How Cyprus went from economic miracle to desperate times

Cyprus has been growing steadily since 1977 – so what went wrong?

Three wars and the collapse of the Soviet Union explain how banking became the Cypriot republic’s chief economic sector.

In 1974, Turkey invaded and occupied the northern 36 per cent of the island, appropriating 70 per cent of its productive capacity, largely represented by citrus orchards, small industries, property and tourism. Greek Cypriots, who accounted for 82 per cent of the population in north and south, fled or were expelled to the south where the government encouraged hard work and self-reliance and imposed strict austerity.

In August 1977, The Economist carried an article entitled "Miracle in half an island," on Cyprus's economic recovery.

A second war, the Lebanese civil conflict, 1975-90, became a major factor in the country’s economic advancement. Tens of thousands of Lebanese and thousands of international professionals who had been based in Beirut poured into the country. Foreigners were granted temporary residency, rented flats, bought furnishings and vehicles, opened bank accounts, and put their children in schools, injecting funds into the country’s small economy, expanding it onshore and providing outreach. Nicosia became the main base for the Middle East press corps.

In 1976 parliament passed legislation imposing a 10 per cent tax on offshore firms and began to negotiate double taxation agreements.

These agreements solidified Cyprus’s economic relations with the Soviet Union and East European states. The Cypriot connection with Russia and Eastern Europe is multi-dimensional and goes beyond business and finance to faith and politics. The Cypriot Orthodox Church has strong ties to the Russian and Eastern European churches and AKEL, the powerful Cypriot Communist party, also enjoyed close relations with its counterparts during the Soviet era.

Thousands of businesses set up shop in the republic or established representative offices. These firms were encouraged by an efficient bureaucracy, simple procedures, lack of corruption, and good infrastructure – by contrast with Greece, another destination for refugees from the Lebanese war, many of whom regretted not coming to Cyprus.

The collapse of the Soviet Union in 1991 and the subsequent ethnic wars in the former Yugoslavia brought fresh injections of funds into Cyprus from, as one Cypriot put it, “our Orthodox brothers”. Russian and Serb banks, businesses and individuals deposited billions in Cypriot banks. Bulgarians, Ukrainians, and Romanians contributed too.

Russians and East Europeans came to Cyprus because of instability in their own banking sectors and political and economic uncertainty in their home countries where the transition from centrally controlled to market economies was chaotic, painful and, occasionally, dangerous due to exploitation by mafias and rapacious governments.

Cyprus promoted itself as a gateway to Europe and, after it joined the EU in 2004, Cyprus attempted to serve as an Eastern Mediterranean financial hub for East European and Arab investors and enterprises seeking entry into European markets. The growth of the financial sector was accompanied by a tourism boom. Despite volatility in Greece, banks bought high earning Greek bonds and invested in businesses there and property in the Balkans.

As tourist arrivals increased, developers, hoteliers, and restaurateurs borrowed from Cypriot banks to provide facilities for visitors and expatriate residents. The construction sector boomed due to the demand for flats and villas from expatriates and retirees seeking to settle in Cyprus.

In 2010 Cyprus began to feel the pinch of the recession. While tourism thrived, construction and real estate were hit hard and property prices fell. Unemployment rose to 15 per cent and banks were troubled by non-performing loans. The Greek economic meltdown cost Cypriot banks, businesses, and investors an estimated €29 billion, 160 per cent of GDP.