For a country that earns its keep by catering to foreign holiday makers, Cyprus has a most unhelpful tourist attraction in the Green Line. An untidy barrier of concrete, old tires and barbed wire, the line separates the Greek Cypriot south of the island from the Turkish Cypriot north. At the main crossing point at Nicosia’s Ledra Palace Hotel, which houses United Nations peacekeeping troops, the contrast between the two sides is overwhelming. Just a five-minute stroll to the south, tourists and wealthy Greek Cypriots sip cappuccinos in trendy cafés on Makarios Avenue and snap up the latest fashions at the local outlets of Gucci and Prada. Five minutes to the north, past disused colonial buildings and a Turkish Army checkpoint proclaiming “North Cyprus Forever,” squalor and neglect abound. The Saray, the only hotel, is still pockmarked with bullet holes from Turkey’s 1974 invasion, and vendors in the main market sell cheap counterfeit clothes from Turkey.
The Green Line is all the more incongruous because of Cyprus’s status as a new member of the European Union. Enlargement was a historic healing act that put an end to the cold war division of Europe by bringing eight former Communist countries of Central and Eastern Europe into the EU fold. But Cyprus brought a new division into the Union when it joined in May, and the island’s age-old ethnic rivalries seem impervious to the unifying force of European integration.
Cyprus -- the Greek Cypriot part of it, that is -- is at once the EU’s most prosperous and most problematic new member. The island’s Mediterranean climate, well-established tourist industry and Anglo-Saxon legal and business traditions -- a legacy of British colonial rule before independence in 1960 -- have produced living standards in the south that are higher than in any other accession country. EU membership ought to extend that prosperity by fostering deeper trade and investment links with Europe. Because of accession, says Andros Kourouna, head of development at Leptos Estates, the island’s largest real estate developer, “people clearly feel more secure buying property here, and that has been very good for us.”
But the 30-year-old political division between the Greek Cypriot south and the Turkish Cypriot north threatens to deny Cyprus the full benefits of EU accession. The divide resulted from Turkey’s invasion of the island’s northern half after a Greek Cypriot coup attempt. The persistence of this rift threatens to frustrate government-led efforts to revive growth in tourism, which generates nearly half of the country’s foreign exchange earnings, after a downturn in 2002 and 2003. It also is stymieing efforts to attract foreign direct investment, a key goal for a country that lags behind even Serbia in that regard. As for the Turkish Cypriot north, which remains outside of the EU, the economy looks set to languish, with average income barely one third that of its southern neighbor.
The prospects for ending the island’s division appear worse than at any time in recent years. Political positions have hardened on both sides of the Green Line since April, when Greek Cypriots overwhelmingly rejected a U.N.-sponsored peace plan that Turkish Cypriots had strongly endorsed in a separate referendum. The U.N. plan would have created a loose central federation over separate regional administrations. It also would have returned some 8 percent of the island’s territory to Greek Cypriot control, including the rich agricultural area around the town of Morphou, on the island’s north-central coast.
Before talks can be reopened, Greek Cypriot President Tassos Papadopoulos demands fundamental changes to the plan as well as greater security guarantees from Turkey. He contends that separate regional administrations would perpetuate the island’s divide and prevent the kind of unified economic policymaking that would foster growth and attract investment. He also wants stronger assurances that Turkey would follow a timetable for withdrawing the bulk of its 35,000 troops in the north, and demands the repatriation of an estimated 80,000 Turkish settlers. Turkish Cypriots, however, are ruling out any changes to the U.N. plan. Faced with a stalemate, the EU and the U.N., which had counted on the carrot of accession bringing both sides to an agreement, have largely abandoned peacemaking efforts for the time being, now that that leverage has vanished.
The EU has proposed a substantial E259 million ($311 million) aid package for the north as well as the opening of direct trade relations -- a step that would end the region’s long isolation. (Turkey is the only country to recognize the Turkish Republic of Northern Cyprus.) EU officials hope the moves will promote eventual unification by boosting investment and living standards in the north. The Dutch government, which holds the EU’s rotating presidency, is pushing hard to reach agreement on the package this fall, before the Union decides whether to open membership negotiations with Turkey. Failure to reach a deal could threaten Turkey’s EU ambitions because Cyprus, as a new EU member, holds a potential veto over enlargement.
