposing duties or taxes (which need a two-thirds majority). However, parliament’s

fragmented composition often undermines its efficiency. Apart from its legislative

function, the House exercises parliamentary control through the approval of the state

budgets and of the main legal persons of public law, as well as the submission of written

questions to ministers. The body’s (self-appointed) examination of various matters

submitted by members or parliamentary committees, which examine these matters, is

also considered as the exercise of indirect parliamentary control.

The progress of the

reunification talks

started in 2008 has

been slow and the

outlook is negative

The constitution is

extremely rigid and

complex

The legislature

exercises

parliamentary

control through the

approval of state

budgets



The Executive

The president is both head of state and head of government, is elected by universal

suffrage for a five-year term of office, and may serve unlimited terms. The president

exercises executive power through a council of ministers that he/she appoints. The

ministers may be chosen from outside the House of Representatives; MPs who are

appointed as ministers must resign their seats in accordance with the principle of the

separation of powers. The president has the right of final veto on any law passed by the

House that concerns foreign affairs, defence and security. However, as far as all other

types of legislation are concerned, the president has only a delaying power: if the House

persists in its decision to pursue its legislation against executive branch delays, the

president is bound to promulgate the law or decision in question. The strong position of

the legislature, which cannot be dissolved by the president, constrain the ability of the

executive to implement policies, thereby encouraging a consensual approach to

decision-making, especially on controversial issues.

Executive power at local government level is exercised by municipal and community

councils and groupings of communities. There are 24 municipalities and 352

community councils and groupings of communities. The municipal councils provide

services and have administrative powers in the cities and in two or three large rural

areas in which municipalities have been established, and the community councils

manage local government affairs in the villages. The councils are independent bodies,

and their members are elected by universal suffrage every five years, while their

finances derive from municipal taxes, fees and duties as well as state subsidies.

The Judiciary

Cyprus has a fair and independent judiciary, which scrutinises legislation effectively.

The legal system is based on English law, but has been heavily modified since

independence. Cyprus has a two-tier court system: First Instance Courts and the

Supreme Court. The principal first instance courts are the District Courts operating in

every district of Cyprus, with the exception of the occupied areas, and hearing both

criminal and civil cases. The other first instance courts are the Assize Courts; the

Military Court; the Industrial Disputes Court; the Rent Control Courts; and the Family

Courts. The Supreme Court is the final court of appeal and is also vested with

jurisdiction to determine the constitutionality of laws, rules and regulations, and has

sole competence and exclusive jurisdiction to review the legality of acts, decisions or

omissions emanating from the exercise of executive or administrative authority.

Political Forces

Cyprus has a multi-party system, with three or four strong parties that generally

dominate the political landscape. Political parties are stable and inclusive in character,

revolving around ideological platforms rather than personalities and representing a

broad spectrum of ideologies. Ideological polarisation runs deep, and most people have

a strong sense of belonging to the right or the left. Voting patterns are relatively stable.

Political Parties

Coalition Government Parties

Progressive Party of Working People (AKEL): AKEL was founded in 1941 as a

successor to the Communist Party. Despite being banned, it re-appeared as Cyprus

achieved independence in 1960. It has since occupied a prominent place in the political

landscape and is currently the largest party in parliament. It supports an independent,

demilitarised and non-aligned Cyprus, and a federal solution of the internal aspect of the

Cyprus problem. AKEL has traditionally adopted the most accommodative approach

towards the Cypriot issue and through the trade unions has maintained contact with the

Turkish north. While still a declared communist party, its economic policy is more akin

to Western social-democratic norms. AKEL has supported Cypriot EU membership

since the mid-1990s, but is considered moderately eurosceptic.

The ability of the

executive to

implement policies

is constrained by a

strong legislature

Political parties

represent a wide

spectrum amid deep

ideological

polarisation

AKEL, the leading

party in parliament,

is still a declared

communist party



Democratic Party (DIKO): Established in 1976 by Spyros Kyprianou and people that

were strongly involved in the enosis struggle (i.e. union with Greece), DIKO positions

itself as a centrist party. However, it is often regarded as an extreme-right party owing

to the way in which it has, since mid-1980s, rejected all proposals for solutions to the

Cyprus issue. It was also the only party to uniformly reject the Annan Plan put forward

in a referendum in 2004 (see Political Overview, p24). Nevertheless, the party supports

a settlement of the Cyprus problem based on UN resolutions and has accepted the idea

of federation. It favours Cypriot EU membership and has remained the third-largest

party in parliament since 1990. Following the defeat of its candidate, former President

Tassos Papadopoulos, in the first round of the February 2008 presidential election,

DIKO announced its support for AKEL candidate Demetris Christofias in the second

round. In parliament, DIKO is the junior coalition partner of AKEL, but there are

tensions in the coalition concerning economic policy and the reunification process (see

Domestic Politics, p6).

Opposition Parties

Movement of Social Democrats (EDEK): Established in 1969, EDEK is a centre-left

social democratic party. It supports an independent and united Cyprus within a federal

system with a strong central government and a settlement based on UN resolutions and

the implementation of human rights for all its citizens. The party is strongly in favour of

EU membership, which is considered a security mechanism against Turkish

advancement on Cypriot territory. EDEK backed Demetris Christofias of AKEL in the

second round of the February 2008 presidential election, but left the coalition

government (formed with AKEL and DIKO) in February 2010 because of disagreement

on the reunification talks.

Democratic Rally (DISY): Founded by veteran politician Glafkos Klerides in 1976,

DISY is a centre-right political party, led by Nicos Anastasiades. Its political platform

focuses on less state involvement in the economy (combined with a greater social role

of the state), as well as a solution to the Cyprus problem on the basis of a bi-zonal, bi-

communal federation. It is pro-Western, pro-NATO and pro-EU. DISY was represented

in parliament for the first time in 1980 and became the largest party five years later. In

the 1991 and 1996 parliamentary elections, DISY joined forces with the Liberals, who

finally merged with the party in 1998. The leaders of DISY supported the Annan Plan

for the re-unification of Cyprus. Following its rejection by the Greek-Cypriot

community, four MPs who had opposed the party line were expelled and formed a new

party, while a number of members voluntarily resigned.

European Party (EURO.KO): This is a centrist party founded in 2005, largely out of the

New Horizons party, and is led by Demetris Syllouris. It believes that the solution to the

Cyprus problem should be compatible with the European acquis communautaire (the

entire body of EU laws) and based on UN resolutions as well as human rights. In this

respect, it supports the idea that the results of the 2004 referendum on the Annan Plan

should be fully respected. It is also in favour of closer EU involvement in finding a

solution to the problem, to ensure, inter alia, that the European principle of abolishing

artificial divisions is respected and that Greek-Cypriots and Turkish-Cypriots live

together in a united island without any ethnic or other segregation.

Ecological-Environmental Movement (KEP): Also known as the Cyprus Green Party,

this is a green political party founded in March 1996 and led by George Perdikis. It is

opposed to any geographical division of the island and the people of Cyprus based on

ethnic origin or religion, while it is not in favour of any arms build-up.

Interest Groups

Greek-Cypriot Refugees: The 170,000 Greek-Cypriot refugees in the south of the island

remain a potent political force. They have formed associations, non-governmental

organisations and unions calling, among other things, for the removal of Turkish troops

and the repatriation of colonists. The absolute right of all refugees to return is an

emotive issue that virtually no Greek-Cypriot politician has yet had the courage to

DIKO was the only

party to uniformly

reject the Annan

Plan

Greek-Cypriot

refugees are a

potent political force



question. The Greek-Cypriot refugees were at the forefront of the ‘no’ campaign leading

up to the April 2004 referendum (see Political Overview, p24), while they have brought

several cases to the European Court on Human Rights, where their right to return to

their homes and properties in the Turkish-Cypriot North has been legally recognised

Greek-Cypriot Orthodox Church: The powerful Greek-Cypriot Orthodox Church has

been very influential and has played an active role in the political sphere since the

establishment of the Republic of Cyprus: in fact, the first elected president of the new

state was Archbishop Makarios III, who stayed in power for 17 years. The Church has

been actively involved in all major developments concerning the efforts to reach a

settlement of the division of the island: in 2004, it was very influential in harnessing

opposition to the Annan Plan (see Political Overview, p24), while, since the launch of

the new reunification talks in September 2008, Archbishop Chrysostomos II has held

regular meetings with all Greek-Cypriot political leaders, as well as foreign officials

involved in the process, in order to be informed and to express the views of the Church.

Security

Cyprus is generally a safe country with low crime rates, with the main risk stemming

from pick-pocketing and other street theft. However, the volume of serious offences has

been rising in recent years, the majority of which are financial offences. Cyprus’

success as an international offshore centre makes it vulnerable to international money-

laundering activities. Even though the authorities have made some effort to tighten up

the rules, the reporting system for suspicious transactions is weak.

