Cyprus WT/TPR/S/25
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I. THE ECONOMIC ENVIRONMENT
(1) Major Features oftheCyprus Economy
1. Since the1960s, when primary products, minerals, particularly copper, andcitrus fruits,
dominated exports, theCypriot economy hasbeentransformed bythecontinuous development ofits
tertiary sector, withservices today accounting forabout twothirds ofbothGDPandforeign exchange
receipts. Business services, withCyprus asanimportant centre foroffshore activities, andtourism
havebeenthemain contributors toeconomic growth inrecent years.
2. Percapita income inCyprus hasgrown rapidly inthelasttenyears from US$4,570 in1985
toUS$13,650 in1996, which provides Cypriots withliving standards onaparwithSpain. Besides
theimportance ofservices, salient economic features oftheRepublic ofCyprus aretheopenness of
theeconomy (trade ingoods andservices asapercentage ofGDP hasfluctuated around 100percent
sincetheearly1980s); strong tradeandeconomic relations withtheEuropean Union (EU)-theCyprus
pound hasbeenpegged totheECU since 1992; ahighly educated labour force andfullemployment
combined withlowinflation.1(Chart I.1andTable I.1)
3. External factors playanimportant rôleinCyprus 'continued growth, particularly given the
small sizeofthedomestic market (population 650,000; labour force 300,000) in1996. Itsreliance
ontourism asasignificant contributor toGDP andforeign exchange receipts places theeconomy in
avulnerable position toexternal shocks. Inaddition, long-standing preferences intheEUarebeing
eroded, asenlargement continues; andrising unitlabour costs inexcess ofthose inpartner countries
areaffecting external demand.
4. Further totheabove factors, constraints togrowth include limited natural resources, including
water; declining profitability inmany sectors; alowlevelofinvestment intechnologically advanced
equipment; alegalceiling oninterest ratesandincreasingly acute labour shortage.2Also, thesmall
sizeoftheeconomy prevents theadequate development ofinter-sectoral linkages.
1TheRepublic hastheworld 'sthirdhighest number ofuniversity graduates percapita, aftertheUnited States
andCanada (EIU 1995-1996).
2Inthe1990s, foreign workers havehelped toalleviate theshortage (in1996, around 4percentofthelabour
force wasforeign, compared to1.5percentin1988.WT/TPR/S/25 Trade Policy Review
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Table I.1
Major features oftheeconomy, 1995
1995 1996a
Population (thousands) 648 652.3
Labour force (thousands) 303 ...
GDP atcurrent prices (US$ million) 8,688.4 ...
GDP percapita (US$) 11,536.7 13,650
Share inGDP atfactor cost(percent)
Agriculture 5.3 4.7
Industry 24.2 23.8
Manufacturing 12.5 12.0
Construction 9.1 9.2
Services 70.5 71.5
Trade, restaurants, hotels 21.7 20.9
Finance, insurance, realestate, business 17.4 18.2
Employment byeconomic activity (percent)
Agriculture 11.1 ...
Industry 25.2 ...
Manufacturing 15.6 ...
Construction 9.1 ...
Services 63.7 ...
Trade, restaurants, hotels 26.5 ...
Finance, insurance, realestate, business 8.0 ...
Merchandise exports f.o.b. (US$ million) 1,228.7 ...
Merchandise imports f.o.b. (US$ million) 3,314.2 ...
Merchandise exports toGDP (percent) 14.4 ...
Merchandise imports toGDP (percent) 38.8 ...
Non-factor services: credits (US$ million) 2,960.1 ...
Non-factor services: debits (US$ million) 1,102.7 ...
Exports ofgoods andnon-factor services/GDP (percent) 46.5 47.6
Imports ofgoods andnon-factor services/GDP (percent) 50.2 53.0
... Notavailable.
a Provisional.
Note: Allfigures arebased oncurrent market prices, unless otherwise stated.
