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Cyprus enjoys higher growth, but must meet EU challenges

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
April 2005
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For Cyprus—one of 10 countries to join the European Union (EU) last year—EU accession poses significant challenges, but also offers substantial economic opportunities, according to the IMF’s bi-annual assessment of the economy. Economic growth rebounded to about 3½ percent in 2004, driven mainly by increased domestic demand, and is expected to rise to almost 4 percent in 2005, reflecting an improved external environment. The IMF’s Executive Board commended the authorities for achieving low inflation, near full employment, and stronger growth. It also welcomed the authorities’ plan to join ERM2— the exchange rate mechanism that countries wanting to adopt the euro must participate in for two years before they can join the EU’s Economic and Monetary Union. The Board cautioned, however, that joining ERM2 and preparing for euro adoption will require sustained fiscal adjustment.

Cyprus has tightened its fiscal policy following a slippage in 2003. The recently adopted Convergence Program aims to reduce the general government deficit to 2.9 percent of GDP in 2005, thereby bringing it in line with the 3 percent limit set out in the EU’s Stability and Growth Pact. Substantial progress has also been achieved in adopting structural reforms that would allow Cyprus to conform with current EU legislation.

The Board noted that these reforms—which include tax reform, capital account liberalization, and strengthening financial sector legislation in line with EU directives—will help lay the foundation for sustained economic growth in the future. But it also encouraged the country to further strengthen competitiveness, including by modernizing the governance structure of public enterprises, considering privatization where appropriate, and enhancing labor market flexibility.

The Board expressed support for the central bank’s cautious monetary policy but stressed that continued vigilance would be necessary in the face of possible inflationary pressures leading up to adoption of the euro.

Cyprus20012002200320042005

Projections
(percent change)
Real GDP growth4.12.11.93.73.8
(percent)
Unemployment2.93.23.53.63.2
(percent of GDP)
General government
Overall balance-2.3-4.5-6.3-4.2-3.0
Public debt61.965.269.871.969.5
Data: IMF staff report, March 2005; and Cyprus Statistical Service.
Data: IMF staff report, March 2005; and Cyprus Statistical Service.

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