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Restarting Growth in Cyprus Some reflections from an international perspective Dirk Reinermann, Program Manager Southern Europe Nicosia, Republic of Cyprus July 4, 2014 The Republic of Cyprus is currently undergoing a deep recession Unemployment rate, % of labor force Real GPD growth, % 18 6 Cyprus EU15 average EU15 average Cyprus 16 4 14 2 12 0 10 8 -2 6 -4 4 -6 2 -8 0 2007 2008 2009 2010 2011 2012 2013 2014e Source: IMF World Economic Outlook database 2007 2008 2009 2010 2011 2012 2013 2 A new growth model is needed • Reliance on financial services to drive growth and welfare proven unsustainable by the crisis need to diversify • New model can build on ROC’s competitive advantages • Strategic geographic location: part of huge EU market and a bridge between Europe and Asia • Strong institutional framework • Human capital [?] • Faster growth, beyond restoring the fiscal and financial health, rests on adopting reforms that boost private investment, innovation, and global integration • To achieve this, both horizontal and vertical reforms are needed 4 Part of world’s largest and most connected economic bloc Note: Map resized according to economic strength. 5 Key blocks for a growth reform agenda in the Republic of Cyprus Trade Finance Business environment Innovation Human capital Energy Effective governance Smart industrial policy 6 Trade: Trade facilitation and logistics fall short of European and global standards Logistics Performance Index Score 4.50 4.00 3.50 Timeliness 3.00 Customs and Clearance 2.50 2.00 1.50 1.00 0.50 EU 15 Average 0.00 Cyprus Singapore Tracking & tracing Infrastructure for trade Logistics competence International shipments Source: World Bank, Logistics Performance Index 7 Trade: Export sophistication is behind some EU peers Export sophistication (EXPY) 10.7 10.6 Log of Product Sophistication (EXPY) 10.5 10.4 10.3 10.2 10.1 10.0 9.9 9.8 9.7 2008 Cyprus 2009 Germany Greece 2010 United Kingdom Source: World Bank, World Integrated Trade Solution Database (WITS) 2011 Ireland 2012 Iceland Malta 8 Finance: Need to restore the financial sector as an engine for growth… 1 35 0 30 25 -1 NPL ratio (right) ROA (left) -2 20 15 -3 10 -4 5 -5 0 € billion 2008 40 35 30 25 20 15 10 5 0 2009 2010 2011 2012 2013 25 20 Inv. to GDP (right) Res. loans (gross, left) 15 10 5 • Restructuring and recapitalization progress, but… • NPL overhang unsustainable, with… • credit contraction holding back recovery… • and the collapse in investment a telling drag on future competiveness 0 2008 2009 2010 2011 2012 2013 9 Source: CBC, SSC, ECB, IMF FSIs, BoC Finance: …while rethinking its structure and services 1,000 100 800 80 600 60 400 40 200 20 0 0 2009 2010 2011 Bank to fin. assets (right) 2012 2013 Fin. assets to GDP (left) 100% 60% 40% Non-res. loans 20% 0% 2008 2009 2010 2011 2012 • A renewed dialogue is needed on the financial structure… • …including banking sector competition • …and alternative sources of finance • And a ‘rethink’ is vital… • …on the sector as a service to the local economy • …and on its future as a international center Res. loans 80% Bank of Cyprus alone accounts for about 40% of the banking sector 2013 10 Source: CBC, SSC, ECB, IMF FSIs, BoC Business environment: Good overall, but some areas for improvement 100 Cyprus's Distance to the Frontier in Doing Business Indicators, 1-100 (best) Areas for further improvement 80 60 40 20 0 Enforcing Contracts Getting Electricity Dealing with Registering Const. Property Permits Protecting Getting Credit Resolving Paying Taxes Investors Insolvency Source: Doing Business 2014 Note: Distance to frontier is in percentage points, with 100 being the frontier Trading Across Borders Starting a Business 11 Business environment: International experiences in investment licensing reforms and WBG support Greece IL reform • Move toward ex post as opposed to ex ante regulatory control • Use of risk and risk management to determine how, where, and when to regulate Informed by good practices • Assessed common practices of 5 EU countries—Austria, France, the Netherlands, Poland and United Kingdom—to determine which features comprise an effective and efficient investment licensing regime • Case study of new investment in cardboard packaging plant detailed key administrative procedures, institutional arrangements for setting compliance standards, reviewing solicitations for permits, licenses and authorizations, executing inspections, monitoring compliance and enforcing these licenses • UK at the forefront of using market mechanisms to regulate. To understand these types of regimes better, study was expanded to assess the regulatory regimes of Australia, Denmark and New Zealand • Move toward use of self-declarations, insurance and liability markets where it is incentive compatible • With the support of the World Bank, Greece is tackling this with comprehensive investment licensing reforms that regulate licensing in several industrial and service sectors 12 Innovation: R&D spending per capita has remained well below EU average, especially in the business enterprises sector Total R&D spending (Euro per inhabitant) Business enterprise R&D spending (Euro per inhabitant) 700 450 600 400 350 500 Cyprus 400 Euro area (17 countries) 300 300 Cyprus 250 Euro area (17 countries) 200 150 200 100 100 50 0 2003 2005 2007 2009 2011 0 2003 2005 2007 2009 2011 Source: Eurostat 13 Innovation by firms can benefit from more integration with EU R&D institutions and industry