Another source of concern for Cyprus, closely linked to money-laundering activities, is

organised crime, both foreign and domestic: Russian organised crime, in particular, is

using Cyprus extensively to launder money. The Russian ‘mafia’ owns nightclubs and

dominates criminal operations, such as prostitution and illegal gambling. Bombings

linked to vendettas occur in Limassol and Nicosia, and may affect third parties. In

addition, its geographic location (see Natural Environment, p36) makes Cyprus a

convenient transit point for illicit drugs and destination of human trafficking, especially

women trafficked into the sex industry. The authorities are trying to address the

problem, but have not yet made significant progress.

Despite the continued division of the island and occasional tensions between extremist

groups, the threat of inter-communal violence is limited. A UN peacekeeping force

(UNFICYP) continues to patrol the ‘Green Line’, a cease fire line, which marks the start

of the 180-kilometre demilitarised zone that divides the island’s two communities. In

June 2010, the UN Security Council voted to extend the UN peacekeeping mandate on

Cyprus for another six months (until 15 December 2010), welcoming the progress in the

ongoing talks between the leaders of the two communities that began in September

2008 aimed at reunifying the island. However, since the election of Dervish Eroglu as

President in the Turkish-Cypriot part of the island in April 2010 the talks have

developed less favourably. Meanwhile, UN officials have mentioned the possibility of a

withdrawal of the peacekeeping mission, due to the stable situation on the island and the

UN’s need to use the budget on more important operations.

International Environment

Relations with Russia

Relations between Russia and Cyprus are traditionally friendly. This is largely due to

the coincidence or proximity of their positions on important international issues, as well

as in the consistent and valuable support of Russia in the efforts to find a just, viable

and comprehensive solution to Cyprus’ division on the basis of the relevant resolutions

of the UN Security Council. As the EU is a strategic partner of Russia, another

dimension was added to Cyprus-Russia relations with Cyprus’ membership: within the

EU, Cyprus has opposed proposals for energy ‘unbundling’ and blocked proposals for

increasing European involvement in the post-Soviet space, and has often taken the lead

in defending Russia’s position on issues such as energy or the ‘Eastern neighbourhood’.

The Church is very

influential and is

involved in efforts to

resolve the island’s

political problems

Money-laundering

and organised crime

are sources of

concern

Cyprus can count

on Russia’s support

in the reunification

talks



Relations with the US

The US extends diplomatic recognition only to the Republic of Cyprus and its Greek-

Cypriot government, with which it works closely in the ‘war against terrorism’.

However, the US also maintains close and regular contacts with the Turkish-Cypriot

administration. The Greek-Cypriot administration is always displeased when US

representatives meet Turkish-Cypriot officials (this last happened in April 2009). Since

2004 the US has channelled an USD30.5m assistance programme to the Turkish-

Cypriot North aimed at assisting economic development in the Turkish-Cypriot

community. It also provides approximately USD15m annually to reduce tensions and

promote peace and co-operation between the two sides.

Relations with Turkey

Turkey flatly refuses to recognise the government of the Republic of Cyprus, stating

that the Republic (as established by the Constitution of 1960) ceased to exist when the

inter-communal violence that started in December 1963 ended Turkish-Cypriot

participation in the Cypriot government (see Political Overview, p24). In 1983, Turkey

recognised the independence of the northern part of the island, and since then more than

100,000 settlers from the Turkish mainland have emigrated to the TRNC. In addition to

the Turkish settlers, there are around 40,000 Turkish soldiers based on the island.

Cyprus’ entry into the EU has caused further tensions between the two countries, as it

had a negative impact on Turkey’s accession negotiations. Turkey’s refusal to fully

implement an EU customs union agreement (allowing Greek-Cypriot ships and planes

to use Turkish ports and airports) has resulted in a partial suspension of its accession

negotiations.

International Affiliations

Historically, Cyprus has followed a non-aligned foreign policy. Directly after its

independence it joined the Non-Aligned Movement (NAM), becoming a high-profile

member. However, Cyprus withdrew from the NAM after joining the EU, retaining

observer status (since membership of the EU does not permit it to maintain, in parallel,

its membership of the NAM).

Since 1974, the chief aim of the foreign policy of the Republic of Cyprus has been to

secure the withdrawal of Turkish forces and the reunification of the island under the

most favourable constitutional and territorial settlement possible. This campaign has

been pursued primarily through international forums, such as the UN and the EU (and

through the NAM previously).

Cyprus is a member of the UN and its specialised agencies, the Commonwealth of

Nations, World Bank, IMF and Council of Europe. In addition, the country has signed

the General Agreement on Tariffs and Trade (GATT) and the Multilateral Investment

Guarantee Agency Agreement (MIGA).

The US encourages

the reunification

talks

Relations between

Cyprus and Turkey

are historically

troubled

The chief foreign

policy aims are the

withdrawal of

Turkish forces and

reunification



Economic Environment

Economic Overview

Following the post-independence period (see Political Overview, p24), the Cypriot

economy gradually shifted from agriculture to services and light manufacturing. The

successful transformation of Cyprus into an advanced economy is attributed, inter alia,

to the adoption of a market-oriented economic system, the pursuance of sound

macroeconomic policies, and the existence of a dynamic and flexible entrepreneurship

alongside a highly educated labour force. Moreover, the economy has benefited from

close co-operation between the public sector and the social partners, and has undergone

significant economic and structural reforms in the lead-up to and following its accession

to the EU.

These achievements are all the more striking bearing in mind the severe economic and

social dislocation created by the Turkish military intervention of 1974 and the

continuing division of the island (see Political Overview). The military intervention and

the resulting division inflicted a serious blow to the Cypriot economy and in particular

to agriculture, tourism, mining and quarrying: 70% of the island’s wealth-producing

resources were lost; the tourism industry lost 65% of its hotels and tourist

accommodation; the industrial sector lost 46% of its capacity, and mining and quarrying

56%. The loss of the port of Famagusta, which handled 83% of general cargo, and the

closure of Nicosia International Airport, in the buffer zone, were additional blows.

However, over the past years Cyprus has witnessed high levels of growth that have led

to rising living standards, as shown by the high level of convergence with the EU. From

1997 until 2009, GDP per capita (in purchasing power terms) grew from 86% of the

EU27 average to 98%.

At present, the tertiary (services) sector makes up the largest (and fastest growing) area

of the economy. Cyprus is markedly dependent on the tourism sector, making it

particularly vulnerable to swings in tourist arrivals caused by political instability on the

island, currency variability (with many tourists coming from Russia and the UK) and

fluctuations in economic and political conditions in Western Europe and the Middle

East. However, it has also developed an important financial and business services

sector, which is gaining in importance as the relative contribution of the tourism sector

declines. In particular, Cyprus’ entry into the EU appears to have accelerated the growth

of the non-tourism sector. Reforms imposed by EU membership, such as the

liberalisation of telecommunications and energy, have already lowered costs and

boosted Cyprus’ appeal as an international business centre. Nevertheless, tourism, as

well as medical and ‘wellness’ activities, development projects in the field of natural

resources (gas, oil) and R&D are among the most promising sectors for future

development and investment.

Economic Framework

Industrial Relations and the Labour Market

Although severely hit by the effects of the global financial crisis, the labour market in

Cyprus is relatively flexible and well-functioning, and is characterised by a high

employment level, outperforming the EU average on all fronts; in particular, in 2009 the

employment rate was the highest among the member states that joined the EU in 2004

and 2007, and well above the EU average. In addition, Cyprus has a relatively high

employment rate for women and a low youth unemployment rate. Employment

expanded until the beginning of the financial crisis in mid-2008, sustained, to a

considerable extent, by continued inward immigration and the employment of Turkish-

Cypriots following the partial lifting of restrictions on movement between the two

communities in 2004.

The country’s

advanced economy

is based primarily

on services

High dependence on

the tourism sector

makes the economy

vulnerable to

external shocks

The labour market

is relatively flexible

and well-

functioning



A decisive contributing factor to the increase in employment during the pre-crisis period

(and particularly since 2003) was the government’s decision to allow the temporary

employment of foreign workers in certain sectors of the economy, given the labour

market shortages created by fast economic growth.

The Cypriot labour market has a tradition of social dialogue and a well-developed

institution of free collective bargaining. The labour market is characteristically highly

unionised: approximately 70% of the labour force is unionised (in some sectors, such as

the public sector and banking, unionisation rates reach virtually 100%) and is covered

by collective bargaining. Collective agreements regulate employment conditions, such

as remuneration, working hours, health and safety, annual holidays and a provident

fund, and usually have a duration of two to three years.

The Industrial Relations Service of the Ministry of Labour and Social Insurance acts as

the national mediator for the settlement of labour disputes in the private and semi-

government sectors of the economy, adhering to the provisions of the Industrial

Relations Code, which is a voluntary agreement signed by the social partners in 1976,

providing for procedural provisions for dealing with disputes over rights and disputes

over interests. The Service mediates in around 250-300 labour disputes every year, with

more than 95% of these disputes settled without any side resorting to industrial action:

in fact, the incidence of industrial action has fallen steadily since 2006.

Wage determination in Cyprus is the result of bargaining between the most

representative employer and trade union organisations at the sectoral and industry

levels, without, however, any operational co-ordination between the two levels. Labour

productivity is the basic factor used for calculating the level of claimed wages. Another

factor affecting the level of wage increases is the implementation of the COLA system

(cost of living allowance, see Inflation, p13), which provides for the automatic

adjustment of wages on the basis of general changes in price levels. Specifically, under

the current system the gross earnings of workers are revised at the end of every six

months (i.e. on 1 January and 1 July) on the basis of the CPI percentage increase of the

preceding six-month period.

