Economic Growth vs. Inflation: Challenges Facing the Turkish Cypriot Economy

The World Bank’s report on the Turkish Cypriot economy highlights a strong post-pandemic recovery but warns of persistent inflation, labor market informality, and financial risks. It emphasizes the need for structural reforms, data-driven policymaking, and economic integration to ensure sustainable and inclusive growth.

The World Bank’s macroeconomic monitoring note on the Turkish Cypriot (TC) economy, “Translating Opportunities into Shared Prosperity,” was published under the Supporting Economic Convergence and Integration in Cyprus Programme, funded by the European Union Aid Programme for the Turkish Cypriot community. The research was conducted by the World Bank’s Macroeconomics, Trade & Investment team, with contributions from Metin Nebiler, Matija Laco, Mertkan Hamit, and İzge Arısal, alongside peer reviews from experts at the European Commission and the Turkish Cypriot Chamber of Commerce. The report provides a comprehensive analysis of the TC economy’s post-pandemic recovery, structural vulnerabilities, and potential for sustainable growth. It emphasizes the need for evidence-based policymaking to address pressing socio-economic challenges.

The TC economy rebounded strongly in 2023, with GDP growth exceeding 5%, surpassing pre-pandemic levels. This marked a significant turnaround from the deep 16.2% contraction in 2020, one of the worst economic downturns in Europe. The recovery was primarily driven by a robust services sector, particularly retail trade and tourism, alongside a surge in construction. Green Line crossings reached an all-time high, boosting trade between the TC economy and the Republic of Cyprus (RoC). Despite this progress, Green Line trade remains well below its potential due to logistical barriers, inefficient payment mechanisms, and stringent quality standards. Inflation remains a critical issue, with the Turkish lira’s (TL) depreciation fueling price surges. Inflation peaked at 120.7% in October 2022 before moderating to 94.5% in March 2024, while food inflation remains alarmingly high at 79%, among the highest rates in Europe. The ongoing cost-of-living crisis continues to erode household purchasing power, disproportionately affecting lower-income groups.

Jobs Are Back, but Informality Looms Large

The labor market showed notable improvement, with over 9,600 new jobs created in 2023, 44% of which went to women. This represents a significant milestone given the historically low female labor force participation rate. The private sector accounted for most of the job creation, while public sector employment remained stagnant. However, informality surged, with nearly 50% of new jobs falling outside formal labor regulations, particularly in the services and construction sectors. While more women entered the workforce, the overall participation rate remains below regional and EU averages.

Job stability and income security remain key concerns, especially for workers in sectors prone to external shocks. Tourism and construction, two major employment drivers, are highly sensitive to global economic conditions. Informal employment lacks social protection and contributes to financial insecurity, making it crucial for policymakers to develop strategies that formalize jobs and enhance labor rights. The report highlights the need for workforce development programs, skill training, and policies aimed at improving job quality.

Fiscal Tightening Amid Shrinking Support from Türkiye

Fiscal consolidation efforts have stabilized public finances, with total government spending reaching TL 40 billion (EUR 1.5 billion) in 2023. This represents a doubling of expenditure compared to 2022, although it remains at 29% of GDP. Public spending is dominated by wages and social transfers, while capital expenditures have declined. The fiscal deficit has returned to pre-pandemic levels, partly due to declining financial aid from Türkiye, which has redirected resources toward its own post-earthquake recovery efforts.

The approval of the first-ever Medium-Term Budget Framework (MTBF) for 2024-2026 is a crucial step toward improving fiscal discipline. The framework aims to enhance tax collection, reduce informality, and reform public spending to ensure greater efficiency and transparency. However, the continued reduction in external financial support from Türkiye could limit the TC economy’s ability to invest in critical infrastructure and social programs. Raising domestic revenues while maintaining economic stability remains a key challenge for the administration.

Banking Sector Stability at Risk

The TC banking sector remains resilient but faces mounting risks due to high interest rates and currency mismatches. Loan growth was strong in 2023, driven by consumer and corporate lending, but non-performing loans (NPLs) began rising toward the year’s end. Interest rates have soared, with consumer loan rates reaching 55% in March 2024, significantly increasing debt burdens for businesses and households.

Despite strong capitalization and profitability, prolonged inflation and potential financial instability pose risks, particularly for small businesses and lower-income borrowers. High inflation has forced the banking sector to increase interest rates, which could slow down investments and consumer spending. The report warns that financial regulators must closely monitor rising risks in the financial sector and implement proactive measures to mitigate potential economic shocks.

Building a Sustainable Future with Data-Driven Policies

Long-term structural challenges persist, and economic growth is expected to moderate to 2.7% in 2024 due to persistent inflation, global uncertainties, and policy constraints. While Green Line trade and crossings are expected to continue growing, supporting economic integration, the TC economy remains vulnerable to external shocks, particularly fluctuations in the Turkish lira and commodity prices. Climate change, labor shortages, and an aging population further threaten long-term growth prospects.

The report emphasizes the importance of data-driven policymaking and highlights recent initiatives like the Input-Output Tables (IOTs) and the Household Budget Survey (HBS). The IOT analysis reveals that the TC economy is heavily dependent on imported inputs, particularly in agriculture and industry, whereas services remain the dominant sector. Intra-island trade with the RoC could help reduce input costs and enhance local production. The HBS analysis highlights rising income inequality, with the Gini coefficient increasing from 0.34 in 2015 to 0.37 in 2022. Relative poverty remains high at 14.4%, nearly double the rate in the RoC. Poor households are disproportionately reliant on social transfers and informal employment, making them more vulnerable to economic shocks.

To strengthen evidence-based policymaking, the report calls for three key actions: improving data collection through sustained funding and institutional capacity building, integrating data into policymaking to enhance policy effectiveness, and investing in public data literacy to promote transparency and informed decision-making. These measures will be crucial in fostering inclusive economic growth and ensuring that policy decisions are based on accurate, timely information.

The report concludes that while the TC economy has shown resilience, long-term prosperity depends on decisive policy action. Strengthening economic integration, promoting digital and green transitions, and improving social protection mechanisms are vital for sustaining growth and reducing inequality. Addressing inflation, labor market informality, and fiscal imbalances will require coordinated efforts from policymakers, businesses, and international partners. With the right reforms, the TC economy can turn its current challenges into opportunities for sustainable and inclusive development.