Economic affairs in Cyprus are dominated by the division of the country into the southern area controlled by the Cyprus Government and the northern Turkish Cypriot-administered area. The Greek Cypriot economy is prosperous but highly susceptible to external shocks. Erratic growth rates in the 1990s reflect the economy's vulnerability to swings in tourist arrivals, caused by political instability on the island and fluctuations in economic conditions in Western Europe. Economic policy in the south is focused on meeting the criteria for admission to the European Union. As in the Turkish sector, water shortage is a growing problem, and several desalination plants are planned.

The Turkish Cypriot economy has about one-fifth the population and one-third the per capita GDP of the south. Because it is recognised only by Turkey, it has had much difficulty arranging foreign financing, and foreign firms have hesitated to invest there. The economy remains heavily dependent on agriculture and government service, which together employ about half of the work force. Moreover, the small, vulnerable economy has suffered because the Turkish lira is legal tender. To compensate for the economy's weakness, Turkey provides direct and indirect aid to tourism, education, industry, and so on.

Economy - In Depth

Cyprus has an open, free-market, service-based economy with some light manufacturing. The Cypriots are among the most prosperous people in the Mediterranean region. Internationally, Cyprus promotes its geographical location as a "bridge" between West and East, along with its educated English-speaking population, moderate local costs, good airline connections and telecommunications.

Throughout the post-Independence period, Cyprus has had a record of successful economic performance, reflected in rapid growth, full employment conditions and external and internal stability. The underdeveloped economy, inherited from Colonial Rule in 1960, has been transformed into a modern economy, with dynamic services, industrial and agricultural sectors and advanced physical and social infrastructure.

Cyprus is classified among the high-income countries, with a per capita income of CY£9,477 in 2004. It has a standard of living that is even higher than some European Union member-states and the performance of the economy compares favourably with that of most EU countries. Cyprus holds 16th place worldwide in terms of per capita income. The average annual rate of growth in the past five years was about 3.8%, while inflation stood at 2.9% and unemployment at 3.4% over that period.

These achievements appear all the more striking, bearing in mind the severe economic and social dislocation created by the Turkish invasion of 1974 and the continuing occupation of the northern part of the island by Turkey. The Turkish invasion inflicted a serious blow to the Cyprus economy and in particular to agriculture, tourism, mining and quarrying: 70% of the island's rich producing resources were lost, the tourist industry lost 65% of its hotels and tourist accommodation, the industrial sector lost 46%, and mining and quarrying lost 56% of production. The loss of the Port of Famagusta, which handled 83% of the general cargo, and the closure of the Nicosia International Airport, in the buffer zone, were additional blows.

The success of Cyprus in the economic sphere is attributed, inter alia, to the adoption of a market oriented economic system, the pursuance of sound macroeconomic policies by the government as well as the existence of a dynamic and flexible entrepreneurship and a highly educated labour force. Moreover, the economy benefited from the close cooperation between the public sector and the social partners.

In the past 20 years, the economy has shifted from agriculture to light manufacturing and services. The service sector, including tourism, contributes 76.8% to the GDP and employs 54.4% of the labour force. Industry and construction contribute 19.6% and employ 38.2% of labour. Agriculture is responsible for 3.7% of GDP and 7.4% of the labour force. Potatoes and citrus are the principal export crops.

After robust growth rates in the 1980s (average annual growth was 6.1%), economic performance in the 1990s has been mixed: Real GDP growth was 9.7% in 1992, 1.7% in 1993, 6.0% in 1994, 6.0% in 1995, 1.9% in 1996, 2.3% in 1997 and 3.8% in 2006. This pattern underlines the economy's vulnerability to swings in tourist arrivals (i.e., to economic and political conditions in Cyprus, Western Europe, and the Middle East) and the need to restructure the economy. Declining competitiveness in tourism and especially in manufacturing will act as a drag on growth until structural changes are effected.

Trade is vital to the Cypriot economy - the island is not self-sufficient in food and has few natural resources - and the trade deficit continues to grow. Cyprus must import fuels, most raw materials, heavy machinery, and transportation equipment. More than 50% of its trade is with the European Union (especially the UK); the Middle East receives 20% of exports.