The existence of this automatic wage indexation mechanism is a divisive issue in

Cyprus: until recently, it has been considered a non-negotiable issue during collective

bargaining, enjoying the strong support not only of trade unions but also of successive

governments, despite opposition from the employer organisations. Recently, the

Governor of the Central Bank repeated his call for changes to COLA, but some parties,

such as the governing coalition, consisting of the Progressive Party of Working People

(AKEL) and the Democratic Party (DIKO), have strongly objected to COLA being

totally abolished or even lowered. One of the basic arguments against the COLA system

is that it undermines the flexibility and competitiveness of the labour market, while its

uniform application does not allow wages to reflect productivity differences across

economic sectors. Moreover, at times of strong inflationary pressures it can impede the

stabilising role of fiscal policy, an even more significant danger within the context of

the European Monetary Union.

Fiscal Framework

Following the Turkish military intervention in 1974, Cyprus’ policy of balanced

budgets was replaced by expansionary fiscal and monetary policies aimed at stimulating

economic activity, which led to unsustainable fiscal deficits and high public debt. EU

membership and the country’s entry into the European Exchange Rate Mechanism

(ERM II) in 2005 brought fundamental reforms to the fiscal policy framework. Under

the requirements of the Stability and Growth Pact (SGP) and the Maastricht

convergence criteria, a tight fiscal policy was adopted that enabled the gradual reduction

of the fiscal deficit (which turned into a surplus in 2007) and the return of public debt to

a sustainable path. However, that path was abandoned during the financial crisis when

revenues decreased sharply and expenditures, especially for the unemployed, rose

sharply. This led to a fiscal deficit of 6.1% of GDP in 2009, more than twice as much as

the SGP allows.

Most labour

disputes are

resolved without

resort to industrial

action

Wages are

determined on the

basis of labour

productivity and an

automatic

indexation

mechanism

The EU Stability

and Growth Pact

sets the framework

for fiscal policy



The prime reference framework for fiscal policy in Cyprus is still the EU’s SGP.

Cyprus, which is currently under an EU ‘excessive deficit procedure’, has to reduce its

fiscal deficit to 3% of GDP or lower by the end of 2012, with the first steps in this

direction needing to be complete by end-2010. In this context, medium-term fiscal plans

are submitted to the European Commission every year. As fiscal consolidation is the

main priority of the government’s economic policy, adherence to the SGP has been

relatively strict.

Monetary Regime

Following its accession to the euro-area in 2008, Cyprus ceded monetary policy-making

to the ECB, which aims primarily at safeguarding price stability in the euro-zone,

defined as inflation of ‘close to, but below 2%’. However, the ECB does not operate a

formal inflation-targeting regime, but bases its interest rate decisions on a ‘two-pillar’

strategy. The first pillar consists of an analysis of monetary variables, such as money

and credit growth. The second pillar involves the ECB’s monitoring of developments in

the real economy and financial markets, such as wages, productivity, fiscal policy, asset

prices and exchange rates, with a view to identifying short-term inflationary pressures

created by the interplay of supply and demand. The ECB’s monetary regime has helped

to subdue inflation expectations, and the ECB has also demonstrated its willingness to

adopt non-standard measures, such as the purchase of covered or state bonds, in order to

improve credit conditions in the euro-area (see Monetary Policy, p15).

Exchange Rate Regime

Since adopting the euro, Cyprus has had no monetary or exchange rate policy of its

own. The euro floats freely against the other major currencies. Some smaller countries

have pegged their currencies to the euro, or their central banks keep currency

movements against the euro within small bands. The FX reserves of euro-area member

states such as Cyprus are also now managed by the ECB. The euro-area’s large FX

reserves make it unlikely in theory that a euro-zone member will get into serious

external financing problems. However, EU law stipulates that ECB FX reserves cannot

be used to help a euro member state pay off its national foreign currency debt. A

country in major debt-financing difficulties, would, as in the case of Greece, be

expected to receive financial support from other member states, but would not be

guaranteed to avoid default, particularly if this were to threaten the existence of the

single currency project or would lead to ‘moral hazard’ problems.

Trade Profile

International trade has always played a crucial role in the development of the economy.

Exports are vital in supplementing aggregate demand for Cypriot agricultural, mineral

and manufacturing products, due to the small size of the domestic market.

Manufactured products constitute the bulk of Cyprus’ total merchandise exports with a

60.0% share in 2009, up from 58.3% in 2008. Cyprus’ merchandise exports still include

a large proportion of agricultural products, a sector in which Cyprus faces increasing

competition from North African and Asian countries. Moreover, the structure of

Cyprus’ export profile makes the country vulnerable to global price shocks, as more

than half of Cyprus’ exports are re-exports, such as petroleum-related products, which

are subject to price fluctuations.

The ECB’s

monetary regime

has helped to

subdue inflation

expectations

Manufactured

products constitute

the bulk of Cyprus’

exports



Export Mix, 2009

Processed

agricultural

products

17%

Raw agricultural

products

17%

Manufactured

products

60%

Other

6%

Source: Statistical Service of Cyprus

The EU is by far the most important market area for Cyprus. Exports to the EU27

countries amounted to 56% of total exports in 2009, up from 53% in 2008. In 2009,

exports to Greece, Cyprus’ most important individual country export market, increased

to 24% of total exports (from 20% in 2008), although exports to Greece decreased in

absolute terms, from USD336m down to USD297m. Euro-zone countries received 41%

of Cypriot exports in 2009, compared with 38% in 2008. The second-most important

group, the Middle Eastern countries, absorbed around 12% of Cyprus’ exports during

2009, picking up from 10% in 2008; major markets in this group are Lebanon and the

United Arab Emirates. Exports to Asian countries increased sharply during 2009, while,

in contrast, Russia’s share declined marginally. Despite this level of export

diversification, Cyprus’ further integration into the euro-zone economy might lead to a

further expansion of trade with the EU/euro-zone.

Export Markets, 2009

UK

9%

Greece

24%Other

32%

Middle East

12%Other-EU

14%

Germany

9%

Source: IMF, Direction of Trade Statistics

Cyprus lacks sufficient raw materials, energy resources and heavy industry for the

production of capital goods, which necessitates the importation of such input. In order

to satisfy its growing domestic market and industrial needs, Cyprus also imports large

quantities of durable consumer goods and capital equipment. The country imports food

and most raw materials mainly from the EU, and oil from neighbouring Middle East

countries; as a result, Cyprus is vulnerable to global commodity price fluctuations.

Most Cypriot

exports are directed

to the EU



Cyprus is particularly vulnerable to oil price volatility, as it is not energy-self-sufficient

and has to import most of its oil. However, this could change in the near future: oil has

recently been discovered in the seabed between Cyprus and Egypt, while the seabed

separating Lebanon and Cyprus is believed to hold significant quantities of crude oil

and natural gas. Talks are underway between Cyprus, Lebanon and Egypt to reach an

agreement regarding the exploration of these resources.

Import Mix, 2009

Manufactured

products

16%

Transport

equipment

25%

Construction &

mining

12%

Food & beverages

11%

Other

8% Fuels & lubricants

28%

Source: Statistical Service of Cyprus

The EU is the main source of imports for Cyprus. In 2009 almost 72% of its total

imports came from the EU27 countries, up from almost 69% in 2008. In particular,

imports from Greece increased from 2008 to 2009, from 17% to 20%. Within the EU,

Greece, Italy, the UK and Germany remain the most important suppliers of imported

goods.

Import Sources, 2009

UK

9%

Italy

11%

Other-EU

23%

Germany

9%Israel

7%

China

6%

Greece

20%Other

15%

Source: IMF, Direction of Trade Statistics

Outside the EU, Asian countries are the second-most important group of suppliers (with

their share marginally increasing in 2009), followed by Middle Eastern countries, while

China and Israel are the two major import sources from these groups: in 2009 imports

from China increased moderately (by 4%) while imports from Israel skyrocketed by

460%. Israel supplies Cyprus with mineral fuels and oils, household plastics, machinery

and mechanical appliances, iron/steel/stone/plaster/cement products and glass, while

Cyprus’ imports from China comprise mostly manufactured goods and machinery.

Cyprus is vulnerable

to oil price volatility

as it imports most of

its oil



Long-Term Economic Potential

Over recent years Cyprus has enjoyed strong economic growth and exhibited rising

living standards, as shown by the high level of convergence with the EU: GDP per

capita stood at 94.0% of the EU27 average in 2009, rising from 92.6% in 2008. Cyprus’

long-term growth potential has been boosted significantly by the structural reforms

initiated to ensure that the country achieved EU membership in 2004 and entry into the

euro-zone in 2008. D&B expects Cyprus’ potential annual average real GDP growth

rate over the next ten years to be around 2.0-3.0%.

