Transcript of a Conference Call on Cyprus

April 4, 2014

Washington, D.C.
Tuesday, April 1, 2014

Delia Velculescu, Mission Chief for Cyprus
Ángela Gaviria, Communications Department

MS. GAVIRIA: Hello everyone. I'm Angela Gaviria with the IMF’s Communication Department. This is a conference call on the staff report of the third review of the IMF program with Cyprus. Let me introduce the main speaker today, Delia Velculescu, who is the IMF Mission Chief for Cyprus. She will make some brief remarks and then she'll take your questions.

MS. VELCULESCU: Thank you, Angela, and thanks everyone for participating. Let me start with a brief overview of the key takeaways from the third review of Cyprus' EFF supported program.

First, the program remains on track. Indeed, Cyprus over-achieved its fiscal targets in 2013. In particular, the primary fiscal deficit was lower than the target by about 1½ percent of GDP.

Also, the recapitalization of the banking sector was completed in February with the injection of 1.5 billion euro of state funds into the cooperative sector. Moreover, 93 individual cooperative credit institutions were merged into 18 institutions.

IN addition, deposit restrictions have been relaxed in line with the authorities' roadmap, while maintaining financial stability. In particular, automatic renewals of maturing term deposits were abolished, and limits on domestic transfers have been raised.

Finally, structural reforms were advanced. In particular, the privatization law and the budget framework law have been recently passed. The authorities also submitted to Parliament legislation to fight tax evasion. Progress is being made on advancing the welfare and revenue administration reforms.

Second, reflecting this good policy performance, the growth outturn was better than expected. While Cyprus did experience a deep recession in 2013, with the latest data suggesting that output declined by around 5.4 percent, the recession was less severe than anticipated at the time of the second review, when we had projected a decline of about 7.7 percent in output.

The economic adjustment has occurred through both quantities and prices. Private consumption declined somewhat less than projected, while on the supply side, the tourism and service sectors have held up.

Looking forward we expect the recession to continue this year, and a modest recovery to take hold next year. Projections will be reassessed during the next review, in light of new data. They remain subject to unusually high uncertainty, given the unprecedented shock to the economy last year and continued balance sheet stress.

Third, regarding the policy agenda, while much has been accomplished already, challenges remain. Let me highlight four such key challenges.

First, nonperforming loans need to be addressed. Such troubled loans now amount to about 50 percent of total loans. To address this challenge, banks need to operationalize the existing arrears framework and code of conduct, as well as define loan restructuring targets. The authorities will need to closely monitor the banks' operational capacity and progress toward these targets.

At the same time, a comprehensive legal framework is needed to put in place adequate incentives for renegotiations. This will include a reform of the insolvency regime for both households and corporates, foreclosure legislation, as well as an overall strengthening of institutions.

The second challenge is to continue to relax payment restrictions gradually, in line with the authorities' roadmap, while maintaining financial stability. Key here are heightened monitoring of deposit trends, coordinated and enhanced communication to the markets, and continued provision of adequate liquidity to the banks.

The third policy challenge is to further strengthen public finances to place debt on a sustainable downward path. This requires continued prudent implementation of this year’s budget, while maintaining flexibility if macroeconomic conditions deteriorate. In the outer years, additional measures will need to be developed to reach the primary balance target of 4 percent of GDP and put debt on a sustained downward path.

The fourth policy challenge is to continue to advance structural reforms. Priority will need to be placed on the welfare reform to protect the most vulnerable groups during the downturn. In addition, the authorities need to take steps to implement the reform of the revenue administration aiming at improving its efficiency and effectiveness, while ensuring that collections are protected during the transition. The implementation of the recently passed budget frameworks law also needs to advance. Finally, with the privatization law now in place, the next step is to start preparing state assets for privatization.

In sum, almost one year into the program, the authorities have made significant progress with policy implementation, including by taking the most difficult decisions to address the root of the crisis up front. While macroeconomic conditions have proven better than expected, the economic situation remains difficult and subject to risks. Continued strong program implementation remains essential to put the economy on a path of recovery and sustainable long-run growth.

QUESTIONER: In paragraph 39 of your assessment you say that if the factors that led to the over performance in 2013 proved to be temporary, automatic stabilizers would be allowed to operate. Could you elaborate on that, please?

MS. VELCULESCU: As we have detailed in our report, part of the fiscal over performance in 2013 was assessed to be permanent, meaning that it is expected to continue in the outer years. As a result, the fiscal targets for 2014 have been tightened to lock in these savings due to the over performance.

What we are also saying in the report, as you correctly have pointed out, is that should this over performance prove to be temporary or should macroeconomic conditions deteriorate beyond what we are now currently expecting, we would consider allowing automatic stabilizers to operate, meaning that we would consider adjusting fiscal targets accordingly.

MS. GAVIRIA: Thank you all for participating. Good bye.

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