Source: International Monetary Fund, International Financial Statistics (various issues); Government ofCyprus, Department ofStatistics
andResearch.Cyprus WT/TPR/S/25
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(2) Recent Economic Performance
5. Inthe1990s, annual realGDPgrowth hasaveraged 4percent,lower thanthe6percentgrowth
rateofthe1980s, reflecting theeffects ofanoverall global slowdown during theearly1990s, lingering
effects oftheGulfWarontourism revenues, anddeclining costcompetitiveness. In1995, private
consumptionroseby10percentinrealterms,accompaniedbyampleliquidityavailableintheeconomy,
exerting anexpansionary impact onimports (Table I.2). In1996, therewasaconsiderable slowdown
intherateofeconomic growth toaround 2percentinrealterms duemainly toadeceleration inthe
rateofincrease ofdomestic demand (particularly private consumption) andexternal demand.WT/TPR/S/25 Trade Policy Review
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Table I.2
Economic performance, 1990-96
1990 1991 1992 1993 1994 1995 1996a
Percentage change
RealGDP atmarket prices 7.4 0.6 9.7 1.7 6.0 5.0 1.6
Private consumption 9.2 9.0 3.6 -4.9 5.6 10.0 1.0
Government consumption 17.6 6.0 12.4 -10.8 5.1 4.2 11.9
Gross domestic investment -5.1 -4.8 20.9 -15.5 2.6 7.8 -0.1
Exports ofgoods andnon-factor services 8.5 -8.8 14.2 -3.5 6.9 4.2 6.8
Imports ofgoods andnon-factor services 3.1 -0.2 15.6 -20.8 7.3 10.6 5.8
Monetary survey
Reserve money (M1) 11.2 7.5 9.5 8.8 4.9 6.2 6.7
Broad money (M2) 14.8 13.6 13.9 16.4 12.5 11.4 10.1
Annual average rate(percent)
Unemployment 1.8 3.0 1.8 2.7 2.7 2.6 ...
Interest rate Actual rates (percentperannum)
Deposit rate 7.0 7.0 7.0 7.0 7.0 7.0 7.0
Lending rate 9.0 9.0 9.0 9.0 8.5 8.5 8.5
Government finance Share ofGDP (percent)
Government revenue 27.7 27.1 28.3 30.4 31.9 32.9 ...
Government expenditure 32.9 33.4 32.6 32.4 33.3 33.8 ...
Government surplus/deficit(-) -5.3 -6.8 -4.7 -2.3 -1.4 -1.0 ...
Public debt(excluding
intragovernmental) 50.8 56.8 56.3 59.0 54.8 54.9 ...
Memorandum:
Gross Domestic Investment/GDP 27.1 25.4 28.8 24.2 25.6 25.4 25.6
Gross Domestic Savings/GDP 17.3 22.0 18.2 23.6 23.3 20.7 ...
... Notavailable.
a Provisional.
Note: Databased on1990 constant pr.
Source: International Monetary Fund, International Financial Statistics (various issues); Government ofCyprus.Cyprus WT/TPR/S/25
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6. Inflation, which peaked at6.6percentin1992, hasbeendisciplined bythetightmonetary
policy required tosupport theexchange ratepeg(BoxI.1).Other regulatory factors havebeenrestrictive
fiscal policy during the1994-1996 period andrestraint inunitlabour costgrowth. Indeed, achievement
oftheconvergence criteria oftheMaastricht Treaty guide overall macroeconomic policy inCyprus.3
Asaresult ofafallinagricultural prices andaslowdown inthegrowth ofimport prices astheCyprus
pound appreciated vis-à-vis theU.S.dollar, inflation declined in1995to2.6percent, itslowest level
since 1971, andwasabout 3percentin1996.
BoxI.1Monetary Policy Framework
Theexercise ofmonetary andcredit policy bytheCentral Bank focuses onthesupply ofadequate
liquidity tofacilitate thedevelopment process; atthesame time, itaims tosafeguard conditions of
internal andexternal stability, i.elowinflation andahealthy balance-of-payments position.aGiven an
interest rateceiling of9percent, restrictions onexchange andcapital movements and, since 1992, a
fixed exchange rateregime, theCentral Bank traditionally used liquidity (liquid asset) ratios and
minimum reserve requirements asitsmain monetary instruments.bInrecent years, theeffectiveness of
thispolicy toolwaslimited bytheproliferation ofcooperative banks orcredit institutions, holding one
third ofprivate savings, which have notbeen subject totheliquidity ratio requirements noranyother
form ofmonetary supervision; andthenon-enforcement ofpenalties onviolating banks. Inmoving
towards harmonization withEUpolicies, anewmonetary framework wasintroduced on1January 1996.