In the lead-up to EU accession, Cyprus dismantled most investment restrictions,

attracting increased flows of FDI, particularly from the EU. According to the latest UN

Conference on Trade and Development (UNCTAD) World Investment Report 2009,

Cyprus ranks among the world’s leading countries per capita in terms of attracting FDI.

In 2009, the inflow of FDI reached USD5.78bn, compared with USD4.02bn in 2008.

The majority of the FDI inflows were directed towards the construction and real estate

sector. The long-term trend is positive and Cyprus has the potential to attract even

higher FDI levels.

Labour market conditions in Cyprus have generally been favourable, while the

workforce is skilled and well-educated: in 2009, 36.5% of 25-64 year olds had a tertiary

qualification, 2 percentage points more than a year before. However, near-full

employment and institutional rigidities have limited improvements in competitiveness.

Nonetheless, the quality of Cyprus’ labour force will continue to benefit from EU

membership and the free movement of labour from fellow EU countries, which

enhances the island’s opportunities to attract highly-qualified workers for its expanding

service economy. This could strengthen productivity in the long term and stabilise

economic growth in the future.

The country’s population profile will change significantly over then next 50 years: the

share of people over 65 years of age is expected to double by 2050, and the absolute

number of people over the age of 80 is set to quadruple between 2004 and 2050, more

than tripling their share in the total population. At the same time, the share of the

working population (aged 15-64) will fall to 61% from 68% over the same period. The

rapidly ageing population and lower labour participation rates of those within the

working-age bracket has long-term implications for the social security system and

public finances, but the government took measures in 2009 to address the implications

of the country’s adverse demographic outlook by reforming the pension system, mainly

focussing on slightly higher contributions and stricter eligibility conditions.

Three decades of division have left Cyprus with an economic development gap. A

successful settlement of the country’s political problems would have positive effects on

the island’s economy: an increase of GDP by 20-40%, as well as a direct increase of

financial activities and economic growth. In particular, according to an independent

report from the local branch of the International Peace Research Institute of Oslo, the

impact of a political settlement on tourism, transport, higher education and financial and

business services would raise real GDP growth by 3 percentage points in the first five

years, creating more than 33,000 jobs, especially in the tourism and the real estate

sectors. In addition, there would be some indirect positive repercussions such as the

opening of the vast market of Turkey to Cyprus, the elimination of defence expenses

and an increased level of confidence in the Cypriot economy.

We forecast 2.0-

3.0% annual growth

in the next ten years

The government has

taken measures to

address the costs of

a rapidly ageing

population

A successful

settlement of the

island’s division

would be positive

for the economy



Commercial Environment

Overview

Cyprus offers a favourable commercial environment. A number of factors contribute to

make it a suitable base for business activities and at the same time a gateway for

expansion in other regions and countries: its EU membership; its geographical location

at the crossroads of three continents; a modern infrastructure; a sound legal system; low

tax rates; improving corruption rates; a liberal investment regime; low set-up and

operating costs; and simplified administrative procedures for acquiring necessary

permits. The absence of a political settlement and the ongoing division of the island

pose only a very low risk for businesses. In the World Economic Forum’s latest Global

Competitiveness Index, Cyprus is ranked in 34th position (out of 132 states surveyed).

Over the past two years, Cyprus has improved its ranking significantly; in the 2008/09

edition Cyprus was ranked 44th, up from 50th in the 2007/08 edition.

Relative Competitiveness, 2009/10

0.00=least competitive 7.00=most competitive

5.59

4.57

4.55

4.40

4.31

4.30

4.16

4.04

0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00

US

Cyprus

Slovenia

Portugal

Italy

Malta

Turkey

Greece

Source: World Economic Forum, Global Competitiveness Index

Physical Environment

Natural Environment

Cyprus is situated in the eastern Mediterranean Sea, at the crossroads of three continents

linking Europe with the Middle East, Africa and Asia. It has an area of 9,251 square

kilometres (km) and is the third largest island in the Mediterranean, after Sicily and

Sardinia. The physical setting for life on the island is dominated by the two mountain

masses and the central plain they encompass. Its pleasant Mediterranean climate,

coupled with a relatively extensive coastline of 648km, make Cyprus an attractive

tourist destination.

Cyprus is relatively well-endowed with mineral resources: it is among the five richest

areas in the world with respect to copper-pyrites and also has rich chromite deposits. As

a result, there is extensive quarrying of rocks and industrial minerals. There are around

220 quarries producing various materials for local use (havara, sand and gravel,

aggregates from diabase and limestone, building stone, limestone, clay, gypsum) and for

export (building stone, gypsum, bentonite, umber and ochre). There is also local

production and export of quick and hydrated lime, portland and other types of cement

and gypsum plasters. Asbestos was also once exploited, but its deposits are now closed

for environmental and health reasons.

The commercial

environment is

generally

favourable

Cyprus has

abundant mineral

resources



Oil has recently been discovered in the seabed between Cyprus and Egypt, while the

seabed separating Lebanon and Cyprus is believed to hold significant quantities of

crude oil and natural gas: talks are underway between Cyprus, Lebanon and Egypt to

reach an agreement regarding the exploration of these resources. In January 2009, rich

natural gas reserves were also located between the exclusive economic zones of Cyprus

and Israel, which are said to be in the region of 3.3trn cubic metres, enough to satisfy

the country’s energy needs for the next 20 years.

Cyprus faces little risk of natural disasters: occasionally, it experiences earth tremors,

but these are invariably very mild. In addition, the country suffers chronic water

shortages, as it is heavily reliant on rainfall for water supplies, and regularly imports

water. In 2008, the island suffered one of the worst droughts of the past 100 years,

which sapped water reserves to critically low levels and triggered emergency rationing

to households. In order to address the problem, the government cut the supply of water

to water boards by 30% in 2009, while it has expedited plans for new desalination units.

However, all water cuts were suspended in March 2010 following the country’s wettest

winter in six years.

Infrastructure

Cyprus is well served by sea, air and telecommunications connections. Its role as a

regional commercial and business centre, coupled with increasing tourist traffic, has led

to the development of a wide network of air routes offering excellent connections with

the rest of Europe, Africa and Asia. The island has two international airports, situated

near Larnaca and Paphos, and another 16 national ones. Cyprus’ seaborne cargo and

passenger traffic is served by a fully renewed port system comprising the multi-purpose

ports of Limassol and Larnaca, the industrial port of Vassiliko and the three specialised

oil terminals of Larnaca, Dhekelia and Moni. The Cyprus registry ranks tenth among

international fleets. A significant number of ship management companies have been

established in Cyprus and manage a sizable proportion of the Cyprus merchant fleet, as

well as a large number of vessels under foreign flags. The total fleet managed from

Cyprus represents 20% of the world third-party ship management market, making it one

of the top five countries in this field.

Cyprus has developed one of the most modern road networks in Europe, which is

continuously improved and upgraded. However, it has no working railway system,

following the dismantling of the last railway in 1952.

The telecommunications infrastructure is one of the most modern in the region,

enhanced by an extensive submarine fibre optic cable network and access to major

satellite systems. Coverage of fixed-line telecommunications is almost universal, while

mobile phone penetration was at 126% in 2009, which means that people have more

than one mobile phone on average. The rates of internet usage and broadband

penetration have grown, but are still well below the EU average.

Although almost all households and businesses are connected to a water supply, Cyprus

suffers from water shortages. There are some desalination plants operating; however,

the authorities occasionally introduce controlled supply cuts. Practically all households

are connected to the sewage system and electrification is near universal.

Legal and Regulatory Environment

In recent years a series of legal and regulatory reforms have been implemented, owing

to the country’s EU membership. As a result, existing procedures and regulations

affecting businesses (including foreign investment regulations) are generally transparent

and enforced effectively by an independent judiciary. While foreigners enjoy equal

treatment as nationals, in some cases foreign businesses have expressed concerns about

the appearance of bias and lack of transparency in decisions made by the technical

committees responsible for preparing specifications and reviewing government tenders.

Rich offshore

deposits of oil and

natural gas have

been discovered

Cyprus’

infrastructure is

adequate for

business needs

Water shortages and

supply cuts are a

problem



Judicial Environment

Cyprus has a well-functioning legal system, which is a mixture of legislative statutes

and case law and is based on English Common Law. The Cypriot company law and

other laws regulating business originate in the UK Companies Act of 1948, recently

updated and harmonised with EU directives. Companies can seek redress through the

legal system and can expect to obtain a fair hearing. They will also be able to enforce

orders made by Cypriot courts and those obtained in foreign courts. Cyprus is a

signatory to the 1979 New York Convention on the Recognition and Enforcement of

Foreign Arbitral Awards. However, legal proceedings are usually a last resort and a

system of arbitration is effective in settling disputes. The system is regulated by the

Arbitration Law, under which either an independent ‘umpire’ is appointed or both sides

in a dispute appoint arbitrators.