Greek Cypriots oppose the EU plan, arguing that trade links would cement partition by extending recognition to the north. As an EU member, Cyprus has the power to veto the aid package, which requires unanimous approval.
EU officials admit they have little leverage over the Greek Cypriots now that they are Union members, either to force through the aid package or to get reunification talks going again. “The EU has no competence or mandate,” says a senior official in the European Commission, the EU’s executive agency. “New initiatives can only come through the U.N., which has indicated that unless the Greek Cypriot position changes, there are no prospects for further negotiations.”
The obstruction has left Turkish Cypriots bitter. “We wanted to end division and reunite with the world, but get nothing, while the Greek Cypriots vote no, yet get all the benefits of EU accession,” Mehmet Ali Talat, prime minister of the Turkish Republic of Northern Cyprus, tells Institutional Investor (see box, opposite).
Government spokesman Kypros Chrysostomides insists that Nicosia is willing to resume negotiations if its concerns about security and the repatriation of Turkish settlers are addressed.
“Our aim remains reunification, and we will continue to try to secure this with every means available to us,” Chrysostomides tells II. But the government displays few regrets about the collapse of the U.N. plan or the fact that the U.N., the EU and the U.S. place the blame squarely on Greek Cypriot intransigence. “We need a good solution that reunifies the economy and is workable,” says Yiorgis Lilikas, minister for Commerce, Tourism and Industry. “If, as seemed likely, the U.N. plan had collapsed within a few months, we are better off without it.”
EU leaders would lose little sleep if the deadlock affected only the island, of course. With some 730,000 residents in the south and about 150,000 in the north, Cyprus accounts for less than one quarter of 1 percent of the enlarged Union’s population. But the standoff poses a big political problem because it complicates the bloc’s much larger goal of normalizing relations with Turkey. The European Commission is expected to recommend this autumn that the bloc open membership negotiations with Turkey. Officials worry that President Papadopoulos could use his veto to block Turkey’s membership bid when EU leaders decide on the issue in December.
Spokesman Chrysostomides insists that although the government retains the right to exercise its veto, Cyprus is “too small to play political football” with Turkey’s candidacy. “Our demand for a fair and equitable solution to the Cyprus problem and Turkey’s accession to the EU remain separate issues,” he says.
Papadopoulos has been deliberately vague, saying he won’t exercise his veto “provided Turkey acts like a European country.” Still, the veto remains his best weapon to force the EU and the U.N. to take his demands for changes to the U.N. plan more seriously. Papadopoulos could claim that Turkey’s failure to recognize the Republic of Cyprus -- an EU member state -- and its occupation of the north with 35,000 troops are tantamount to not acting like a European country.
“As he showed at the referendum, he is not afraid to take steps that are deeply unpopular internationally,” says James Ker-Lindsay, head of Civilitas Research, a Nicosia-based political consulting firm.
FOR ALL OF THE POLITICAL PROBLEMS, CYPRUS -- the Greek Cypriot portion, that is -- enjoys a degree of prosperity unmatched by any of the other nine states that joined the EU this year. On a purchasing power parity basis, per capita income was E17,800 in 2003, or 76 percent of the average of the 15 preaccession EU members. That’s ahead of not only such new members as the Czech Republic, at 63 percent, but even a longtime member like Greece, which stands at 71 percent of the preaccession EU 15 average. Growth in Cyprus is expected to accelerate to about 3.4 percent this year from 2 percent in 2003, according to EU projections. Thanks in part to the glow of the Summer Olympics in neighboring Greece, tourist visits have begun to recover after having fallen by 10 percent in 2002 and 5 percent in 2003. Inflation and unemployment, meanwhile, remain very low at just more than 2 percent and 4 percent, respectively.
And Cyprus faces none of the dramatic restructuring challenges of Central and Eastern Europe. There is no legacy of central planning to overcome, and the transportation and telecommunications networks are modern. Services, including tourism, account for three quarters of GDP, while construction and manufacturing generate 10 percent each and agriculture just 5 percent.