Scope for catch-up: Incidence of firm-level innovation is below EU averages 50% External linkages matter: Innovative firms in Cyprus have significantly more external linkages than the average innovative EU firm 100% 40% EU15 EU27 30% 80% EU27 EU15 Cyprus 60% Cyprus 20% 40% 10% 20% 0% 0% % firms that introduced a product or process innovation % firms that introduced an organizational or marketing innovation Note: % of all enterprises Engaged in inhouse R&D activities Engaged in external Engaged in Engaged in R&D activities innovation-related aquisition of other cooperation with external knowledge other firms, clients, or R&D institutes Note: % of innovative enterprises Source: Community Innovation Surveys, Eurostat, 2010 14 Human capital: Tertiary education levels are high and growing Labor force with tertiary education (% of total) 45.0 40.0 35.0 30.0 25.0 2004 2012 20.0 15.0 10.0 5.0 0.0 EU11 average EU15 average Source: World Bank, World Development Indicators Cyprus 15 Human capital: Education outcomes are lower than in other advanced economies 16 Energy: Electricity tariffs are above the OECD average, while labor productivity and operational efficiency remain low 25 Tariff (€cent/kWh) 20 15 Cyprus 10 OECD Europe 5 0 2006 2007 2008 2009 2010 2011 2012 2006 2007 2008 2009 2010 2011 2012 Households Industry Source: Cyprus Energy Regulatory Authority Annual Reports; IEA Energy and Taxes Statistics 17 Energy: Potential to increase renewable energy • Follow a diversification strategy with the addition of renewable energy (solar, wind, and biomass) and strong emphasis on demand side management • Cyprus is geographically located in a spot where the solar irradiation is in the top segment of the global spectrum (2,200-2,600 kWh/m2). • In the medium to long term, the potential introduction of natural gas in the system will reduce costs and provide additional flexibility in the system, especially in combination with renewable energy 18 Governance and quality of institutions: Strong correlation with income per capita 12 Income per capita and government effectiveness 4 6 8 10 ru s C yp -2 -1 0 1 Government effectiveness (2.5=best) Source: Worldwide Governance Indicators and World Development Indicators 2 Governance: Changing the role of the state for growth • Public administration reform long overdue • Modernizing the public sector must be an integral part of medium-term growth strategy • In tandem with broader PFM and strategic management reforms • Centralized policy-making, decentralized decision-taking 20 Governance: Total government spending in Cyprus not the issue, public sector wage bill is Total General Government Spending, 2012 70 60 50 40 30 20 10 0 General Government Spending on Compensation of Employees, 2012 20 18 16 14 12 10 8 6 4 2 0 Source: Eurostat Government Finance Statistics. 21 Governance: Wage bill crowds out other expenditures and is not in line with economy wide productivity gains Composition of general government expenditure, 2012 (%) Cyprus: Real Earnings and Productivity, 2000-2012 130 Category Cyprus 125 Compensation of employees 34.8 23.3 Social benefits 32.1 41.0 Intermediate consumption 10.7 13.5 Interest payments 6.9 5.6 Other current expenditures 6.0 5.0 Capital investments 5.4 5.7 5.4 5.8 of which: Gross fixed capital formation Real GDP per worker (2000=100) European average 120 Average real earnings in the overall economy (2000=100) Average real earnings in the public sector (2000=100) 115 110 105 100 Capital transfers 2.9 3.0 Subsidies 1.2 2.8 Source: Eurostat Government Financial Statistics. 95 Source: World Bank calculations based on Eurostat National Accounts, Government Finance Statistics, and Cystat. 22 Smart industrial policy • • Growth of new sectors is needed to fill gap left by the drop in financial services sector According to Cyprus’s Strategy for Smart Specialization dialogue, priority sectors are tourism, energy, agriculture / food, construction, transportation / shipping and health • In tourism for example, strategies can help differentiate the island from its neighbors, extend the tourism season, and promote specific subsectors (such as diving, agrotourism, sports, and conferences) • ICT and environment were identified as an important horizontal areas 23 Designing and implementing a growth strategy requires strong coordination efforts Leadership at the highest levels of government is critical Public – Business Dialogue / Diagnostics Many reforms require interministerial collaboration Structured and ongoing dialogue with the private sector is key Evaluation of impact of reforms Service delivery measures Full and consistent implementation of reforms (including ICT tools) Identification of most important obstacles Targeted changes in laws and regulations 24 How the World Bank Group can help ROC to design and implement a growth reform agenda • Help with the “what” and “how” of a growth strategy • Stage 1: What to reform – Diagnosing the constraints to growth – Developing a strategy for growth – Identifying reforms needed to operationalize the strategy • Stage 2: How to reform – Assessing implementation gaps – Developing reform roadmaps and action plans – Identifying delivery solutions • The World Bank Group can help by – Bringing in top-notch practitioners and academics to discuss international best practice and how it can be adapted for Cyprus – Providing tailored advisory services – Delivering high quality diagnostics 25 Thank you World Bank Group Dirk Reinermann Program Manager, Southern Europe