Rule of Law, 2009

-2.50=lowest quality +2.50=highest quality

1.65

1.03

1.02

0.75

0.43

0.09

-0.05

-2.50 -2.00 -1.50 -1.00 -0.50 0.00 0.50 1.00 1.50 2.00 2.50

US

Cyprus

Portugal

Greece

Italy

Turkey

Romania

Note: The World Bank’s Worldwide Governance Indicators are derived from annual surveys of businesses, citizens and experts in nearly 200 countries on six governance indicators: voice and accountability; political stability; government effectiveness; regulatory quality; rule of law; and control of corruption. Source: World Bank, Worldwide Governance Indicators

While property rights are enforced effectively, the legal requirements and procedures

for acquiring and disposing of property are complex. More importantly, the absence of a

political settlement poses an inherent risk for the foreign investor interested in buying or

leasing property in the Greek-Cypriot South, in the Turkish-Cypriot North and across

the buffer zone, as property issues are closely linked to the political situation (see Other

Commercial Risks, p22).

Several high-profile cases have already been brought before the European Court on

Human Rights and other international bodies, while other cases are still pending. In

addition, in October 2006 a criminal code amendment relating to property came into

effect. Under the amendment, buying, selling, renting, promoting or mortgaging a

property without the permission of the owner (the person whose ownership is registered

with the Republic of Cyprus Land Registry, including Greek-Cypriots displaced from

Northern Cyprus in 1974) is a criminal offence. This also applies to agreeing to sell, buy

or rent a property without the owner’s permission. Moreover, on May 2010, the

European Court of Justice (ECJ), in a landmark case concerning the right of a Greek-

Cypriot refugee to reclaim land in Northern Cyprus, ruled that although the Republic of

Cyprus, the internationally recognised state, does not exercise effective control in

Northern Cyprus, judicial decisions made in its courts that uphold the property rights of

Greek-Cypriots are applicable through EU law. The case sets a precedent for Greek-

Cypriot refugees to bring similar actions to court (see Other Commercial Risks, p22).

Procedures and

regulations

affecting businesses

are generally

transparent and

effectively enforced

The political

situation creates

risks for investors

interested in buying

or leasing property



Cyprus has a modern and comprehensive set of laws protecting intellectual property

rights, which continues to be upgraded. As part of its accession to the EU in 2004,

legislation relating to various types of intellectual property was harmonised to meet the

demands of EU law and Cyprus officially became a member of the Office of

Harmonisation for the Internal Market. It is also a member of the World Intellectual

Property Organisation (WIPO) and of numerous related conventions. The Department

of Registrar of Companies and Official Receiver is the organisation responsible for the

protection of brands and patents in Cyprus. Enforcement of intellectual property

regulation is typically quite diligent, although it can be improved further. According to

industry sources, although software piracy, largely fuelled by small personal computer

assembly and sale operations, has declined, it is still significantly above the European

average. Internet piracy is also a growing concern.

Competition Law

The principal legislation on competition in Cyprus is the Law for the Protection of

Competition, enacted in April 2008, which replaced the previous Competition Law of

1989. The new law entrusts the Competition Commission (CC), initially established in

1990, with the obligation for the fulfilment of the objective of maintenance of effective

competition within the Cypriot market and specifically appoints the CC as the authority

responsible for the application of the relevant EU regulations. With the enactment of the

new legislation the competencies and powers of the CC have been enhanced and

extended: among other things, the CC has the exclusive competence to investigate and

take decisions on infringement cases and concerted practice, as well as to impose

administrative fines and other sanctions.

Corporate Governance

Starting a business in Cyprus is relatively easy. Regulations have been streamlined,

administrative procedures have been simplified, and business regulations are transparent

and consistently applied. The registration procedure is basically the same for all

categories of business, with straightforward and speedy mechanisms. As of October

2004, foreign investors can register a company directly with the Registrar of

Companies, and obtain any licence, if needed, from the appropriate authority according

to the nature of investment.

The registration of companies and other legal entities, as well as their mode of

operation, is governed by the Companies Act 1968-1995, Chapter 113, as amended by

the House of Representatives as part of the harmonisation with the corresponding EU

directives on company law. Within this legal framework, interested investors may set up

the following legal entities:

Private Company Limited by Shares: Has at least one founding member, and is limited

to 50 shareholders. The responsibility of the associate member is limited to the amount

contributed to the total capital. The offer of shares for public subscription is not allowed

and the transfer of shares is restricted. No minimum capital is required.

Public Company Limited by Shares: Minimum capital requirements apply; there is no

maximum. On formation, there must be at least seven founders (shareholders). No

maximum number is specified. The main feature is the power to extend an invitation to

the public to subscribe to its shares. Subject to fulfilling the requirements of the relevant

legislation a public company may be listed on the Stock Exchange.

General Partnership: Minimum two and maximum 20 associate members. Each

member is personally and indefinitely responsible for the debts and obligations of the

company. No minimum capital is required.

Limited Partnership: Minimum two and maximum 20 associate members. At least one

of the members is personally and indefinitely responsible for the debts and obligations

of the company, the other members’ responsibility being limited in nature. No minimum

capital is required.

Laws protecting

intellectual property

rights have been

harmonised with

EU legislation and

continue to be

upgraded

Starting a business

is relatively easy



In addition to these legal forms, section 347 of the Companies Act Chapter 113 provides

for the registration in Cyprus of foreign companies under the form of a branch. Other

corporate entities that a foreign investor can establish in Cyprus include the European

Public Limited Liability Company (SE): this kind of company can be registered either

by merger between two public companies, which are registered at least in two different

EU countries, or by formation as a new company, under certain circumstances or by

transformation of an existing public company into a European Company.

Financial Sector Oversight

There are effectively four authorities responsible for the regulation and supervision of

the financial system as a whole: the Central Bank of Cyprus (CBC), which is

responsible for the supervision of domestic banks and international banking units; the

Authority for the Supervision and Development of Co-operative Societies (ASDCS),

supervising the co-operative credit institutions; the Insurance Company Control Service

(ICCS); and the Cyprus Securities and Exchange Commission (CySEC). In 2003, the

four supervisory authorities concluded a Memorandum of Understanding to promote

cross-sectoral co-operation and to enhance the exchange of information among them.

Since then, the central bank has made substantial progress in its supervisory practices to

strengthen Cyprus’ supervisory framework for commercial banks. Its supervisory role

has been guided by the recommendations of the Basle Committee on Banking

Supervision and the relevant EU banking directives and has been effective. During 2008

the central bank fully transposed the EU’s capital requirements directive into

legislation, while it issued a number of circulars and directives aimed at improving

supervisory rules and aligning them with international practice and standards. These

included guidelines on the management of credit, market and operational risks. In

addition, a comprehensive bottom-up stress-testing exercise is carried out by the bank’s

Financial Stability Section randomly; the latest stress test (with support from European

authorities) took place in July 2010.

Moreover, the ASDCS has made impressive progress both organisationally and to its

practices to strengthen Cyprus’ supervisory framework for co-operative credit

institutions. The legislative and regulatory framework has been harmonised with EU

directives, while regulatory decisions addressing a number of prudential areas such as

corporate governance, internal controls, supervisory reporting, application of minimum

reserves and anti-money laundering have been issued. In addition, a comprehensive

legislative framework, largely based on EU law, is in place for the supervision of the

securities sector in Cyprus. The regulatory responsibilities of CySEC are set down

clearly in legislation and CySEC appears to be carrying out its function in a consistent

and effective manner.

Despite the considerable progress made so far, further improvements are needed. The

ICCS has introduced significant supervisory and regulatory reforms in the insurance

area: the regulatory approach is in principle reflective of and appropriate for the low

complexity and sophistication of the insurance market in Cyprus. Although supervision

has been updated and international co-operation with other supervisors has been

fostered, the IMF still calls for closer co-operation with foreign supervisors, given the

potential spill-over effects from neighbouring countries. Consideration should also be

given to enlarging the deposit insurance facility. In its latest report on Cyprus from

September 2010, the IMF also highlighted the urgency of strengthening the supervision

and transparency of co-operative credit societies which are not yet properly regulated.

Corruption

Cyprus co-operates closely with the EU and other international authorities on fighting

corruption and providing mutual assistance in criminal investigations. It has signed and

ratified the European Convention on Mutual Assistance in Criminal Matters, while it

uses the foreign Tribunal Evidence Law, Chapter 12, to execute requests from other

countries for obtaining evidence in Cyprus in criminal matters.

Supervision and

regulation of the

financial system is

exercised by four

authorities

The supervisory

framework has

improved…

…but further

enhancements are

needed



Cyprus is also an active participant in the Council of Europe’s Multidisciplinary Group

on Corruption. As such, it has already signed and ratified the Criminal Law Convention

on Corruption and has joined the Group of States Against Corruption (GRECO).

As a result, corruption is not a significant impediment to conducting business in Cyprus.

Indeed, Cyprus is ranked joint-31st out of 180 countries in Transparency International’s

2009 Corruption Perceptions Index, scoring 6.6 (where 10.0 is the lowest level of

perceived corruption and 0.0 is the highest). This marks a small improvement in

corruption perceptions in Cyprus from the previous year, when the score was 6.4. The

score compares favourably with regional neighbours (Greece ranked 71st, with a score

of 3.8, and Turkey was in 61st position, scoring 4.4), as well as with many EU27

countries.

