Cyprus: Selected Issues and Statistical Appendix

This Selected Issues paper and Statistical Appendix provides a brief assessment of Cyprus’s external position and its composition in an international perspective. It discusses estimates of Cyprus’s external position based on partial International Investment Position data as well as on cumulative flows, and compares its level and composition with advanced Organization for Economic Cooperation and Development (OECD) economies and with other accession countries. It finds that a precise assessment of Cyprus’s overall external position is hindered by the lack of data on nondebt stocks. The paper also analyzes aging and long-term fiscal sustainability in Cyprus.

Abstract

This Selected Issues paper and Statistical Appendix provides a brief assessment of Cyprus’s external position and its composition in an international perspective. It discusses estimates of Cyprus’s external position based on partial International Investment Position data as well as on cumulative flows, and compares its level and composition with advanced Organization for Economic Cooperation and Development (OECD) economies and with other accession countries. It finds that a precise assessment of Cyprus’s overall external position is hindered by the lack of data on nondebt stocks. The paper also analyzes aging and long-term fiscal sustainability in Cyprus.

III. Cyprus’s Real Exchange Rate and Export Market Share: 1980–200214

A. Introduction

51. This note provides estimates of the real effective exchange rate and export market share of the Cyprus economy during the period 1980–2002. Cyprus’s current account deficit is projected to have increased to 5.5 percent of GDP in 2002 from 4.3 percent of GDP in 2001. Temporary factors, such as the global economic slowdown and the fall in tourism travel following the September 11 events help explain the increase in the current account deficit, but persistent external imbalances could also raise concerns about the competitiveness of the Cyprus economy.15

52. The note concludes that Cyprus’s real effective exchange rate is broadly in line with historical trends. Although Cyprus’s REER depreciated considerably during the 1980s, part of this gain in price competitiveness was lost during the early 1990s. In the second half of the 1990s, the REER vis-à-vis trading partners was broadly stable, with fluctuations reflecting the dynamics of the U.S. dollar and the sterling. As the real exchange rate dynamics would suggest, Cyprus gained market share during the 1980s, but lost part of it during the 1990s. Part of the loss in price competitiveness and market share during the last decade could be explained by Cyprus’s economic convergence to the advanced economies and by the opening up of the developing world to trade. However, the relatively large level of Cyprus’s current account deficit, even if partly driven by temporary factors, does not leave room for complacency, and a reduction of the deficit is desirable to prevent large increases in the size of net external liabilities.16

B. Real Exchange Rate Indicators

53. Exchange rate policy in Cyprus has been historically targeting macroeconomic stability through the linkage of the Cyprus pound with a currency anchor. The Cyprus pound was pegged to the U.K. sterling for the period of 1960–72, to the U.S. dollar for a short period in 1972, to an import-weighted currency basket for the period 1973–84, and to a trade-weighted currency basket for the period 1984–92. In 1992, the Cyprus pound was pegged to the ecu, with a central rate of 1CYP=1.7086 ecu and fluctuation margins of ±2.25 percent, and in 1999 to the euro, maintaining a central parity rate of 1CYP=1.7086 euro and fluctuation margins at ±2.25 percent, widened to ±15 percent in August of 2001 following strong capital inflows after partial capital account liberalization.

54. Various measures of the real effective exchange rate are plotted in Figures 1 and 2. These measures include: CPI-based and unit labor cost (ULC)-based measures with respect to all Cyprus’s trading partners and with respect to Cyprus’s trading partners in the tourism sector; and a CPI-based measure with respect to the euro area.17 The trade weights are taken from the IMF’s Information Notice System. The ULC-based measures only cover the period 1990–2001, for reasons of data availability.

Figure 1:
Figure 1:

Real Effective Exchange Rate, CPI-Based Measures, 1980-2002

(1980=100)

Citation: IMF Staff Country Reports 2003, 031; 10.5089/9781451809831.002.A003

Source: IMF, INS facility.
Figure 2:
Figure 2:

Real Effective Exchange Rate, ULC-Based Measures, 1990-2002

(1990=100)

Citation: IMF Staff Country Reports 2003, 031; 10.5089/9781451809831.002.A003

Sources: Ministry of Finance; and Fund staff estimates.

55. Cyprus’s REER is currently near its recent historical average—some of its price competitiveness gains during the 1980s were reversed in the 1990s. Three main trends can be seen for the movements of the REER measures in Cyprus during 1980–2002. The REER depreciated substantially in the period 1980–90; during most of this period, the current account deficit declined substantially (Figure 3). It gradually appreciated in the period 1991–95, partly offsetting the earlier gains in price competitiveness, which went together with a deterioration in the current account balance.18 Since 1995, the CPI-based REER appreciated vis-à-vis euro area countries, but remained broadly stable vis-à-vis trading partners more generally, given the strengthening of the U.S. dollar and the sterling vis-à-vis the ecu and then the euro.19 The larger real appreciation vis-à-vis the euro area is consistent with Cyprus’s income convergence toward euro-area levels.

Figure 3:
Figure 3:

Current Account in Percent of GDP, 1980-2002

Citation: IMF Staff Country Reports 2003, 031; 10.5089/9781451809831.002.A003

Source: IMF, World Economic Outlook.

