THE RECESSION in Cyprus’ economy in 2012 will be deeper than expected, according to economists from the Economic Research Centre of the University of Cyprus.

The economists believe that following a slight increase of 0.5% in 2011, the Cyprus economy will shrink by 1.5% – 2% in 2012.

They noted that challenges are big and uncertainty is significant.

The council of experts is composed of M. Clerides, P. Pasiardis, Chr. Pissarides, M. Sarris and L. Christofides.

The forecast does not include the VAT increase from 15% to 17%, which may add at least half percentage point to inflation in 2012.

According to the survey, the current condition of the global economy and the uncertain future of the euro area have increased dramatically the risks for the Cyprus economy.

The necessary fiscal adjustment and measures decided by government and Parliament, admittedly belatedly, have changed the data for 2012. On the one hand, they have improved the fiscal condition of the economy, but on the other hand, they deteriorate the economic condition of households in the short term, pushing their available income down.

As for the external environment, it has worsened and will possibly affect growth prospects in 2012.

The economists believe that the negative risks are greater than the positive and that the economy will be largely affected in 2012.

Specifically, the risks in 2012 are:

• The critical condition in Greece and the uncertainty in psychology and the attraction of investments. This affects negatively the ratings of the Republic and the banks and puts more pressures on the economy. A possible deterioration could largely affect the economy of Cyprus. The negative climate affects international business activities, a significant sector of the island’s economy.

• The slowdown and/or decline in exports as a result of the deterioration in the external environment, especially in the EU and the eurozone.

• The high borrowing level of households and businesses along with the anticipated restriction of credit growth may affect negatively private consumption and investments.

• The reduction in disposable income due to various measures that have been implemented may affect negatively private consumption in the short term, which can be moderated with the improvement of the climate and the increase in employment, given that the government remains committed to the structural reforms announced, including those aiming at the increase in productivity and the permanent reduction of state expenditure.

Although the exact quarter-turning point of the economy cannot be assessed easily due to huge uncertainty in relation to the implementation of the measures in Cyprus and the developments abroad, according to the econometric analysis, GDP is expected to drop in the first and second quarter of 2012.

Specifically, the GDP is expected to decline 2½% – 3% in the first and second quarter of 2012 and 1% – 1½% in next quarters.

The incorporation of the aforementioned risks in the analysis with the use of variables containing information about expectations of consumers, businesses and investors, means that the chances of error are expected mostly positive, i.e. above the central scenario, although chances of error down are still significant.

Policy to be followed is crucial

As for the policy that must be followed, it is noted that the economy faces significant challenges in both the internal and external environment. They expect a slowdown in growth and a possible increase in unemployment, which could be moderated if the government remains committed to promises for structural reforms for an increase I productivity and permanent reduction of the state expenditure.

The permanent improvement of the climate, which can be achieved by demonstrating commitment and determination to the need to promote financial objectives, will affect positively the confidence of international investors. Macroeconomic stability will give a clear message that Cyprus remains a major financial centre, with competitive advantages, including low taxation. This means a decline in spreads, widening the possibility of promoting growth measures.

The anticipated GDP decline may have significant impacts on the state’s fiscal condition. The possibility of a higher deficit must be taken seriously into account in order to cover the subsequent funding deficits that the state will face.

The structural reforms in the public sector and the labour market that must be promoted immediately are critical to the success of the fiscal consolidation effort and the recovery of the economy.

Reforms must re-examine the state’s role, increase productivity and promote private initiative.

Institutional changes should be promoted to enhance financial stability, which is the backbone of the economy, but also to strengthen the institutions in general (supervising and administrative). Those reforms can not only mitigate the adverse effects of fiscal austerity but also to enable the economy to withstand the short-term pressures and to improve the long-term economic outlook. The reforms should be promoted on a constant basis and not only in view of deadlines imposed by the EU.