Filenews 14 September 2022 - by Theano Thiopoulou
The next few months on the inflation front will probably be even more difficult, since the Central Bank revises upwards the forecasts for the harmonized consumer index for 2022 upwards, to 8,4%, compared to 7% that was the forecast in the CBC's economic bulletin in June 2022.
In his speech at the London Business School Alumni Cyprus Club event on September 12, Central Bank Governor Konstantinos Herodotou noted that "we expect that our domestic short-term inflation outlook will continue to remain, overall, at very high levels, similar to inflation developments in the euro area, amid the ongoing significant uncertainty and instability resulting from the Russian war in Ukraine."
"More specifically, Cyprus' harmonised consumer index (HICP) inflation for 2022 has been revised upwards in our most recent forecasts, reaching 8.4%, compared to 7% in the Economic Bulletin of the CBC of June 2022," he noted.
The central banker said that the domestic HICP is mainly attributed to the significant adverse effects of the Russian invasion of Ukraine and also to the ongoing consequences of the pandemic. More specifically, the energy component of the HICP (ie fuel and electricity prices) contributes most to the growing trend of domestic inflation (with a share of about 45% in the HICP) during the period under review, mainly due to the developments related to the Russian invasion of Ukraine, which led to the extraordinary rise in oil and gas prices on international markets.
It is worth noting that the Central Bank regularly revises its inflation forecasts, each time assessing the side effects of the Russian invasion of Ukraine, in contrast to the Ministry of Finance which has been left in the forecast for inflation of 4.5% in 2022! It is expected that the government's new inflation estimates will be given with the submission of the budget for 2023, both for 2022 and for next year.
In his speech, Mr. Herodotou also referred to the performance of GDP, pointing out that the Cypriot economy continued to record a remarkable increase in GDP, despite the outbreak of the Russian-Ukrainian war. Real GDP growth in Cyprus, he added, expanded by around 6% in the first half of 2022, mainly due to the faster than expected recovery of tourism-related activities and, to a lesser extent, to an increase in information and communication activities and professional services.
However, the Central sees that GDP performance will start to cut speed from the second half of the year and in 2023. "The weakness in the performance of the Cypriot GDP is expected to become visible in the second half of 2022 and 2023, mainly due to the expected deterioration of the outlook for the international environment. More specifically, the impact of the war is expected to be channelled directly, through the disruption of services and the rise in the prices of commodities, especially oil and wheat, as well as indirectly, through the impact on the confidence of businesses and consumers", said Mr. Herodotou.
On the labour market, the governor said it was constantly resilient. In the first half of 2022, the unemployment rate reached 6.7%, much lower than the 7.5% rate recorded in 2021. In the future, he explained, and despite the impact of the war on the sectors mentioned earlier, an ongoing downward trend in the overall unemployment rate is projected in the coming years, converging closer to full-time employment conditions in 2024, due to the projected economic expansion and the expected manageable impact of the war.
Risk to banks' profitability
A message to banks to remain cautious, prudent and active, in order to face the difficult period that awaits us, is sent by the central banker Konstantinos Herodotou, speaking at the event of the London Business School Alumni Club of Cyprus. In the section on the banking sector, the governor noted that "while the results of the first round of the geopolitical crisis have so far been manageable, the results of the second round have not yet materialized and uncertainty in an environment with high inflation and weakened growth prospects is elevated".
Adverse macroeconomic developments, the governor said, may worsen banks' profitability and asset quality, causing delays and an upward trend in provisions for bad debts. Interest rate normalisation policies, he added, may support banks' revenue capacity through higher yields. However, the governor stressed that it is vital for banks to adapt their business strategies to the new realities forged by successive crises. And this, he pointed out, would not be an easy route, as challenges arise, often in unpredictable ways.
Mr. Herodotou referred to two issues that he considers important. The first relates to the business model and structural weaknesses. Despite the fact that low profitability is a broader Structural European issue, the governor said, the cost-to-income ratio of the Cypriot banking sector, which stands at 76% in June 2022, is significantly higher than the corresponding EU average of 63%. "Investing in technology is key to efforts to unlock efficiency and bridge this gap, addressing chronic issues that affect profitability, such as cost inefficiency, limited income-generating potential, competitive pressure from entities operating outside the traditional banking spectrum, and changes in customer demands and needs."
COMMENT
Realistic forecast
More realistic sounds the central bank's new forecast for inflation of 8.4% in 2022, well above the Commission's summer estimates of 7%. Inflation does not seem to go away so easily, at least not in 2022, and the forecasts that will be given for 2023, both by the Central and the Ministry of Finance, are awaited with interest. Usually the estimates of the ministry and the Central have always been close. This is the first time that there have been exclusions in the forecasts. It's been a while since the last inflation review by the MoD. Economics, even though the facts have changed.
