VZCZCXYZ0018
RR RUEHWEB

DE RUEHNC #0932/01 3311315
ZNR UUUUU ZZH
R 261315Z NOV 08
FM AMEMBASSY NICOSIA
TO RUEHC/SECSTATE WASHDC 9368
INFO RUEHBS/USEU BRUSSELS

UNCLAS NICOSIA 000932 
 
SENSITIVE 
 
SIPDIS 
 
DEPT FOR EUR/SE 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD CY
SUBJECT: CYPRUS: DEALING WITH THE FINANCIAL CRISIS 
 
REF: NICOSIA 447 
 
(U) This cable is sensitive but unclassified.  Please protect 
accordingly. 
 
¶1.  (SBU) Summary.  Cyprus continues to enjoy economic stability, 
even in the face of ongoing global financial turmoil.  This 
prosperity will come under pressure in 2009, as construction and 
tourism slow in the face of reduced foreign demand.  Against this 
background, the GOC announced an assistance package for the tourism 
and construction sectors, amounting to a paltry - according to the 
opposition - Euro 52 million.  Cyprus is one of the few EU countries 
not considering a comprehensive rescue plan for its banks, 
reflecting the strength of this sector, concern that such a plan 
might lead observers to believe bank failure was imminent, and 
simple inertia.  Various government departments and the banks are 
arguing whether or not the banks have a shortage of liquidity as 
they tighten lending. The situation is exacerbated by acrimony 
between Central Bank Governor Orphanides and Finance Minister 
Stavrakis.  End Summary. 
 
Economic Overview 
----------------- 
 
¶2.  (SBU) The Cypriot economy is still holding up remarkably well in 
the face of ongoing global financial turmoil.  The growth rate for 
2008 is estimated at 3.7 percent - twice the average EU rate.  For 
2009, the GOC predicts a growth rate of 3.0 percent although many 
private analysts expect more moderate growth of around 2.0 percent. 
As of Q3 of 2008, the economy was still growing at a pace of 0.6 
percent over the previous quarter, according to a "flash" estimate 
from the Department of Statistics.  This has been the slowest pace 
Cyprus has experienced in four years, with the deceleration 
attributed primarily to slowdowns in construction, hotel and 
restaurant services, and real estate. 
 
¶3.  (SBU) Things are expected to get worse in the construction and 
tourism sectors.  Property sales, which had been soaring in recent 
years, recorded a 50 percent drop in October 2008, year-on-year. 
This decline has not yet been reflected in property prices, despite 
a meteoric rise in previous years.  Values for residential property 
in Cyprus have increased from Euros 363 per square meter in 1992 to 
Euros 1,269 by the end of 2007.  At the end of 3Q 2008, property 
values rose by just 1.5 percent over the previous quarter.  The 
trend in the near future calls for a leveling off of property 
values, with a tendency to decline in 2009.  However, no one is 
predicting a crash in property prices, largely due to the 
idiosyncrasies of the Cyprus property market.  These include the 
tendency of domestic property buyers, who account for 80 percent of 
total demand, to hold on to their property for a long time; 
conservative lending practices in the mortgage industry; and a legal 
system requiring 5-7 years to foreclose on a property.  In their 
worst-case scenario, most analysts see a price decline of up to 20 
percent over the next one-two years although sales volume will 
continue to decline more than that. 
 
¶4.  (SBU) Tourism has historically been Cyprus' growth engine, but 
has been waning in importance over the last decade due to its 
eroding competitiveness (principally, sky-rocketing domestic labor 
costs, higher air fares, and lack of new investment.) Until the late 
Nineties, tourism contributed up to 22 percent of GDP. Its share is 
now down to 12-13 percent as construction and financial services 
comprise a greater proportion of the island's economic activity. 
The tourism outlook for next year is grim: bookings for the summer 
of 2009 are currently down 14 percent from 2008 and tourism receipts 
have declined 4.1 percent through the first nine months of this year 
with the decline accelerating in October. 
 
