Bank Bailout Would Raise Govt. Debt to 85% of GDP - Commission

If the Cypriot banking system has to resort to a government bailout, the state's debt would rise to 85 percent of GDP, further weakening the long-term sustainability of public finances at a time when Cyprus has limited access to international borrowing markets, said the European Commission in its Spring Forecast.

The government deficit is set to narrow to 3.4 percent of GDP in 2012 and 2.5 percent of GDP in 2013, according to the survey. This is higher than projections from the finance ministry which see a deficit of 2.5 percent this year.

The Commission disagrees with the finance minister's expectation that improvements in tourism will help to reduce the government's deficit, saying that weak domestic demand will outweigh tourism's benefit to the economy.

The weakest economic sectors are the housing market and reduced business investment caused by tightening bank lending conditions, according to the survey.

The island's GDP is projected to contract by 0.8 percent in 2012 due to the fall in domestic demand and persistent financial market uncertainty, says the Commission. Private consumption will be restrained by the squeeze in disposable income, mainly among public sector employees and by the rise in unemployment to unprecedented levels.

Demand for housing is expected to remain sluggish but other construction investment is likely to benefit from reconstruction work in the destroyed Vassilikos power station, said the Commission.

A recovery should set in during the second half of 2012 and economic activity is expected to recovery gradually in 2013, according to the survey.

Inflation is projected to decline marginally to 3.4 percent in 2012 from 3.5 percent in 2011, said the Commission. It should be noted that the inflation rate for April was 3.6 percent, according to the latest figures from the Cyprus Statistical Service.

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