“Our customs agreement with the EU and our strong export orientation meant most sectors of the economy had adjusted to the challenges of accession long before May 1,” says Leonides Paschalides, head of EU relations at the Cyprus Chamber of Commerce and Industry. “Uncompetitive sectors, such as footwear and textiles, have declined, while the others have fully adapted to EU technical, safety and other standards.”
EU membership poses other challenges to Cyprus, however, beginning with the need to close a yawning budget gap. The deficit ballooned to 6.3 percent of GDP last year as sluggish growth and tax evasion hit revenues while the government boosted defense spending. The deficit, combined with a growing debt that stands at 73 percent of GDP, threatens to force the government to postpone its goal of adopting the euro in 2007.
In an effort to keep that goal alive, Finance Minister Makis Keravnos proposed a tough austerity package in June that aims to slash the deficit to 5.2 percent by the end of this year, to 2.9 percent in 2005 and to 2.2 percent in 2006. That would bring Cyprus under the 3 percent deficit ceiling set in the Maastricht Treaty for countries using the euro and start bringing the debt ratio down toward the 60 percent target level for the euro zone.
“We are confident that the fiscal deficit will fall under 3 percent of GDP by the end of 2005 and the public debt will be set on a declining trend, thus fulfilling all Maastricht criteria,” says Keravnos.
Few people share Keravnos’s optimism. The minister promised similar budget reductions last year, only to let spending rip. Consider the size of the public sector. Keravnos aims to achieve most of his budget savings this year by cutting the civil-service payroll, which accounts for almost 40 percent of government spending, and by freezing wages. But in 2003, when similar savings were pledged, the payroll actually surged by 18 percent as the government of thenprime minister Glafcos Clerides granted big pay increases ahead of the February 2003 elections. Then the civil-service head count grew by 700 under Keravnos’s stewardship, to 31,700.
In his latest budget the minister also proposes to increase the retirement age for civil servants from 60 to 63, which would reduce pension payments. Predictably enough, the cuts are strongly opposed by civil-service unions, which have threatened to strike unless they receive a 2 percent pay increase for next year. “We are aware of the economy’s difficulties and the government’s convergence measures, but we can’t accept that workers have to pay every time,” says Nicos Tampas, head of the trade union SEK.
Keravnos also faces opposition from AKEL, the Communist party, whose participation in Papadopoulos’s coalition reflects the fact that nationalism and personality drive Cypriot politics more than ideology. Stavros Evagorou, a senior AKEL member of Parliament, said recently that “it would not be the end of the world” if Cyprus adopted the euro in 2008 or 2009 instead of 2007.
The Finance minister also aims to crack down on tax evasion, which is believed to cost some 170 million Cyprus pounds ($365 million) a year, or 5 percent of the budget; impose new levies on real estate transactions, ports, airports and mobile telephones; and slash defense spending to C£70 million from C£250 million this year.
The European Commission, which vets member states’ budgets, is skeptical about the fiscal package. Keravnos’s proposals would introduce so many deficit-cutting measures at one time that the package “might complicate implementation, both practically and politically,” the commission said in an initial assessment in June. EU finance ministers will review Cyprus’s budget next month and could order bigger spending cuts or revenue-raising measures.
Many local economists and business executives also fear that the government will miss its 2007 target date to join the euro zone. “It’s unrealistic,” says Yiannis Tirkides, an economist who is head of investments at Laiki Cyprialife, the life insurance arm of Laiki Group. He warns that Keravnos must rein in public sector wages or risk eroding the country’s competitiveness, given that public pay deals set a benchmark for the private sector. “Government in this country is the wage leader,” he says.
Cyprus has had great success in luring European property buyers, judging by the current building boom, but its record of attracting more substantial investors is poor. The country’s stock of foreign direct investment is estimated at about $570 million, or just under $800 per person. In Central and Eastern Europe, by contrast, FDI inflows since the collapse of Communism range from about $1,000 per person in Poland to more than $3,500 in the Czech Republic. Even Serbia and Montenegro, the rump state of the former Yugoslavia that endured a decade of civil warfare and trade embargoes, has attracted $850 per person in FDI.
The government hopes to improve Cyprus’s attractiveness with a new corporate regime, adopted in preparation for accession. The new system imposes a single corporate tax rate of 10 percent, the lowest in the EU and a steep drop from the previous 25 percent level. Officials hope the low rate will lure foreign investors focusing on the wider Mediterranean and Middle Eastern region.