The GOC Plan 
------------ 
 
¶5.  (SBU) Until mid-November, the response of GOC officials towards 
the global financial crisis had been that Cyprus does not face any 
particular problems. In October, President Christofias said: "We do 
enjoy conditions of labor peace and economic stability over the past 
decades due to the fact that we followed a mixed system and have not 
adopted the call for deregulation in laissez-faire, that is a market 
economy ruled simply by the invisible hand." This sanguine attitude 
changed somewhat on November 14, when President Christofias, after 
meeting with his cabinet, announced a Euro 52 million plan to 
stimulate construction and tourism in the face of the international 
financial crisis.  The plan includes a Euro 12 million grant to the 
(semi-government) Cyprus Tourism Organization (CTO) for additional 
tourism promotion abroad.  The remaining Euro 40 million will be 
spent as follows: 
 
-- Expediting implementation of key infrastructure projects included 
in the 2009 budget; 
-- Strengthening government housing projects; 
 
-- Simplifying the process of issuing a building license; 
 
-- Providing municipalities with extra funding (in addition to 
funding included in the 2009 budget); 
 
-- Providing incentives to hoteliers for hotel and general tourist 
infrastructure upgrades; 
 
-- Simplifying the visa-issuing process for tourists from high 
interest markets (mainly from Eastern Europe); and 
 
-- Establishing consular offices in key tourist markets. 
 
¶6.  (SBU) President Christofias described the measures as 
"pre-emptive" and reiterated that the Cypriot economy was, 
generally, still in a good shape.  A couple of days later, 
Communications Minister Nicos Nicolaides also announced that the 
government was considering a drastic reduction in annual private 
vehicle registration fees.  Details of the plan are still being 
worked out but the cut is estimated to be around Euros 40 million, 
up to half of the annual GOC revenue from car registration fees. 
 
Public Reaction to Government Plan 
---------------------------------- 
 
¶7.  (SBU) The private sector was umimpressed with the government's 
assistance plan.  Haris Loizides, President of the Cyprus Hotel 
(Owners) Association commented that the much-anticipated measures 
fell short of the expectations of those involved in tourism:  "The 
message we are hearing from the government is that it is up to the 
private sector to fend for itself."  He added that he expected the 
GOC to do more for tourism, as the situation develops.  Lakis 
Tofarides, President of the Cyprus Developers' Association, 
commented that his association had expected more help from the 
government, particularly by way of facilitating property purchases. 
He added that the government had seemingly ignored a list of 
measures suggested by the association.  Tofarides pledged to pursue 
further meetings with the GOC on this issue. 
 
¶8.  (SBU) Opposition DISY Deputy Press Spokesman Haris Georgiades 
also expressed his party's disappointment at the measures, noting 
that these were too general and un-focused, failing to provide 
specific support to productive sectors.  Specifically, he noted, 
DISY was hoping that the government would translate words into 
action and would considerably upgrade development spending -he did 
not define what comprises "development spending."  Georgiades also 
expressed serious doubt as the effectiveness of the measures to deal 
with the financial crisis. 
 
 
Banking Sector Sound But Loans Harder to Find 
--------------------------------------------- - 
 
¶9.  (SBU) Cypriot officials, from the President on down, have 
offered repeated assurances that the Cypriot economy is in a good 
shape and that, if worse came to worst, the state would not allow 
any Cypriot bank to fail. However, there remains no coherent plan 
for government action in case things suddenly deteriorate.  Five 
weeks ago, Finance Minister Stavrakis announced that Cyprus would 
provide insurance for bank deposits of up to Euros 100,000 per 
depositor per bank, up from a previous maximum of Euros 20,000.  The 
deposit insurance scheme will be funded exclusively by banks with no 
ROC assets involved.  The bill to implement this decision has not 
yet received Parliament's approval as its mechanics (i.e. how much 
each bank will pay, and when) are still being worked out and the 
banks are balking at carrying the entire cost.  Because the Finance 
Minister implied the government would provide this insurance, and 
since the banks remain in apparent financial health, there has been 
no outflow of deposits from Cyprus banks despite the lack of the 
actual implementing legislation. 
 
