Geopolitical tensions create uncertainty and fiscal planning and the state budget should reflect that uncertainty, Constantinos Herodotou, Governor of the Central Bank of Cyprus said on Monday.

Attending a meeting of the parliamentary committee of Financial and Budgetary Affairs which began the examination of the 2024 state budget, Herodotou said that on the basis of the September 2023 CBC projections the Cypriot economy will expand by 2.4% this year and GDP growth will accelerate to 2.7% in 2024 and 3.1% in 2025.

He noted however that these projections were drafted before the war in Israel which resulted in uncertainty concerning possible impact on the Cypriot economy which will depend on the intensity and the duration of the war.

“It is important the planning and the budget of the country to take into account this uncertainty, allowing flexibility to deal with the crisis depending on its range and duration,” he said in statements following the meeting, describing the budget’s assumptions as satisfactory.

Herodotou also stressed the resilience of Cyprus' banking sector, noting that for the time being the Cypriot banks are in a position to weather a possible crisis.

Speaking before the committee, Herodotou said the state budget for the period of January to September has registered a surplus of 3% of GDP, with state revenue rising by 16.8% year on year, fuelled by both economic growth and increased income due to high prices.

On the state expenditure, the CBC Governor said that they rose by 9.3% in the first eight months, driven by higher wages of state employees and higher welfare spending. He cautioned that risks emanate from pressures for even higher wages, expenditure associated with the National Health Scheme (GEsY) and higher debt servicing costs, although state coffers have high buffers, he noted.

With regard to the banking sector, Herodoou said that despite continuous challenges, the Cypriot banks are resilient with a Liquidity Coverage Ratio of 327% which is more than double of the Euro area average, while Common Equity Tier 1 Capital (CET1) amounting to 18.9% compared with the Euro area average of 15.9%. He however noted that Cypriot banks maintain higher capital levels as they face higher risks.

According to the CBC Governor, despite rising interest rates, until July 2023 no inflow of new non-performing loans was recorded, while loans at stage 2, which shows credit deterioration, were down by 6.9% in the first half of the year.

Herodotou pointed out that in the first eight months of 2023, loan renegotiations spiked to €3 billion compared with €1.4 billion in the same period last year, driven by high interest rates.

“We continue to monitor the situation and to press banks for renegotiations and restructurings to avert a rise in NPLs,” he added.

Moreover, Herodotou said new lending in the first half of this year amounted to €2.08 billion broadly unchanged year on year, with corporate loans rising and housing loans declining.

According to Herodotou, new lending for house purchase dropped to €469 million in the first half of 2023 from €700 in the same period of last year, a reduction associated with rising interest rates.

With regard to the pass through of rising rates to new lending in Cyprus compares favourably with the Euro are average, whereas Cypriot banks are lagging behind in interest rates for deposits. He explained that a significant increase in deposit rates would affect Cypriot banks due to their high liquidity, fuelled by deposits.

Moreover Herodotou said according to data as at end-2022, 44% of total loans in Cyprus are associated with the Euribor interest rate, which is most affected by the ECB rate hikes, whereas 30% are with a floating rate but associated with the bank’s basic rate which is less sensitive to ECB interest rate changes.

According to Herodotou only 13% of the loans in Cyprus are associated with a fixed interest rate.