Boston, MA -- (SBWIRE) -- 03/31/2014 -- Cyprus' major economic headwinds and ongoing territorial dispute with Turkey will remain dominant themes in policy-making over the coming years. Austerity measures and several years of economic decline could increase social tensions and give rise to marginalised political undercurrents, while efforts to develop offshore mineral resources are set to raise tensions with Turkey within a delicate geopolitical context.

The economic downturn seen in Cyprus likely peaked in 2013,but is set to continue over the next few years as there is little to suggest an improvement in domestic demand. Instead, we caution that the onset of deflation highlights that the current policy mix is ill-fitted for a prompt recovery and will in all likelihood prolong the country's economic malaise for several years to come.

The fiscal situation in Cyprus will continue to improve gradually, although insufficient emphasis is placed on generating higher revenues in the absence of economic growth. While bond yields remain well behaved, we caution that near-term rollover risk and a rapidly rising public debt load could test the sovereign's ability to return to capital markets this year. Although default risk remains muted for the time being, with bond yields below 10%, we believe it is only a question of time before Cyprus will require additional bailout funds.

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Major Forecast Changes

We have revised our 2013 real GDP growth forecast from -7.1% to -5.3%.

We estimate the current account deficit to have narrowed to 1.4% of GDP in 2013 from our previous estimate of 3.9% and project a 0.2% of GDP surplus in 2014, having previously forecasted a 1.9% GDP deficit.

We changed our nominal budget deficit forecast for 2014 from 3.2% of GDP to 4.4%.

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