Cyprus signed an Association Agreement with the European Union (EU) in 1972, which resulted in the establishment of a Customs Union between the two sides. Cyprus applied for full EU membership in 1990 and has since linked the Cyprus pound to the European Currency Unit (ECU). EU accession negotiations started on March 31, 1998. In 1991, Cyprus introduced a Value Added Tax (VAT), which is currently 15% in line with the EU minimum. Cyprus ratified the new world trade agreement (GATT) in 1995 and began implementing it fully on January 1, 1996.

On May 1, 2004, Cyprus became a full member of the EU.

The economic benefits of EU accession to Cyprus, as a whole, are quite substantial. Cyprus goods and services will have access to a huge single market consisting of some of the most advanced countries in Europe. Cyprus' participation in the Union's internal market, an area where free movement of goods, services, persons and goods is ensured, will lead in the long term to a more efficient allocation of factors of production towards activities in which Cyprus possesses comparative advantages. This will have positive repercussions on growth and employment.

Cyprus will have a share in the growth and development of the EU economy. It will attract investment from the EU in activities in which Cyprus possesses comparative advantages, thus accelerating the transformation of Cyprus into a regional business centre. Moreover Cyprus will benefit from increased EU financial assistance.

In the new age of globalisation and world economic integration, in an era marked by a technological revolution, which encompasses all sectors of the economy, the key to success is competitiveness coupled with high quality manufactured goods and services and the ability to adjust quickly to the ever changing preferences of the consumers.

Cyprus has the fourth-largest ship registry in the world, with 2,758 ships and 25.5 million gross registered tons (GRTs). It is an open registry and includes ships from more than 43 countries, including Greece, Germany and Russia.

Export Opportunities

Cyprus has been liberalising its trade regime by eliminating import quotas and licenses and lowering tariffs on most products as a result of its obligations under the new world trade agreement and its Customs Union agreement with the European Union. As a result, U.S. products are becoming more competitive in Cyprus and prospects for further expansion of bilateral trade ties are excellent.

Government computerization and telecommunications development, two of the priorities of the government's 5-year development plan (1994-1998), provide excellent opportunities for U.S. exports. Sales of computer-assisted design systems, new capital equipment for textile, clothing, footwear production, medical equipment, environmental equipment, and services are also expected to grow.

Investment Climate

In February 1997, the government revised its policy on foreign direct investment, permitting 100% foreign ownership in certain cases. Regulations on foreign portfolio investment in the Cyprus Stock Exchange also have been liberalized. Additionally, Cyprus passed a modern banking law in July 1997, incorporating all the provisions and directives of the EU for the prudential supervision of credit institutions.

Cyprus has concluded treaties on double taxation with 26 countries, including the U.S., and has removed exchange restrictions on current international transactions. Non-residents and foreign investors may freely repatriate proceeds from investments in Cyprus.

Offshore Sector

The 1,049 full-fledged offshore companies- - which are located in Cyprus but conduct business abroad only - qualify for various tax- and duty-free concessions. Foreign exchange earnings from offshore companies rose to $346 million in 1997.

Turkish Cypriot Economy

The economic disparity between the two communities is pronounced. Although the Turkish Cypriot area operates on a free-market basis, the lack of private and governmental investment, shortages of skilled labour and experienced managers, plus inflation and the devaluation of the Turkish lira (which the Turkish Cypriots use as their currency) continue to plague the economy.

Turkey is, by far, the main trading partner of the "T.R.N.C.", supplying 55% of imports and absorbing 48% of exports. In 1994, the European Court of Justice (ECJ) ruled that only goods bearing certificates of origin from the Government of Cyprus could be recognised for trade by EU member countries. That decision resulted in a considerable decrease of Turkish Cypriot exports to the EU: from $36.4 million (or 66.7% of total Turkish Cypriot exports) in 1993 to $24.7 million in 1996 (or 35% of total exports) in 1996. Even so, the EU continues to be the "T.R.N.C.'s" second-largest trading partner, with a 24.7% share of total imports and 35% share of total exports.

Assistance from Turkey is the mainstay of the Turkish Cypriot economy. Turkey undertakes to provide Turkish Cypriots loans for the purpose of implementing projects related to public finance, tourism, banking and privatisation. Fluctuation in the Turkish lira, which loses about 50% of its value against the U.S. dollar every year, continues to exert downward pressure on the Turkish Cypriot standard of living.

Turkish Cypriot separatist authorities have instituted a free market in foreign exchange and authorise residents to hold foreign-currency denominated bank accounts. This encourages transfers from Turkish Cypriots living abroad.