In Cyprus, corruption in its various forms (active and passive, public and private)

constitutes a criminal offence, punishable by up to seven years of imprisonment and a

pecuniary penalty. Although cases usually move at a slow pace, the government

generally implements the law effectively. To this end, a Co-Coordinating Body Against

Corruption, chaired by the Attorney General, has been created to advise on anti-

corruption policy and is composed of representatives from the public and the private

sectors. The Office of the Ombudsman, which is responsible for overseeing the actions

of the administration, has also operated since 1999.

Corruption Perceptions, 2009

0.0=most corrupt 10.0=least corrupt

7.5

6.6

6.6

5.8

5.2

4.4

4.3

3.8

0 1 2 3 4 5 6 7 8 9 10

US

Cyprus

Slovenia

Portugal

Malta

Turkey

Italy

Greece

Source: Transparency International, Corruption Perceptions Index

In addition, a 2004 anti-corruption law instituted compulsory asset declarations by state

officials, although evidence has shown that many do not comply with the law. In its

annual reports, the office of the auditor-general, who under the constitution controls all

disbursements and receipts and has the right to inspect all accounts on behalf of

Cyprus’s government, has reported serious financial mismanagement in government

departments. In 2007, the government investigated alleged deals between officials and

developers, who made suspicious gains from zoning changes, while an official of the

road transport department was arrested and charged with soliciting a bribe. Furthermore,

in December 2008 the escape of a convict serving a life sentence from a Nicosia private

hospital (where he had been staying for seven months) prompted a series of

investigations into possible corruption of police and other government officials.

Taxation

Following a tax reform that came into effect in January 2003, legislation in the field of

taxation fully complies with EU law and with the Code of Conduct for Business

Taxation. Under the new tax regime the definition of ‘resident in Cyprus’ was

introduced: a company is ‘tax-resident’ in Cyprus when its management and control is

exercised in the country; taxable income includes both incomes earned in Cyprus and

abroad. A non-Cyprus tax resident is taxed only on income earned in Cyprus.

Corruption is not a

significant

impediment to doing

business

Tax legislation is in

line with EU

standards



All companies tax-resident in Cyprus are subject to a uniform tax rate of 10% (the

lowest corporate tax rate in the EU) except for semi-government organisations, which

are taxed at 25%. Dividends received from companies located in Cyprus or abroad are

exempt from corporation tax. Dividends received by a Cyprus-resident company from

another Cyprus-resident company also are exempt from the special defence contribution

under the Special Contribution for Defence Law, which taxes special types of income.

Dividends received from non-resident companies are exempt from the special defence

contribution provided that: a minimum 1% holding in the company paying the dividend

is maintained and either the paying company engages directly or indirectly in more than

50% of activities that give rise to non-investment income or the non-Cypriot tax burden

on the dividend paying company’s income is not lower than 5%.

Special tax treatments apply to shipping companies, international trusts and to Cyprus

holding companies. In addition, Cyprus has a wide and beneficial Double-Tax Treaty

Network. There are currently 44 double-taxation treaties with other jurisdictions, while

Cyprus is one of the few countries in the world that has concluded tax treaties with all

Eastern European countries. In particular, in 2009 Cyprus signed a double-taxation

avoidance agreement with the Czech Republic, which provides several incentives to

Czech businesspeople to invest in Cyprus, while it initialled an agreement with Russia

to avoid double-taxation between the two countries, thus removing Cyprus from the

Russian tax blacklist. Under the agreement, the profit made on the shares of Russian

subsidiaries of Cyprus holding companies that will have more than 50% of their assets

in property in Russia will be taxed in Russia (thus addressing Russia’s concerns over

the possibility of Russian nationals laundering ill-gotten gains through the island by

taking advantage of the local lack of income tax controls for non-residents). The

agreement will also reinforce Cyprus’ advantages as an investment portal between the

EU and Russia by eliminating double-taxation on assets and business activities for both

individuals and companies.

Headline Corporate Tax Rates, 2009

%

40.00

35.00

31.40

25.00

25.00

21.00

20.00

10.00

0 5 10 15 20 25 30 35 40 45

US

Malta

Italy

Portugal

Greece

Slovenia

Turkey

Cyprus

Source: KPMG, Corporate and Indirect Tax Rate Survey

VAT is imposed on domestic goods and services, as well as on imports to Cyprus. Since

January 2003 VAT has been set to 15%; the lowest rate permitted in the EU. Cyprus

also applies a reduced VAT rate of 5% on the hospitality sector, newspapers and

magazines. A zero-rate VAT is imposed on specific supplies of goods and services,

such as exports, foodstuffs, medicines, commissions received for arranging exports of

goods, international air and sea transport, and others. In April 2010 (with effect from 1

January 2011), the parliament decided to rise VAT on some previously zero-rated goods

(e.g. pharmaceuticals and food) to finance the increased government deficit (see Policy

Agenda, p7).

Special tax

treatments apply to

some companies,

while a wide

network of double

taxation treaties is

in place



Cyprus has a progressive personal income tax system with effectively four tiers,

including a tax-free threshold up to EUR19,500. Annual income between EUR19,501

and EUR28,000 is taxed at 20%; income from EUR28,001 to EUR36,300 is taxed at

25%; and 30% is levied on income exceeding EUR36,300. Resident individuals (i.e.

individuals who stay in the Cyprus for 183 days in the year of assessment) are subject to

income tax on their worldwide income, while non-residents are taxed only on their

Cyprus-sourced income.

Trade Environment

Current Account Exchange Regulations

Cyprus has accepted the obligations of Article VIII, Sections 2, 3 and 4 of the IMF’s

Articles of Association to refrain from imposing restrictions on payments and transfers

for current international transactions and from engaging in discriminatory currency

arrangements or multiple currency practices without IMF approval.

Trade Regulations

As a member of the EU, Cyprus applies the EU’s integrated tariff (TARIC) regime on

imports from non-EU countries. The TARIC database, updated daily by the EU’s

Directorate General for Taxation and Customs Union, contains information on the tariff

rates and quantitative restrictions in place for any good and from any source country.

Tariffs

The EU’s Common Customs Tariff (CCT) rates, which differ by product and origin,

depend on the economic sensitivity of products and are a means of protecting the EU’s

producers. Raw materials, as well as semi-manufactured goods not produced within the

EU and needed for manufacturing, usually benefit from duty-free entry or low tariff

rates. Duty suspensions may be made for imports needed to produce EU exports.

Over half of all products from non-EU countries can enter the EU tariff-free. For

example, under the WTO Information Technology Accord, the EU has eliminated tariffs

on a range of IT products in six categories: computers; telecommunications equipment;

semiconductors; semiconductor manufacturing equipment; software; and scientific

instruments.

While the (weighted) average EU tariff level for non-agricultural goods is relatively low

at 1.64%, some goods attract a higher rate of up to 25.0%. The majority of agricultural

imports are subject to variable (and sometimes high) levies under the Common

Agricultural Policy (CAP). These bound duties are designed to equalise the prices of

imported commodities with those of EU produce. Hence, the (weighted) average EU

tariff level for agricultural goods stands at a comparatively high 10.06%.

Regarding the origin of goods imported to the EU, it is important to note that the EU

has entered various regional trade pacts:

• The European Economic Area (EEA) integrates Iceland, Liechtenstein and Norway

(with Switzerland as an observer member) into the single market for most goods.

• In the context of the Euro-Mediterranean Partnership (EMP), EU Association

Agreements are in force with Algeria, Egypt, Israel, Jordan, Lebanon, Morocco, the

Palestinian Authority, Tunisia and Turkey. Negotiations with Syria on an

Association Agreement have also been concluded and the agreement might enter

into force by end-2010. Libya has the status of observer in the EMP. The

Association Agreements encompass gradual, reciprocal dismantling of trade barriers

between the EU and the other contractual party, with manufactured goods usually an

initial priority. The EU intends to create a fully fledged Euro-Mediterranean regional

free-trade area in the course of 2010.

Tariff rates on

manufactured goods

tend to be low

EU agriculture

remains heavily

protected by high

tariff barriers



• In addition to its Association Agreement (which dates from as early as 1963),

Turkey has also been in a customs union (a two-way free-trade agreement, FTA,

with common external tariffs) with the EU since 1995, although this excludes

crucial areas such as agriculture, services and public procurement.

• The EU operates a separate Customs Union Agreement with Andorra covering

manufactured goods (but not agricultural products).

• Free-trade areas (with varying degrees of product coverage and transition periods,

but all without common external tariffs) are in operation with Chile, Mexico and

South Africa. In October 2009 the EU concluded an FTA with South Korea (which

could take effect by end-2010) in a deal worth around EUR19bn for EU exporters.

• Under the Everything But Arms initiative, the EU has eliminated quotas and duties

on all products except arms for the world’s 50 least-developed countries since 2001.

• A total of 79 former European colonies in the African, Caribbean and Pacific

regions (the so-called ACP countries) have long enjoyed preferential access to the

EU market on the basis of a series of ACP-EU Partnership Agreements, the latest of

which was signed in Cotonou in 2000. However, as these agreements only stipulated

EU tariff exemptions for ACP products (and not vice versa), they have become

incompatible with WTO provisions on reciprocity and are therefore being replaced

with new, reciprocal Economic Partnership Agreements (EPAs). As of early 2010, a

full EPA had been signed with the Caribbean countries (CARIFORUM). A number

of interim agreements have been concluded with other ACP countries.