“Cyprus has traditionally been a meeting place of three continents -- Asia, Africa and Europe -- and I see the benefits becoming even greater with accession,” contends Commerce Minister Lilikas.
The new regime carries a sting as well as opportunity, though. The new 10 percent rate represents a sizable increase for the island’s big offshore sector, which previously enjoyed a special tax rate of just 4.25 percent. The government also has abandoned Cyprus’s tradition of banking secrecy to comply with EU regulations. Now banks are required to demand identification from anybody opening an account, and tax authorities may request information about depositors. Such requirements could pose a serious threat to the offshore banking industry, which holds an estimated C£4.5 billion in deposits -- including a chunk of Russian flight capital -- compared with about C£8.4 billion in domestic deposits. To reduce that threat, the government has offered a partial tax amnesty that allows secret account holders to declare their holdings and be taxed at a preferential rate of 5 percent until the end of this year, when the rate rises to 6.5 percent.
Bankers say privately that they expect to lose some deposits because of the new transparency, but they believe they can compete on the basis of products and services. “We are no longer an offshore banking center, but with our links to Europe and the Middle East, the opportunity to become a leading financial center -- maybe another Luxembourg -- is considerable,” says Michalis Kammas, director of the Association of Cyprus Commercial Banks.
Tourism, the linchpin of the local economy, also faces pressure. The industry is still reeling from the downturns of 2002 and 2003, when the SARS outbreak and the onset of the war in Iraq depressed tourist arrivals.
The national flag carrier, Cyprus Airways, has been hit hard by the dips as well as by growing competition from new budget airlines like Helios Airways, which has bitten into the all-important Larnaca-London route. Management announced a tough restructuring in August that will lay off 10 percent of the workforce, ax unprofitable routes and sell at least two of the airline’s ten planes. With debts of C£40 million and cash to last only until next month, the company says the cutbacks are its last hope of averting bankruptcy.
For the airline and its economy, Cyprus needs to get tourist numbers growing again. The government has projected a 5 percent increase in arrivals this year, to 2.3 million, and aims to grow that number to 3.5 million by 2010. Its seven-year development plan, adopted in 2003, calls for increasing the number of hotel beds by 25 percent, to 120,000, by the end of the decade, building a dozen new golf courses and creating a new marina on the south coast near Limassol. “Our accession to the EU means that people who had not previously considered Cyprus as a destination will now want to come and see what we have to offer,” Commerce Minister Lilikas contends.
Cyprus is a relatively high-cost destination, however, and it faces increasing competition. Cheap, long-distance holiday packages lure growing numbers of Europeans to places like Thailand and Malaysia, or, closer to home, Turkey. The republic may even be losing tourism business to northern Cyprus, which enjoyed a 33 percent surge in visitor numbers last year after Green Line border crossings were opened as part of the island’s peace process.
To be sure, the threat of competition from the north pales in comparison with the advantages for both sides if Greek and Turkish Cypriots can resolve their differences and end the island’s bitter divide. The business community knows that reunification would mean new opportunities for tourism and construction and would boost the island’s appeal to foreign investors.
“Any solution that allows free movement of capital and people and poses no impediments to business will have a major positive impact on the economy,” says the Association of Cyprus Commercial Banks’ Kammas.
Finance Minister Keravnos acknowledges that an agreement “would enhance growth prospects” in the long term despite imposing “substantial” budgetary costs to improve infrastructure and promote development in the north in the short term.
Prospects for resuming the peace process appear dim in the wake of the referendum defeat, however. Papadopoulos’s government is opposing the EU proposals to initiate direct trade with the north and open direct flights, and it threatens to veto the E259 million EU aid package.
To counter the EU’s trade proposals -- and refute suggestions that it is not really interested in ending the island’s division -- Papadopoulos’s government has offered a plan of its own. In July it proposed that both sides pull back troops and create a two-kilometer-wide demilitarized zone around the Green Line, with eight new crossing points between north and south. The government also proposed measures to boost intra-island trade, including allowing most northern goods to be sold in the south or reexported to the EU free of duties. Turkish Cypriot Prime Minister Talat dismissed both initiatives, calling them a distraction from the U.N. plan.