TheCentral Bank hasabandoned theliquid asset ratio andreduced minimum reserve requirements to
7percentofdeposits, introducing a"lombard" facility, (anovernight rate), which fixes theupper endof
money market rates. Itnow relies onmarket mechanisms (auctioning treasury bills andissuing
repurchase agreements) toregulate liquidity andsteer interest rates. Aceiling oncredit expansion has
been setfor1996 butthisismore ofaguideline thanamain toolofmonetary policy. TheCentral Bank
isaproponent oftheabolition oftheinterest rateceiling, which should bejustaquestion oftime, given
prospective fullfinancial liberalization.
a According totheCentral Bank ofCyprus Law, thestatutory goalis"tofoster monetary stability andsuchcredit andbalance
ofpayments conditions conducive totheorderly development oftheeconomy...".
b Commercial banks were required tomaintain liquid assets equal to27percentoftheirdeposits, 12percentwere heldas
minimum reserves withtheCentral Bank.
7. Theshare ofinvestment inGDPfellfrom30.4percentin1985to25.8in1996. Thisdecline
canbecorrelatedwithfallingprofitability,particularlywithrapidlyrisingunitlabourcosts.Construction
stillrepresents thelion'sshare offixedinvestment; investment inmachinery andequipment fluctuates
between 20and23.5percentoftotalgross fixed investment, compared to40to50percentinmost
developed countries.
3TheMaastricht criteria formacroeconomic convergence areasfollows:
(i) amember State'sprice index should notexceed bymore than1.5percentage points thatofthethree
bestperforming member States interms ofprice stability
(ii) theratioofthegeneral government deficit toGDP should notexceed 3percentandtheratioofpublic
debttoGDP should notexceed 60percent;
(iii) amember State'sexchange rateshould remain within thefluctuation margins allowed bytheexchange
ratemechanism oftheEuropean Monetary System;
(iv) amember State should have hadanaverage nominal long-term interest ratethatdoesnotexceed by
more than2percentage points thatof,atmost, thethree bestperforming member States interms of
price stability.WT/TPR/S/25 Trade Policy Review
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8. Inthelastseveral years, while theunemployment ratehasfallen andthelabour shortage has
become acute, realwages haverisen accompanied byslowing productivity growth (Chart I.2). The
labour market ishighly unionized andcost-of-living adjustments inthecentrally negotiated wage
agreements haveallowed wage growth tooutstrip productivity improvements.4Theinitial adjustment
burden hasbeenshouldered byprofitability; in1995, thesocial partners agreed tolimitwage increases
toaverage productivity growth (3.2percent), wages inthepublic sector werefrozen for1995and1996
andthewage bargaining process isbeing reviewed withaviewtoformalizing thelinkbetween wages
andproductivity increases andtoreassess theindexation parameters, e.g.excluding indirect taxes.
Initial results ofthesocial consensus show apartial success incontaining nominal andrealwage
increases.
4Theinstitutional orlegislative framework forlabour markets isminimal (there arefewhiring restrictions
andtheduration ofunemployment benefits isshort) andtherefore flexible. Butagreat dealofrigidity inreal
wages iscreated bythetripartite process -theGovernment actsasmediator between employers andworkers
incentralizedcollectivebargaining,providedforunderthe1977IndustrialRelationsCode,forwagedetermination.
About 75percentoftheworkforce isorganized intrade unions andanother 15percentfollows thepattern of
collective agreements. Contracts arenegotiated fortwotothree years; fullbackward-looking indexation ofwages
totheCPI,adjusted twice ayear, hasbeenpartoflabour agreements since 1951 andapplies throughout theentire
economy, including thepublic sector, reducing relative wage flexibility andhampering thereallocation oflabour.WT/TPR/S/25 Trade Policy Review
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(3) External Performance andTrade Patterns
10. Forthelastfewdecades Cyprus hashadtrade deficits; given itssmall manufacturing base
andthemovement ofdomestic resources intoservices activities, merchandise imports represent nearly
40percentofGDP, outweighing exports byafactor ofthree(Table I.3).In1995, merchandise exports
amounted toUS$1.2 billion; imports (f.o.b.) US$3.3 billion; comparable datafor1996wasexports
ofUS$1.4billionandimportsofUS$3.9billion.Astheexchangerate,peggedtotheECUinJune1992,
hasstrengthened, inbothnominal andrealterms, domestic exports haveshown littlechange inthe
lastseveral years while import growth hasbeenstrong, atroughly 12percentannually inthe1993-1995
period.
