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The Road Ahead: Cyprus is Repositioning Itself for Life After the Bailout

Written by Cyprus Profile on April 15, 2013

Despite predictions of its demise as an international business centre by its competitors and detractors, Cyprus continues to stand tall and is adamant not to ‘waste this crisis’, but to turn it into an opportunity to become a more competitive jurisdiction.

Fresh from securing €10 billion in financial assistance, the country is now focused on restructuring and revitalising the economy, making sure every cent counts in safeguarding the future. With Cyprus’ corporate structures still a compelling proposition for global companies, new investment opportunities in tourism and with the ‘world class’ discovery of hydrocarbons, there is every reason to believe that Cyprus will weather the storm.

Cyprus has taken centre stage in recent months as the fifth EU member state to request a financial assistance package. The small Eastern Mediterranean country captured the world’s attention as it fought hard to bounce back from the brink of bankruptcy through intense negotiations with international lenders, while at the same time undergoing presidential elections and a change of government.

Recent economic developments have put Cyprus on the world map, albeit for all the wrong reasons, but what may have been lost in the coverage of these events is that the island’s core offering remains as relevant today as it has for the past decade. The country’s status as a financial centre has certainly been wounded, but what remains intact is Cyprus’ solid experience in corporate structuring and offering blue chip companies and tax planners preferential access to high growth markets like Europe, Russia, China and India. With close to 50 double tax treaties, Cyprus continues to provide international businesses an attractive base for their operations, a fully EU-harmonised tax and legal framework and one of the lowest and most competitive corporate tax rates in Europe at 12.5%.
The Perfect Storm

The current situation in Cyprus has been described by many as the perfect storm. Having enjoyed decades of uninterrupted growth before the current global financial crisis, Cyprus first began to feel the effects in 2010 when the booming construction and real estate sector suffered a severe hit with falling property prices and a decrease in overseas buyers.

The economic climate deteriorated further with rising unemployment, a bloated public sector and public overspending pushing the government deficit further into the red.  But even at that stage the situation was manageable. While Cypriot banks were already grappling with a rising number of non-performing loans, the collapse of the Greek economy and the island’s significant exposure to Greek government bonds became the proverbial straw that broke the camel’s back.

Both domestic and international critics have questioned why Cyprus invested so heavily into Greece. Cyprus has strong trade and investment relations, as well as a cultural and religious affinity with Greece, provided a natural market in which to expand during the boom years. Government bonds are not usually considered to be a risky investment and there was some pressure on Cypriot banks, especially those operating in Greece, to buy the bonds. However the risks involved were grossly underestimated as was the outcome of the Greek bailout, which imposed staggering losses of around €4.5 billion on Cypriot banks following the EU/IMF debt haircut on Greece.
The Banks

The unprecedented decision by the Eurogroup to impose losses on depositors sent shock waves around the world and resulted in the closure of Cyprus’ entire banking sector for nearly two weeks with the imposition of capital controls in a bid to prevent a bank run. However, what emerged as the world watched with baited breath, was not a run on the banks or violent riots, but a defiant show of resilience and solidarity among the Cypriots – who say ‘we have overcome worse times than this’. Granted, there has been justified anger over these developments and the losses imposed on uninsured depositors. Cypriots and the local banking sector have been severely affected by the winding down of Laiki Bank and the restructuring of the Bank of Cyprus, and those with deposits over €100,000 in these banks have unfortunately had to take this costly setback ‘on the chin’.

Despite reports of Cyprus’  financial centre being in complete meltdown, in reality, out of the 40 banks operating in Cyprus only two local banks have been forced to undergo restructuring – leaving the majority of banks on the island unaffected. Today, temporary capital controls remain in place to safeguard the banking system and while a definite date is yet to be set to lift these measures, companies in Cyprus have reportedly been able to operate despite the inconvenience. Naturally, both the government and the private sector are keen to see these controls lifted as soon as possible and there have been assurances that the restrictions on capital movement will gradually be relaxed as the situation improves.
Money Laundering

Prior to joining the European Union in 2004, the reputation of Cyprus suffered from rumours of money laundering, tax evasion and being a haven for Russian oligarchs. During the negotiation process to join the EU, Cyprus had to undergo extensive measures to implement its current fully EU-approved tax framework. Cyprus is also on the OECD White List and has implemented all EU directives to achieve transparency. In fact, Cyprus is currently the only EU member state applying a stricter threshold to identify beneficial owners of legal entities – in Cyprus 10% ownership must be disclosed rather than the EU benchmark of 25%.

