‘Productivity must drive Cyprus growth as migration reaches high levels’

Cyprus fiscal gains offer chance to tackle long-term problems, council saysCyprus Fiscal Council president Andreas Charalambous has described Morningstar DBRS’ decision to raise Cyprus’ credit outlook to positive as expected, while warning that pension reform and the approaching election period could create fiscal risks. Morningstar DBRS affirmed Cyprus’ long-term credit rating at ‘A’ and revised its outlook from stable to positive, while also affirming the Republic’s short-term ratings at R-1 (low) and moving their outlook to positive. Charalambous said the decision reflected Cyprus’ favourable macroeconomic conditions, particularly its strong fiscal position. “It was an expected development, which reflects Cyprus’ positive macroeconomic data and, in particular, its good fiscal position,” Charalambous said in comments to the Cyprus News Agency (CNA). He said the Fiscal Council’s own assessment, due to be published in mid-September, would highlight the opportunity created by the country’s fiscal position to tackle long-standing structural problems. A strong fiscal position gives Cyprus room to address problems linked to the structural characteristics of the economy, social inequalities and climate change, he said. “It gives us an opportunity to address these problems, which have been going on for years, and this is how we should see it,” Charalambous said. Morningstar DBRS said Cyprus could receive a further rating upgrade if public debt continues to fall in line with current expectations, while greater economic resilience and higher labour productivity could also support an upgrade. Charalambous said the positive outlook indicated that Cyprus was moving in the right direction, but stressed that further progress would be needed before an upgrade could be expected. “We are moving in the right direction, and if we continue, we will have this possibility,” he said. He cautioned, however, that international rating agencies continued to be influenced by Cyprus’ historical inconsistency in maintaining strong fiscal performance. “Historically, we have had fluctuations. We have not always been consistent in achieving good fiscal performance. We had periods with very poor results,” Charalambous said. “They are still waiting to see a long period of stabilisation and good performance before they can move to even better ratings,” he said. The warning comes as Cyprus has built up one of the strongest fiscal positions in the European Union. Morningstar DBRS said Cyprus recorded a fiscal surplus of 3.4 per cent of GDP in 2025, down from 4.1 per cent in 2024 but still the highest in the EU. Government revenue reached €15.9 billion, equivalent to 43.6 per cent of GDP, compared with €9.7 billion, or 41.3 per cent of GDP, in 2019. The agency attributed the increase to an expanding corporate tax base, government policies aimed at attracting foreign companies to establish headquarters in Cyprus, and higher employment and wages, which have boosted social insurance contributions and personal income tax receipts. The surplus is expected to narrow to 2.3 per cent of GDP in 2026, partly reflecting measures to address the effects of the Middle East war, tax reform and costs associated with the agreement between Kedipes and Hellenic Bank. The finance ministry expects the surplus to increase again from 2027, averaging 3.1 per cent of GDP between 2027 and 2029. Public debt has also fallen sharply, from 96.5 per cent of GDP in 2021 to 55 per cent in 2025, and is expected to fall below 50 per cent by the end of 2026 and below 40 per cent by 2029. Finance Minister Makis Keravnos welcomed the positive outlook on Saturday, describing it as further confirmation of the resilience of the Cypriot economy amid global uncertainty. “The decision constitutes yet another confirmation of the resilience demonstrated by the Cypriot economy amid a period of continuing instability for the global economy, full of challenges and risks,” Keravnos said. He said the assessment was particularly significant because it confirmed what he described as the government’s prudent and proactive economic policy, which had strengthened the Republic’s economic position and contributed to the steady reduction of public debt. “It is particularly important that the agency confirms the prudent and proactive economic policy pursued by the government, which continuously strengthens the economic position of the Republic of Cyprus and leads to the steady reduction of public debt,” Keravnos said. Keravnos also highlighted substantial fiscal buffers, saying these provided the government with room to respond in the short term to risks arising from international geopolitical developments. He said the government would continue supporting the economy in a responsible and flexible manner, both in relation to growth and employment and public finances, while seeking to take advantage of opportunities for further growth alongside continued debt reduction. President Nikos Christodoulides also welcomed the rating decision, saying Cyprus was continuing on an upward trajectory while pursuing reforms intended to strengthen competitiveness, resilience and credibility. “The affirmation of the ‘A’ rating and upgrade of the outlook from stable to positive follows the economy’s strong growth, historically high employment levels and significant reduction in public debt,” Christodoulides said in a post on social media platform X. “We continue with the same responsibility, consistency and determination for an economy that is even stronger, more competitive and resilient, which broadens opportunities and strengthens prospects for all citizens. Cyprus is changing,” he said. Morningstar DBRS said strong fiscal surpluses and favourable growth prospects should help reduce the public debt burden. It expects public debt to fall from 49.9 per cent of GDP in 2026 to below 40 per cent by 2029. The agency expects private consumption, investment and strong services exports, including tourism and non-tourism services, to continue supporting economic growth. GDP expanded by 3.8 per cent in 2025, while the Central Bank of Cyprus expects real growth of around 3 per cent annually over the forecast period. Morningstar