Table I.3
External performance, 1990-95
(US$ million, unless otherwise indicated)
1990 1991 1992 1993 1994 1995
Merchandise trade balance -1,552.8 -1,601.8 -2,315.2 -1,506.8 -1,735.5 -2,085.5
Exports f.o.b. 951.6 951.7 985.9 867.7 967.5 1,228.7
Imports f.o.b. 2,504.4 2,553.5 3,301.1 2,374.5 2,703.0 3,314.2
Services: credits 2,003.6 1,857.1 2,521.4 2,335.1 2,646.7 2,960.1
Transport 260.0 269.0 317.0 302.0 344.0 385.0
Travel 1,254.0 1,029.0 1,548.0 1,404.0 1,651.0 1,797.0
Other private services 246.0 270.0 352.0 339.0 403.0 503.0
Services: debits 673.9 729.1 884.0 765.0 862.1 1,102.7
Transport 380.0 412.0 508.0 413.0 466.0 583.0
Travel 177.0 191.0 224.0 217.0 246.0 330.0
Other private services 106.0 113.0 139.0 122.0 135.0 172.0
Services balance 1,329.7 1,128.0 1,637.4 1,570.1 1,784.6 1,857.4
Income: credit 158.9 175.3 156.8 131.9 121.5 142.3
Income: debit -216.8 -230.8 -234.9 -198.4 -211.1 -244.0
Current transfers, net 126.6 108.9 117.6 113.0 114.8 117.1
Current account balance -154.3 -420.3 638.2 109.8 74.4 -212.6
Direct investment, net 122.0 67.2 92.7 71.1 69.1 112.5
External debt 2,186.3 2,382.1 2,695.4 2,375.0 2,441.0 2,611.5
Foreign exchange reserves 1,485.3 1,364.5 992.8 1,061.6 1,427.2 1,079.0
External debt/GDP (percent) 39.3 41.5 39.3 37.9 33.6 29.4
Current account balance/GDP
(percent)-3.4 -8.0 -9.8 1.4 0.6 -2.7
Percentage ofexports ofgoods andservices
Debt service ratio 10.6 13.1 13.1 14.1 12.9 9.3
US$perCyprus pound (period average)
Exchange rate 2.1874 2.1585 2.2212 2.0120 2.0347 2.2113
Nominal effective exchange rate
(Index; 1990=100)100.0 102.3 104.8 105.8 109.6 113.8
Realeffective exchange rate
(Index; 1990=100)100.0 100.0 102.7 103.3 105.8 106.7
Source: Dataprovided byCentral Bank ofCyprus; theInternational Monetary Fund; andInternational Financial Statistics (various
issues).Cyprus WT/TPR/S/25
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11. Merchandise exports accounted forjust14percentofGDPin1995and16percentin1996;
agricultural products representing justunder halfandmanufacturing exports justoverhalfoftotal
domestic exports (Table AI.1). Since 1992, re-exports haveovertaken domestic exports. Asignificant
partofthere-export activity, consisting mainly ofcigarettes andconsumer electronic goods which
aredestined fortheMiddle EastandEastern Europe, iscarried outby"offshore" companies based
inCyprus.8
12. While much localfarmproduction isgeared towards domestic requirements (e.g.milkand
certainmeat),foodimportsexceedexports:US$358millionversusUS$236million;leadingagricultural
exports arepotatoes, citrus fruitandwine(Table AI.2).
13. Reflectingthedecliningcompetitivenessinthesector,manufacturedexports(principallyclothing,
pharmaceuticals andfootwear) areonasecular decline, earning US$267 million in1995 compared
toUS$310 million in1990. Domestic exports ofclothing alone fellfrom US$153 million in1990
tounder US$100 million in1995. More andmore trade, however, isbeing carried outusing Cyprus
asatransit orprocessing centre. When re-exports areincluded, totalmanufactured exports in1995
equalled US$540 million, ofwhich US$150 million wasinmachinery andtransport equipment. Imports
ofmanufacturesamountedtoUS$2.4billionin1995,withmachineryandtransportequipmentaccounting
forUS$1 billion.
14. TheEUisCyprus 'mostimportant trading partner, withtheUnited Kingdom accounting for
25percentofdomestic exports in1996. Inspite oftheimplementation oftheCustoms Union
Agreement, theshare ofCyprus 'exports totheEUhasfallen inthelastfiveyears, astheEastern
European andMiddle Eastern markets havegrown inimportance (Tables AI.3andAI.4). Imports
from North America areassuming agrowing importance intheregional pattern oftrade.
15. Inspiteofthedeficit inmerchandise trade, thecurrent account wasinsurplus in1993and1994,
thanks toarebound intourism arrivals andgrowing receipts fromoffshore business. In1995, asbuoyant
private consumption fostered aspurt inimport growth andtourism slumped, thecurrent account fell
intodeficit,equivalentto2.5percentofGDP;thedeficitwidenedtoaround5percentofGDPin1996.