• An FTA has been signed with six Central American countries (Costa Rica, El

Salvador, Guatemala, Honduras, Nicaragua and Panama) but are awaiting

ratification in the parliaments of each of these respective countries.

• FTAs have been signed with Colombia and Peru but are awaiting ratification in the

Peruvian and Colombian parliaments (expected in 2011).

Moreover, negotiations for inter-regional FTAs are ongoing with:

• the South American trade bloc Mercosur (comprising Argentina, Brazil, Paraguay,

Uruguay and Venezuela; although Venezuela has not yet implemented most of the

practical trade arrangements, such as Mercosur’s common external tariff);

• the Gulf Co-operation Council (GCC, consisting of Bahrain, Kuwait, Oman, Qatar,

Saudi Arabia and the United Arab Emirates);

• the Association of South East Asian Nations (ASEAN, encompassing Brunei

Darussalam, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines,

Singapore, Thailand and Vietnam);

The EU has also launched bilateral negotiations with major trade partners such as India

(with an FTA to be concluded by end-2010) and Canada (with which negotiations

started in 2009).

Quotas and Licences

In accordance with its EU membership, Cyprus is subject to the EU import regime.

Import licences are issued with due consideration for the provisions of relevant EU

trade agreements and the fulfilment of quotas, established in accordance with such

agreements. There are some restrictions, especially on agricultural products, following

the implementation of the CAP, while special import licences are required for a small

number of goods, including iron and steel products from some low-cost countries.

The licensing system is administered by the Department of Trade of the Ministry of

Commerce, Industry and Tourism. Importers apply for import licences at the respective

government department that controls the commodity. Licences are granted if all

conditions have been fulfilled, and are valid for one year.

The EU import

regime applies to

Cyprus



Anti-dumping and Countervailing Duties

The EU adheres to WTO conventions covering anti-dumping duties, subsidies and

countervailing duties; these set the preconditions for the imposition of such duties and

their duration. The EU defines the ‘community interest’ (which must be threatened by

imports before any anti-dumping duties can be levied) in a way that includes the

interests of EU importers, retailers and consumers, rather than just those of domestic

producers of import-competing goods.

Nonetheless, the EU’s anti-dumping investigations are still liable to abuse by import-

competing industries, as allegations that certain overseas competitors are ‘dumping’

their products onto the EU market (i.e. selling them at below-cost price) are notoriously

difficult to verify or refute; much depends on the price accepted as the benchmark by

the investigation. As in the case of other major trading blocs, anti-dumping duties can

therefore be the easiest way to gain protection from outside competition for an EU

industry, despite the European Commission’s procedural safeguards. One of the widely

publicised examples of anti-dumping duties imposed by the EU is that on Chinese and

Vietnamese leather shoes, in place since 2006.

Non-Tariff Barriers

Importers to Cyprus benefit from a liberal trading regime, in line with EU stipulations;

non-tariff barriers are the exception, rather than the rule. However, it is advisable to

examine Cypriot and EU phytosanitary, animal health and consumer protection rules.

For example, the Conformite Europeenne (CE) marking has become a de facto

requirement for importing a wide range of goods into the EU. This is because the EU-

based importer incurs legal liability for any damages caused by a product not labelled

with the CE marking, and few are prepared to take that risk. The symbol indicates that a

product meets the essential health, safety and environmental requirements of any EU

product safety directives applicable to the specific product. It can be self-awarded by

the manufacturer. The CE mark is not a quality mark and only signifies to EU

surveillance authorities that the product is in compliance with EU legislation.

CE marking directives apply to the following product categories: construction products,

explosives for civil uses, gas appliances, active implantable medical devices, new hot

water boilers, low voltage devices, machine safety, medical devices, non-automatic

weighing machines, personal protection equipment, recreational craft, simple pressure

vessels, telecommunications terminal equipment, toys and in vitro diagnostic devices.

Non-Tariff Trade Barriers

Cyprus Region OECD

Average Average

Documents required for export (number) 5.0 4.0 4.3

Time required for export (days) 7.0 12.0 10.5

Cost to export (USD per container) 820 852 1,090

Documents required for import (number) 6.0 4.8 4.9

Time required for import (days) 5.0 12.2 11.0

Cost to import (USD per container) 1,030 958 1,146 Note: The region average refers to Mediterranean Countries (Cyprus itself, Greece, Italy, Malta, Portugal and Spain). Source: World Bank, Doing Business

According to the World Bank’s Doing Business 2010 report, Cyprus’ documentation

requirements are more complex than in other Mediterranean countries because more

documents are required in Cyprus than in neighbouring states. However, the processing

of documents required for import and export transactions requires less time in Cyprus,

taking only takes 5.0 days (import) and 7.0 days (export), while in neighbouring states

the comparable figures are, on average, 12.2 days (import) and 12.0 (export).

With scope for

conventional tariffs

heavily restricted by

WTO disciplines…

…anti-dumping

duties have become

an important

instrument of

protectionism

EU rules on specific

products can result

in compliance costs

to producers



Trade Documentation

The ten-digit TARIC codes, used in all documentation for custom and statistical

purposes, are based on the international Harmonised System (HS) code. All EU

countries accept the Single Administrative Document (SAD), which facilitates intra-EU

cross-border commerce, allowing firms to ship products to a variety of national markets

from a single gateway port with a minimal amount of paperwork. The SAD is

completed by the importer.

Where Cyprus is the first port of call within the EU, the following documentation

guidelines apply:

Bill of Lading: There are no special requirements affecting the preparation of bills of

lading, but they should show the marks of identification and indicate the name and

address of the consignee. ‘To Order’ bills of lading are recognised and protected. Air

cargo shipments require air way bills, while mail and parcel post shipments require

postal documentation in place of bills of lading.

Delivery order: A delivery order, duly certified by a customs official, is required for the

release of the specified goods.

Commercial Invoice: An invoice must be presented to Customs. Evidence of freight and

insurance, if not given in the invoice, must be produced separately. There are no

requirements regarding chamber of commerce certification and/or consular legalisation.

Follow importer’s instructions in this regard.

Insurance Certificate: Normal commercial practices obtain. Follow importer’s and/or

insurance company’s instructions.

Packing List: Required. A minimum of two copies should be issued and data should

agree with the data in other documents.

Investment Environment

A number of factors make Cyprus an attractive country in which to invest: the island’s

strategic location between Europe and the Middle East; its preferential tax regime (with

the lowest corporation tax rate in the EU); an extensive network of double-taxation

treaties; a legal and accounting framework based on UK law and practice; the

availability of a well-qualified labour force particularly skilled in accounting and law; a

reliable telecommunications system; the island’s status as an international shipping

centre; and relatively liberal immigration and visa regulations.

Attracting foreign investment is among the primary objectives of Cyprus’ development

policy. For this reason, the government has liberalised FDI policy for both EU and non-

EU nationals: foreign companies can invest and establish business in Cyprus on equal

terms with local investors. Administrative procedures have been simplified and no

limitations apply in most sectors of the economy. Bureaucratic intervention has also

been reduced.

In particular, restrictions concerning the maximum allowable percentage of foreign

participation, as well as minimum level of foreign investment in any enterprise in

Cyprus, were lifted as of January 2000 for EU-citizens and from October 2004 for non-

EU citizens. Most capital restrictions and limits on foreign equity participation or

ownership have been lifted, granting national treatment to foreign investors, while non-

EU investors can invest freely in Cyprus in most sectors, either directly or indirectly

(including all types of portfolio investment in the Cyprus Stock Exchange). The only

exceptions primarily concern the acquisition of property (Other Commercial Risks,

p22) and, to a lesser extent, ownership restrictions on investment in the sectors of

tertiary education, mass media, banking and construction.

FDI policy for EU

and non-EU

nationals has been

liberalised

Most restrictions on

capital and foreign

participation have

been lifted



As of October 2004, foreign investors can register a company directly at the Registrar of

Companies through qualified accountants or lawyers, a procedure that is exactly the

same for local residents. Similarly, foreign investors can acquire shares in an existing

Cypriot company directly, without earlier authorisation by the central bank. They are

expected, however, to inform the Registrar of Companies about any change in

ownership status.

In order to foster the influx of foreign investments, the Foreign Investors Service Centre

operates under the auspices of the Ministry of Commerce, Industry and Tourism. The

Centre (which constitutes the central agency of information, support and foreign

investors’ relations), assists foreign-based companies investigating investment

opportunities in Cyprus. It plays a vital role in attracting FDI in targeted industries,

focusing especially on the development of high-technology products, the enhancement

of R&D and technology transfer.