56. A considerable part of the movements in the real exchange rate of Cyprus is explained by nominal exchange rate movements, since Cyprus’s inflation differential with other advanced economies has been relatively low—less than 1 percentage point on average during the last twelve years with respect to OECD economies.

57. A simple regression for the period 1980–2001 of the balance of goods and services (bgs), expressed as a ratio of GDP, on the real effective exchange rate and the growth differential between Cyprus and world growth (grdif) suggests a strong comovement between the balance of goods and services and relative prices:

bgs= 1.9(4.2)0.43(4.3) log(reer)0.54(1.9)grdifR2¯ = 0.55

where t-statistics are reported in parenthesis.

C. Export Market Share Indicators

58. Cyprus’s export market share movements in the period 1980–2002 are consistent with the REER movements. World and EU market shares for Cyprus are estimated for exports of goods, services, and of goods and services—these are calculated as the ratio of Cyprus’s exports to world and EU exports respectively (Figures 4 and 5). Cyprus’s market share for goods and services increased considerably in the 1980s, both with respect to the world and the EU, but part of this gain was lost in the 1990s. These movements are driven by Cyprus’s marker share in services, while its market share in goods have been consistently following a downward trend during this period. This trend reflects the decline of agriculture and manufacturing and the evolution of Cyprus as a service-oriented economy, as it catches up with income levels in advanced economies; in turn, the decline in the share of the exports of goods is also linked to the opening up of the developing world to trade.

Figure 4:
Figure 4:

Cyprus’s World Market Share, 1980-2002

(1980=100)

Citation: IMF Staff Country Reports 2003, 031; 10.5089/9781451809831.002.A003

Source: IMF, World Economic Outlook.
Figure 5:
Figure 5:

Cyprus’s EU Market Share, 1980-2002

(1980=100)

Citation: IMF Staff Country Reports 2003, 031; 10.5089/9781451809831.002.A003

Source: IMF, World Economic Outlook.

59. The overall gain in the market share in services is also reflected in Cyprus’s market share in tourism. The share of tourist arrivals in Cyprus over world tourist arrivals increased during the 1990s (data for earlier years and for 2002 were not available), in particular in the second half (Figure 6). The overall gain in market share during the 1980s was a continuation of a trend that started in the mid-1970s, as the Cyprus economy recovered from the 1974 invasion.

Figure 6:
Figure 6:

Tourist Arrivals in Cyprus as a Percent of World Arrivals, 1990-2001

Citation: IMF Staff Country Reports 2003, 031; 10.5089/9781451809831.002.A003

Sources: Cyprus Statistical Service and World Tourism Organization.

D. Conclusions

60. This note has provided estimates of Cyprus’s real exchange rate and export market share. Cyprus’s real effective exchange rate appears broadly in line with historical trends; its appreciation and loss of market share during the 1990s have partly offset gains in earlier years. Although part of this loss may be explained by Cyprus’s income convergence process, there is no room for complacency, in particular given the relatively large current account deficits in recent years.

Table 1.

Cyprus: Aggregate Demand, 1996–2001

(At constant 1995 prices)

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Source: Ministry of Finance.
Table 2.

Cyprus: Aggregate Demand, 1996–2001

(At current prices)

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Source: Ministry of Finance.
Table 3.

Cyprus: Origin of Gross Domestic Product, 1996–2001

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Source: Ministry of Finance.
Table 4.

Cyprus: Origin of Gross Domestic Product, 1996–2001

(At current prices)

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Source: Ministry of Finance.
Table 5.

Cyprus: Gross Manufacturing Output by Major Industries, 1996–2001

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Source: Central Bank of Cyprus.
Table 6.

Cyprus: Tourist Arrivals and Receipts, 1996–2001

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Source: CYSTAT
Table 7.

Cyprus: Labor Force and Employment by Sector, 1996–2001

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Source: Ministry of Finance.

Includes employees of British military authorities and the national guard.

Table 8.

Cyprus: Wage and Productivity Indicators, 1996–2001

(Percentage change over previous year)

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Source: Ministry of Finance.

Including basic wages or salaries, cost of living and other allowances, bonuses, gratuities, and payments in kind. Data exclude overtime payments and are gross of income tax and social security deductions.

Based on average earnings.

Deflated by the GDP deflator.

Table 9.

Cyprus: Price Indices, 2000–02 1/

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Source: Ministry of Finance.

The components of the CPI index in Cyprus changed in 2000.

Components may not sum to totals due to rounding.

Table 10.

Cyprus: Implicit Deflators, 1996–2001

(Annual percentage change)

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Source: Ministry of Finance.
Table 11.

Cyprus: Consolidated Central Government Budget, 1996–2001

(In millions of Cyprus pounds)

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Source: Ministry of Finance.

Euro-commercial paper.

Table 12.

Cyprus: Consolidated Central Government Budget, 1996–2001

(In percent of GDP)

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Source: Ministry of Finance.
Table 13.

Cyprus: Consolidated Central Government Budgets, 1996–2001

(In millions of Cyprus pounds)

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Source: Ministry of Finance.