DBRS also assessed the impact of the Middle East war on Cyprus as smaller than initially expected, although it expects lower tourist arrivals and higher imported inflation to weigh on economic activity in 2026. Charalambous said the effects of the conflict had generally been milder than expected. “There were various reasons at global level, mainly the investments being made in the technology sector,” he said. For Cyprus specifically, he said population growth driven by well-paid migrants had been an important source of economic expansion over the past one to two years. “This translates into consumer demand and has favourable implications for the economy,” Charalambous said, while stressing that this was the main reason for the resilience but not the only one. He warned, however, that Cyprus remained disproportionately exposed to energy prices because of its continued reliance on conventional energy sources. “We have not made major steps towards reducing our dependence on conventional forms of energy. That is why every energy crisis hits us disproportionately, to a much greater degree,” he said. Charalambous also stressed that the country’s reliance on population growth through migration could not continue indefinitely and that productivity would increasingly become the key driver of economic performance. “Until now, growth in Cyprus has been based to a large extent on migration, meaning an increase in employment. This is being exhausted,” he said. “In the future, economic performance will depend on productivity. The domestic population is not increasing and migration has already reached high levels,” Charalambous said. “We know from international experience that after certain levels, it cannot continue at the same rates,” he said. He said higher productivity would depend on investment, adaptation to technological developments and artificial intelligence, as well as continuous training for the workforce. Morningstar DBRS also identified Cyprus’ social insurance system as a significant fiscal strength, with accumulated reserves of around €12bn, equivalent to 33 per cent of GDP. The system currently generates an annual surplus of about €1bn, or 2.7 per cent of GDP, providing a stable source of financing for public finances. Short-term financing risks are further reduced by the central government’s cash buffer, which stood at 6.9 per cent of GDP in July. Charalambous nevertheless warned that pension reform needed to be implemented carefully, particularly the planned end of government borrowing from the Social Insurance Fund and the repayment of existing amounts owed to it. He said the process should be gradual to avoid undermining the downward trajectory of public debt. “We should start by ending additional borrowing from the Social Insurance Fund, and this should happen when we have created institutions that can invest properly. We do not have them at the moment,” Charalambous said. “We must create these institutions during 2026-2027 and, probably from 2028, start directing the surpluses into this special fund and investing them for the benefit of pensioners,” he said. “Repayment must take place over a long period, precisely to avoid this possibility,” Charalambous said, referring to the risk of putting the decline in public debt at risk. He added that any additional measures currently being discussed as part of the pension reform should be assessed for their actuarial impact. Morningstar DBRS also identified potential risks from an economic shock or the materialisation of contingent liabilities linked to Cyprus’ large domestic banking sector, whose total assets exceed 200 per cent of GDP. The agency said the political environment remained stable despite a more fragmented political landscape following May’s parliamentary elections. Because Cyprus has a presidential system, Morningstar DBRS said the election result had not changed the composition of the government and was unlikely to significantly alter fiscal policy or reforms under the Recovery and Resilience Plan. Charalambous nevertheless warned that Cyprus had experienced fiscal overruns during previous election periods. “One of the problems in the past was that during election periods there were overruns, and we are paying for this,” he said. “Particularly during election periods, we must be able to demonstrate that we can maintain a proper and fiscally prudent policy,” Charalambous said. Morningstar DBRS was also more cautious about Cyprus’ institutional indicators, pointing to a deterioration in the country’s standing in the Worldwide Governance Indicators, including measures covering control of corruption and the rule of law. The indicators are now below the EU average, although the agency said EU membership continued to provide an important institutional anchor. Charalambous said this could have direct economic consequences because Cyprus depended heavily on its attractiveness to foreign investors and companies. “In an open country such as Cyprus, which also relies on its attractiveness to foreign investment and on attracting foreign companies to establish themselves in Cyprus, all these things play a major role,” he said. “For this reason, the competent services must take the issues of corruption seriously,” Charalambous said. He also pointed to delays in the administration of justice as another constraint on the economy. “We could do much better if we had made progress in the field of justice and in the direction of combating corruption, which is also linked to the proper interaction between the different branches of power,” he said. Morningstar DBRS said the prospects of significant progress in UN-led reunification talks on the Cyprus problem remained limited. The agency said the positive outlook could eventually lead to an upgrade if public debt falls in line with current expectations and there is evidence of greater economic resilience and improvements in labour productivity. Conversely, the outlook could return to stable if the economy proved less resilient to external pressures or the expected decline in public debt fell significantly short of projections. A substantial deterioration in the public debt trajectory or a structural weakening of Cyprus’ growth prospects could ultimately lead to a downgrade.