Moreover, in its effort to facilitate, accelerate and simplify the process of setting up a

business and reduce the level of bureaucratic intervention, in 2007 the government set

up a ‘one-stop shop’ under the auspices of the Ministry of Commerce, Industry and

Tourism, for both local and foreign-based companies. Investors and businesspeople now

have a single point of contact to obtain almost all the required permits in one

streamlined, co-ordinated process, considerably reducing the average time for setting up

a business. In the same year, the government also established the Cyprus Investment

Promotion Agency (CIPA), tasked with providing extensive and professional assistance

to foreign-based companies and individuals that wish to investigate the possibility of

investing in Cyprus, as well as after-care services to already established foreign-based

companies in Cyprus. The CIPA will work in tandem with the Foreign Investors Service

Centre, under the same ministry.

Capital Account Exchange Regulations

Cyprus allows complete freedom of capital movements and payments, in accordance

with EU law.

Investment Incentives

Cyprus-based enterprises can benefit from the favourable tax regime and enjoy the

lowest corporate tax rate in the EU (10%). Moreover, various tax exemptions apply for

both corporate and personal tax: exemptions in respect of dividends received from local

and foreign subsidiaries, profits of permanent establishments abroad, capital gains

derived from the disposal of securities, outward dividends, company reorganisations,

free repatriation of profits and capital, and others.

In addition, the government has introduced various Grant Schemes. Such schemes and

incentives, among other things, aim at the encouragement, strengthening and

reinforcement of entrepreneurship; the technological upgrading of Cypriot enterprises;

the export promotion of industrial products; the development of technologically

advanced products and services; and the attraction of capital-intensive foreign

investments.

Cyprus has three free-trade zones (FTZs). The first two, located in the main seaports of

Limassol and Larnaca, are used only for transit trade, while the third, located near the

international airport in Larnaca, can also be used for repacking and reprocessing. These

areas are treated as being outside normal EU customs territory and as a result non-EU

goods placed in FTZs are not subject to any import duties, VAT or excise tax. FTZs are

governed under the provisions of relevant EU and Cypriot legislation. The Department

of Customs has jurisdiction over all three areas and can impose restrictions or

prohibitions on certain activities, depending on the nature of the goods.

The process of

setting up a

business has been

simplified and

bureaucracy

reduced

Investors can

benefit from a

favourable tax

regime, tax

exemptions and

grant schemes

There are three

free-trade zones



Additional Sources of Information

Central Bank of Cyprus

Tel: +357-22-71 41 00

http://www.centralbank.gov.cy

Cyprus Chamber of Commerce and

Industry Tel: +357-22-889800

http://www.ccci.org.cy

Cyprus Stock Exchange Tel: +357-22-712300

http://www.cse.com.cy

Department of Customs and Excise

Tel: + 357-22-601 713

http://www.mof.gov.cy/customs

Ministry of Commerce, Industry and

Tourism

Tel: +357-22-867100

http://www.mcit.gov.cy

Ministry of Labour and Social

Insurance

Tel: +357-22401600

http://www.mlsi.gov.cy

D&B provides information relating to more than 155m companies worldwide. Visit

www.dnb.com for details. Additional information relevant to country risk can be found

in the:

International Risk & Payment Review: Provides timely and concise economic, political

and commercial information and analysis on 132 countries. Available as a subscription-

based internet service (www.dnbcountryrisk.com) and monthly update journal, the

IRPR carries essential information on payment terms and delays. It also includes the

unique D&B Country Risk Indicator to help monitor changing market conditions.

http://www.dnb.com

http://www.dnbcountryrisk.com

http://www.centralbank.gov.cy

http://www.ccci.org.cy

http://www.cse.com.cy

http://www.mof.gov.cy/customs

http://www.mcit.gov.cy

http://www.mlsi.gov.cy



Glossary

Balance of payments The sum of payments made to all other nations less the sum of external receipts.

Basis point One one-hundredth of a percentage point.

CAD Cash against documents: On payment, the buyer receives the documents that give access to the goods.

CiA Cash in advance: The buyer pays the seller before shipment is effected.

CIS Commonwealth of Independent States (Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyz

Republic, Moldova, Russia, Tajikistan, Ukraine, Uzbekistan)

CLC Confirmed letter of credit: A letter of credit in which payment is guaranteed by the opening bank in the

buyer’s country and by another bank.

CPI Consumer price index

Current account balance Part of the balance of payments that records a nation’s exports and imports of goods and services, and

income and transfer payments.

CWP Claims waiting period: The time between when the covered risk materialises and the earliest time when

indemnification of a claim can take place.

DSR Debt service ratio: Annual interest and principal payments on a country’s external debts as a percentage

of exports of goods and services.

ECB European Central Bank

ECGD Export Credits Guarantee Department (UK)

EU European Union

Eximbank Export Import Bank (US)

FDI Foreign direct investment: Investment in productive assets by a foreign company.

Fitch Fitch Ratings

FX Foreign exchange

G7 Group of Seven industrial nations (Canada, France, Germany, Italy, Japan, UK, US)

G8 Group of Eight industrial nations (G7 plus Russia)

GDP Gross domestic product: The value of goods and services produced in an economy.

GNP Gross national product: GDP plus net income from abroad.

Government balance The balance of government expenditure and receipts.

HIPC Heavily Indebted Poor Countries initiative: A framework for creditors to provide debt relief to the poorest

and most heavily indebted countries.

IMF International Monetary Fund

Import cover The amount of official FX reserves a country has in relation to the average monthly value of imported

goods and services.

Inflation The increase in prices over a given period.

IT Information technology

LC Letter of credit: A guarantee of payment to a seller from a buyer’s bank. Payment is conditional on named

documents being presented by specific dates.

Moody’s Moody’s Investors Service

MP Member of parliament

NATO North Atlantic Treaty Organisation

NGO Non-governmental organisation

Nominal effective exchange rate The weighted average exchange rate of the local currency vis-a-vis a basket of foreign currencies.

OA Open account: credit extended that is not supported by formal written evidence of indebtedness.

OECD Organisation for Economic Co-operation & Development

OPEC Organisation of Petroleum Exporting Countries

Q1; Q2; Q3; Q4 First, second, third and fourth quarter

R&D Research and development

Real effective exchange rate The nominal effective exchange rate adjusted for inflation differentials with a country’s trading partners.

Real GDP GDP adjusted for inflation

S&P Standard & Poor’s

SD Sight draft: A draft or bill that is payable on demand or on presentation.

STIPP Short-Term Insurance Pilot Program (US): Provides short-term cover to buy US goods in countries where

Eximbank is otherwise not open for medium-term financing in the public or private sector.

Terms of trade The ratio of the index of export prices to the index of import prices.

UN United Nations

VAT Value-added tax: A consumption tax levied at each stage of production.

WTO World Trade Organisation



Country Risk Indicator Definition & Report Guide

D&B’s Country Risk Indicator provides a comparative, cross-border assessment of the risk of doing business in

a country. The indicator seeks to encapsulate the risk that country-wide factors pose to the predictability of

export payments and investment returns over a time horizon of two years. The risk indicator comprises a

composite index of four over-arching country risk categories:

Political risk Internal and external security situation, policy competency and consistency, and other

such factors that determine whether a country fosters an enabling business environment.

In this report, analysis on the current factors affecting the political risk outlook of the

country can be found in the Political Risk chapter; this is complemented by contextual

information on the country’s political structures in the Political Environment chapter.

Macroeconomic risk The inflation rate, government balance, money supply growth and all such

macroeconomic factors that determine whether a country is able to deliver sustainable

economic growth and a commensurate expansion in business opportunities.

External economic risk The current account balance, capital flows, foreign exchange reserves, size of external

debt and all such factors that determine whether a country can generate enough foreign

exchange to meet its trade and foreign investment liabilities.

In this report, analysis on the current factors affecting the domestic and external

economic risk outlook of the country can be found in the Economic Risk chapter; this

is complemented by contextual information on the country’s economic structures in the

Economic Environment chapter.

Commercial risk Sanctity of contract, judicial competence, regulatory transparency, degree of systemic

corruption and other such factors that determine whether the business environment

facilitates the conduct of commercial transactions.

In this report, analysis on the current factors affecting the commercial risk outlook in

the country can be found in the Commercial Risk chapter; this is complemented by

contextual information on the country’s commercial structures in the Commercial

Environment chapter.

The risk indicator is divided into seven bands, ranging from DB1 to DB7. Each band is subdivided into quartiles

(a-d), with an a designation representing slightly less risk than a b designation and so on. Only the DB7 indicator

is not divided into quartiles. The individual DB risk indicators denote the following degrees of risk:

DB1 Lowest risk Lowest degree of uncertainty associated with expected returns, such as export payments

and foreign debt and equity servicing.

DB2 Low risk Low degree of uncertainty associated with expected returns. However, country-wide

factors may result in higher volatility of returns at a future date.

DB3 Slight risk Enough uncertainty over expected returns to warrant close monitoring of country risk.

Customers should actively manage their risk exposures.

DB4 Moderate risk Significant uncertainty over expected returns. Risk-averse customers are advised to

protect against potential losses.

DB5 High risk Considerable uncertainty associated with expected returns. Businesses are advised to

limit their exposure and/or select high-return transactions only.

DB6 Very high risk Expected returns subject to large degree of volatility. A very high expected return is

required to compensate for the additional risk or the cost of hedging such risk.

DB7 Highest risk Returns are almost impossible to predict with any accuracy. Business infrastructure has,

in effect, broken down.

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