Recent opinion polls show that a majority of Greek Cypriots would favor another referendum on the U.N. peace plan if the government’s security concerns are addressed and steps are taken to ensure that Turkey honors its commitments under the plan. The problem remains Papadopoulos, who suggests that he merely wants to secure better terms but has made no effort to unblock the political stalemate.
“His opposition seems fundamental,” says consultant Ker-Lindsay. “If he were to come out and ask for a few changes to make the plan acceptable to Greek Cypriots, the U.N. -- and probably Turkey and the Turkish Cypriots -- would probably try to oblige, but he refuses to put his cards on the table.”
Until he does, there is little prospect of resolving the island’s division, or of realizing its full economic potential.
A view from the other side of the Green Line
Mehmet Ali Talat scored a surprise victory in parliamentary elections in the Turkish Republic of Northern Cyprus in December 2003 after campaigning strongly in favor of the United Nations’ plan for reunifying the island. The plan lies in limbo since its rejection by Greek Cypriots in an April referendum, but Talat is campaigning with renewed vigor for direct trade relations with Europe that would end his breakaway republic’s long isolation. The prime minister spoke to Institutional Investor Contributor Justin Keay about the north’s prospects.
Institutional Investor: Some two thirds of Turkish Cypriots voted yes in the April referendum on the U.N. peace plan, while almost three quarters of Greek Cypriots voted no. How do you explain this result?
Talat: As far as the Turkish Cypriots are concerned, it proved our desire to reintegrate with the global community and put isolation behind us, despite the fact that the plan would have dislocated one third of our people. The result also reflected the fact that Turkish Cypriots were well informed about the plan, despite the efforts of some of our politicians to spread misinformation. For the Greek Cypriots, the result demonstrated just the opposite -- the extent to which their politicians, who made negative propaganda to try and get more concessions from us, misinformed them. During the negotiations the Greek Cypriot media and government were universally negative, with ministries stressing that Greek Cypriots would bear most of the costs, which were exaggerated.
Where do you go from here? What are your priorities?
The main one is to end our international isolation. As the U.N. secretary general said after the referendum, the logic behind this isolation -- to prevent our secession and setting up a separate state whose recognition would mean the end of a united Cyprus -- has been undone by our voting for unification and a solution to the Cyprus problem. Thus it is no longer fair to isolate us from the rest of the world.
Ending this [isolation] won’t further separation. On the contrary, it will promote unification by making the Greek Cypriots act more constructively and realize they cannot punish us forever.
What specific steps are you seeking?
Direct flights and the right to trade -- preferentially -- through our own ports. The first is vital for our tourist industry, which is in turn crucial to our economy. As regards trade: Cyprus is a member of the EU, so we have the right to export to EU markets without taxes or customs duties. The problem is that Greek Cypriots continue to oppose this. Although they say they want to represent us, they want to strangle us and prevent us breaking from the isolation they have imposed on us. If the international community recognizes our rights -- by allowing direct flights and allowing exports from our ports -- I believe the Greek Cypriots will be forced to reassess the situation.
Anyone crossing the Green Line can see that your economy is in desperate need of revitalization. Per capita income is between one fifth and one third that of the south, and unemployment is estimated at about 40 percent. What are you doing to redress this?
What we need is large-scale foreign investment and an end to isolation. The opportunities are obvious. We have beautiful, unspoiled countryside and a historical and cultural heritage. I believe many companies would be keen to invest.
I’ll give you an example of how bad our unemployment is. Recently, 24 temporary positions were advertised in one of our hospitals. We had 1,046 applications!
How do you envisage the next few months? What if the international community fails to end the north’s isolation?
Ending our isolation -- starting with direct flights -- will transform the situation in Cyprus and make Greek Cypriots reassess the situation. At the moment, they know what they don’t want but not what they do want. This will change. The U.N. plan is shelved but is still there; it could be revived.
In the meantime, we will work to harmonize our economy with the EU. The E259 million [$319 million] promised by Brussels will go toward this. The important thing is to sustain the momentum, to keep the pressure on the U.S. and the EU to end our isolation and give us our rights. Otherwise the hopes of Turkish Cypriots will fade, and we may see a return to the less-constructive attitudes that dominated here for so long.