¶10.  (SBU) The only other measure the ROC has considered for helping 
the banking sector has been finding ways to increase bank liquidity. 
The loans-to-deposits ratio has increased steadily over the last two 
years, from 72 percent in January 2007 to 92 percent in September 
¶2008.  This was on the back of several of years of sizzling growth 
in total lending, which reached a 37.5 percent increase in September 
2008 year-on-year. New loan volume declined dramatically in October 
as banks increased their lending standards and their pricing as 
deposit growth slowed.  Businessmen are complaining they are 
cash-strapped, and that tight lending is hurting their businesses 
and the economy.  Auto dealers tell us that their sales declined by 
up to 50 percent last month as customers couldn't find loans except 
or only at high rates.  The construction sector is anticipating a 30 
-40 percent decline in revenue for 2009 and plans to lay off almost 
half of its 45,000 workers despite the GOC's stimulus plan. 
Hefty Deposits That Banks Can't Use 
----------------------------------- 
 
¶11.  (SBU) According to the European Central Bank, total lending in 
Cyprus reached 231.0 percent of GDP in September 2008, from 180.5 
percent in September 2005 (and compared to a Eurozone average of 
123.5 percent).  Over the same period, total deposits in Cyprus 
(excluding deposits from third countries) reached 219.0 percent of 
GDP in September 2008, from 191.7 percent in September 2005 (and 
compared to a Eurozone average of 104.8 percent).  If deposits from 
third countries are counted, the ratio of total deposits to GDP 
improves to 279.2 percent.  However, Cypriot banks are not allowed 
to lend more than 30 percent of their non-Euro deposits received 
from third countries.  The Central Bank requires local banks to 
maintain 70 percent of such deposits in reserves (down from 75 
percent at the beginning of this year).  Cypriot banks have been 
pressuring the Central Bank (and the government) to reduce the 
foreign currency reserve requirement by 10-20 percentage points to 
inject more liquidity in the system so that banks could lend more 
easily.  So far, the Central Bank has steadfastly blocked such 
efforts, fearing it might endanger the stability of the system, in 
case there is a run by foreign depositors. The biggest structural 
weakness in the banking system is that 25 percent of all Cyprus bank 
deposits are from Russia, or companies formed to do business in 
Russia, and denominated largely in US$. Any significant decline in 
these deposits would result in a severe liquidity crisis for the 
banking system. 
 
Central Bank vs. Finance Ministry 
--------------------------------- 
 
¶12.  (SBU) The government has been sympathetic to the banks' request 
but has done little more than apply political pressure on the 
Central Bank to reduce the liquidity requirement.  This has further 
aggravated already tense relations between Central Bank Governor 
Orphanides and Finance Minister Stavrakis.  Several months ago, the 
Ministry of Finance pressured the Central Bank to sell off part of 
its gold reserves to "take advantage of high gold prices," meeting 
with the Central Bank's outright refusal to be told what it should 
do with its reserves and forcefully noting that it is an independent 
body. This exacerbated government mistrust of the Bank Governor and 
his "neo-liberal" approach (learned from his 19-year career at the 
US Federal Reserve.) 
 
¶13.  (SBU) Some analysts believe that the reduction in new bank 
lending is more of a pricing issue than a liquidity shortage. New 
banks entered the market over the past year and began offering 
above-market rates to win market share. The result has been a 
deposit interest rate war amongst banks - with rates currently 
reaching 6.5 percent for sizeable (over Euro 50,000) fixed-term 
deposits. With many recent loan rates tied to the ECB refinancing 
rate, currently at 3.25 percent, pressure on bank Net Interest 
Margins has been building. 
 
¶14.  (SBU) Comment: While the economy slows and banks tighten their 
lending practices, consumer and business confidence is not helped by 
the ongoing personal rivalry between Orphanides and Stavrakis -- 
arguably, the two most important players for the Cypriot economy. 
Regardless of the merits of each side's arguments, the current 
acrimony helps no one, particularly at such a dangerous juncture for 
the Cypriot economy. 
 
URBANCIC