Nov. 1, 2010 -
PRLog -- The government's ability to pass key legislation through parliament is under threat as the ruling AKEL Party's relationship with coalition partner DI KO is set to come under increasing strain. DI KO members have been increasingly vocal in their criticism of President Demetris Christofias and his administration this year, and early in July voted against an emergency tax proposal to shore up public finances. We believe further clashes over the best way to bring a spiralling budget deficit under control are likely in the coming months, with reunification talks with Turkish Cypriots also a potential catalyst for disagreements within the alliance. Since Socialist Party EDE K withdrew from the coalition in February this year, Christofias has been reliant on DI KO support to achieve a majority in parliament. While we do not believe DI KO will abandon the government in the near future, this support is certainly not guaranteed, and could impede policy-making at a crucial time for the economy. Given this threat, we have lowered our short-term political risk rating to 61.5, from a previous 63.8. Talks between the leaders of Greek Cyprus and Turkish Cyprus continue apace, even though April saw hardliner Dervi ş E roğ
lu replace Mehmet Talat at the negotiating table. While communication channels remain open, we retain our core view that reunification is now a highly unlikely conclusion. With both sides still deadlocked on key issues, a UN report in November will provide the best clues as to where settlement talks will go from here, with some sort of formal partition becoming more of a possibility unless a major breakthrough comes soon. As we have previously stated, a continuation of the status quo is unsatisfactory but not disastrous for the parties involved, and therefore the downside risk to political stability is limited. Fiscal consolidation has become an urgent priority, as the government attempts to rein in a budget deficit more than twice the eurozone's 3.0% Maastricht ceiling. Given our forecast for modest GDP growth over the 10-year period, structural reforms are required to keep public finances on a sustainable trajectory. We believe these are forthcoming, though doubt that the government has the capacity to meet its own ambitious targets for the coming years. Instead we target a deficit of 6.0% of GDP in 2010, falling only marginally to 5.2% in 2011 and remaining above 3.0% throughout the five-year forecast period. Cyprus continues to hold the status as a regional financial hub, due to its strong rule of law, eurozone membership and extremely low corporate tax rate (10%). However, investment activity in Cyprus will continue to be weighed down by the island's political problems and economic imbalances (namely twin fiscal and current account deficits)
, which are a major deterrent for investors. In addition, the traditionally important tourism sector is suffering from a decline in the popularity of Cyprus relative to other destinations, and faces another very difficult year in 2010. The banking sector - which has been developing rapidly in recent years - has weathered the financial storm thus far, but will continue to come under strain from external risks, particularly from neighbouring Greece.
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