16. Non-factor service credits (commercial services) faroutweigh merchandise exports. In1995
and1996, exports ofcommercial services, ledbytourism receipts, amounted toUS$2.9 billion and
US$3 million, respectively, having grown fromUS$341 million in1980(Chart I.4).Thecomponent,
"other private services", rosetooverUS$500 million in1995; estimated foreign exchange receipts
from "offshore" businesses amounted in1995 to£C171million, equivalent toUS$376 million.9
8CBC (1995), p.35.
9CBC (1995).WT/TPR/S/25 Trade Policy Review
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Cyprus WT/TPR/S/25
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17. Inthelastfewyears, theGovernment hasreduced thescope ofcapital controls andrestrictions
oninward andoutward investment. Between 1990and1995, foreign direct investment inflows oscillated
between £C32million (US$70 million) and£C20million (US$44 million). Inlinewithother fiscal
reforms destined tomake itanattractive candidate forentry intotheEU,theGovernment hasmade
itapolicy toreduce itsreliance onexternal debt. External debt,ofwhich roughly twothirds ispublicly
held, fellto29.4percentasashare ofGDP in1995 andto27.3percentin1996, from close to
40percentin1990.
(4) Economic Outlook
18. Prospects for1997 areencouraging: GDP isexpected togrow by3.5percent, inflation to
hover around 3percent, thefiscal deficit towiden to3percentandthecurrent account tonarrow
slightly withthefallinoilprices andaforecast increase intourist arrivals.WT/TPR/S/25 Trade Policy Review
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Annex I.1Exchange regulations
InJune1992, thepegoftheCyprus pound changed fromabroad basket ofcurrencies tothe
ECU. Thecentral ratewassetat1.7086 ECU/£C withamargin of2.25percentoneither side,the
same bandwidth asthenmaintained onEUmember States 'currencies.
Although theMinister ofFinance hasultimate authority fortheoverall implementation of
exchange control policy, itsadministration istheresponsibility oftheCentral Bank. Exchange controls
areadministered bytheCentral Bank incooperation withauthorized dealers, towhom authority to
approve allocation offoreign exchange foranumber ofpurposes hasbeen delegated. Thelegal
underpinning forexchange controls restsintheExchange Control Law(1952), atranscript oftheBritish
Exchange Control Actof1947. TheCentral Bank setsofficial buying andselling rates, subject to
aspread formajor currencies, several times aday. Authorized dealers (banks) mayquote theirown
buying andselling rates, alsowithin adefined spread. There arenotaxes orsubsidies onsales or
purchases offoreign exchange.
Cyprus formally accepted theobligations ofArticle VIII,Sections 2,3and4oftheIMFArticles
ofAgreement asof9January 1991. While therearenorestrictions onpayments forcurrent transactions,
capital controls arestillinplace. Cyprus ismoving towards greater financial liberalization inview
ofprospective integration withtheEuropean Union. TheCentral Bank foresees theremoval ofall
exchange restrictions within thenextfewyears.
Allexports whose value exceeds £C1,000 aresubject toexchange control monitoring toensure
therepatriation ofsalesproceeds. Export proceeds mustbesurrendered toauthorized dealers without
delay.
Foreign exchange isallocated through authorized dealers, without restriction topayforimports.
Remittances foradvance payments before shipment require theprior approval oftheCentral Bank if
theamount toberemitted exceeds £C50,000. Authorized dealers areallowed toselltodeparting
residents foreign exchange upto£C20,000 forthepurchase andimportation ofgoods intoCyprus;
foreign exchange inexcess ofthislimitmaybesoldtodeparting residents withtheapproval ofthe
Central Bank.
Resident persons andfirms engaged intransit ortriangular trade, manufacturing/exporting
activities orinthehotel business maymaintain foreign currency accounts subject tocertain limits.
Residents engaged intransit ortriangular trade maydeposit uptoamaximum of97.5percentofsale
proceeds inthese accounts topayfortraded goods. Residents engaged inmanufacturing/exporting
maydeposit upto50percentofexport proceeds topayforimports ofrawmaterials usedinproduction.
These traders arehowever required toconvert intoCyprus pounds attheendofeachyeartheexcess
overthebalance required topayfortraded goods orrawmaterials during thefollowing three months.
Non-residents (including offshore companies registered inCyprus) mayfreely maintain foreign
currency accounts withauthorized dealers aswellasoffshore banks inCyprus.