Misgivings in Malta
The tiny Mediterranean island of Malta is not only the smallest new European Union member, it’s also arguably the least enthusiastic.
Malta is one of the two former British colonies to join the EU this year, along with Cyprus, and it shares the U.K.'s ambivalence about Brussels. A narrow majority of 53.4 percent of voters approved accession in a referendum in 2003 -- the slimmest margin of any new member state. Malta’s Labour Party was the only main opposition party in the accession club to oppose membership.
“We wanted to continue cooperation with the EU without being part of it, because I feel joining loses us flexibility,” says Labour Party head and former prime minister Alfred Sant. “Now our priority is to minimize the disadvantages and spread any advantages evenly across the social spectrum.”
The fact that the Maltese overcame their skepticism owes much to the aggressively pro-EU stance of President Edward Fenech-Adami and Prime Minister Lawrence Gonzi. Fenech-Adami, who served as Nationalist Party leader and prime minister for all but two of the past 15 years until ascending to the presidency in March, dedicated his career to obtaining EU membership.
“Culturally and historically, we have a long sense of belonging in Europe,” he tells Institutional Investor. “Our membership is not just about business.”
That may be so, but EU membership poses significant business and fiscal challenges to the small island state of 400,000 people. Many EU opponents feared that membership would threaten the country’s protected ship repair industry. To join the EU, Malta agreed to phase out subsidies to the business by 2010. The government moved to restructure the state-owned industry last November by merging Malta Drydocks and Malta Shipbuilding to create Malta Shipyards. The new entity, which has debts of E644 million ($790.5 million), is in the process of slashing employment by one third, to 1,700.
Other critics contend that the government’s single-minded focus on the EU led it to ignore pressing domestic issues. Because of a sluggish tourism market, the economy has been effectively stagnant since 2000, with growth hitting just 0.4 percent last year. Unemployment has risen to 8 percent, while the budget deficit is projected at 5.2 percent of GDP this year, down from a whopping 9.7 percent in 2003, when it was bloated by restructuring aid for the shipyard industry.
The government’s convergence program doesn’t envisage getting the deficit below the 3 percent ceiling for countries seeking to join the euro until 2006, and even that goal would require deep cuts in health and pension spending that ministers haven’t fully specified yet. As a result, Malta looks unlikely to be in the first wave of accession countries that hope to adopt the euro in 2007. Prime Minister Gonzi says only that the government hopes to adopt the single currency as soon as possible.
High labor and land costs, excessive bureaucracy and the tiny size of the Maltese market have discouraged the inflows of foreign investment seen in other accession countries. In terms of purchasing power parity, per capita income stands at about E16,200 -- 70 percent of the average of the 15 preaccession EU countries but well ahead of the eight new Central and Eastern European members.
Evarist Bartolo, Labour’s European affairs spokesman, believes that Malta has simply exchanged its colonial past for EU tutelage. “We still feel redemption can come only from outside,” he says sardonically of his countrymen. Instead, Bartolo says Malta needs to tackle its perennial problems of corruption and poor management, which have contributed to the continuing fiasco at a long-delayed hospital under construction just outside the capital of Valletta. Budgeted at 80 million Maltese liri ($230 million), its cost has risen to more than 200 million liri amid widespread reports of alleged kickbacks. The project is more than two years behind schedule.
“A recent study by the Commonwealth Institute suggested that in small island states laws and regulations don’t exist, only personal relationships,” says Bartolo. “This is very much the case in Malta, where the private sector is almost completely dependent on the government for contracts.” The Labour spokesman believes his country needs a new system of checks and balances as well as a cultural change.
Such pro-EU Maltese as Fenech-Adami and Gonzi hope membership will force greater competition and transparency. They also see opportunity in acting as an economic bridge between the EU and North Africa. Malta lies just 180 miles off the cost of Libya and has had a special relationship with the government of Colonel Muammar Qaddafi since the 1970s, when the thenprime minister, Labour leftist Dom Mintoff, struck an accord that secured oil supplies from Libya at below-market prices. The two countries agreed last year to cooperate on offshore oil exploration in the Mediterranean, and with Libya restoring commercial and diplomatic relations with Europe after renouncing terrorism and abandoning its nuclear weapons program, the prospect for further deals appears bright.-- J.K.