However, these rumours resurfaced once again during the bailout negotiations and many saw them as an unjustified attack and unfair treatment, considering the measures Cyprus has taken to combat money laundering have been internationally assessed several times by the Council of Europe Committee (MONEYVAL).  Of course financial crime occurs worldwide, but Cyprus’ professionals point out that the country’s money laundering regulations rate better than most countries levelling these allegations.
Sectors of Opportunity

Despite the positive measures taken by the government and private sector, the Cypriot economy is expected to contract by an alarming 8% in 2013, shrink by a further 3% in 2014 and return to growth only in 2015 or 2016. The key challenge now is for Cyprus to control government expenditure and to generate export of services and goods. The road ahead will be long and rocky, but there is reason for optimism with strong economic sectors such as professional services, tourism and shipping. The light at the end of the tunnel for Cyprus has been the discovery of vast hydrocarbons reserves in its Exclusive Economic Zone (EEZ), which if fully exploited could see the reversal of Cyprus’ fortunes.

Energy is the new boom industry in Cyprus and the country has attracted worldwide attention and serious international investment. The country has begun developing strategies to exploit its new-found hydrocarbon wealth, following a ‘world class’ natural gas discovery by US-company Noble Energy in 2011. The reserves are currently estimated at around 7 trillion cubic feet (198 billion cubic metres) – enough to meet the domestic gas demand for around 100 years. There is increasing interest to invest in the energy sector and auxiliary services in Cyprus, presenting new opportunities for growth in the well-established legal, financial services and even construction sectors. Cyprus has already signed multi-million-euro agreements with an Italian and South Korean consortium, ENI/KOGAS, and with French energy giant Total to start natural gas exploration in its other EEZ blocks – and has plans to start building a new infrastructure to utilise natural gas locally. Cyprus is positioning itself to become a regional energy hub and the reserves could contribute to EU energy security.

Cyprus’ maritime sector continues to grow and the island is considered one of the most influential global hubs for ship owning and ship management services – boasting some of the world’s most influential names in shipping. Cyprus is the largest third party ship management centre in Europe and the largest crew management centre in the world, while the island’s international ship register is the third largest in Europe and the tenth largest in the world. This sector contributes over €1 billion to the economy annually, accounting for around 7% of GDP, and directly employs 4,000 shore-based personnel and 55,000 seafarers worldwide. Shipping is one of the success stories in Cyprus and has a fully EU-approved tax tonnage system in place. The overall operational and tax infrastructure for shipping in Cyprus has remained intact, despite current economic developments.

Tourism is expected to do exceptionally well this year. Cyprus saw a 10% increase in visitors in 2012 and projections for 2013 also expect increased numbers. In addition to the traditional ‘sun and sea’ package, Cyprus has been diversifying its tourism product with the development of luxury marinas and golf courses and niche markets such as cultural, conference and agro-tourism. Sports tourism alone generated around €20 million in 2011. Medical tourism is also on an upward trajectory thanks to the many excellent private hospitals and highly-trained medical professionals. Casinos are another new development, which could open up new investment opportunities and revenue streams of up to €50 million annually, according to the Cyprus Tourism Organisation.

The international business and professional services sector has proved remarkably resilient and has continued to grow throughout the international financial crisis. Following the bailout agreement, business leaders have shown optimism saying the impact on international business is not expected to be as significant as first projected. According to a number of accounting and legal firms, the majority of their foreign clients using Cyprus as a regional base or a gateway for investment have expressed confidence in the country as a regional business hub, stating they will continue their operations on the island. Cyprus is mostly used as a business and tax planning jurisdiction and not as an investment location, where foreign investors ‘park’ their funds as part of asset management strategies. While the international business centre is the single most important sector of the economy, it will face challenges and increased competition in core markets, but Cyprus’ strong track record and redoubled efforts to implement new incentives will help maintain and further develop this important sector.
Rolling out the Red Carpet

In addition to the positive outlook of these sectors, the government is implementing new measures to boost the economy. Tax-incentives, fast-tracking of permits for large projects and the relaxation of measures to encourage foreign direct investment into the country will certainly strengthen the economy. In the past, bureaucracy was a key source of frustration for the business community, but the many reforms being implemented today will create a more efficient Cyprus – supporting the efforts to secure a speedy recovery from this economic crisis.

The Cypriot resilience and entrepreneurial spirit has proven formidable throughout its history and despite the current challenges in the local economy, Cyprus presents many new and exciting opportunities. In a high value-added service economy, innovation is the key to survival and the silver lining of a crisis is the chance to restructure, rethink strategies and explore new opportunities. The road ahead will be challenging, but with the right decisions, investment and action Cyprus is hoping to come out of this crisis stronger than ever.

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