Transcript of a Conference Call on the Preliminary Conclusions of the EFF’s Fourth Review Mission to Cyprus

May 19, 2014

Washington, D.C.
Monday, May 19, 2014

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

MS. GAVIRIA: Good morning from Washington. Good afternoon to those in Europe. This is the IMF Conference Call on the preliminary conclusions of the fourth review mission of the economic program with Cyprus.

Here with me is Delia Velculescu, the IMF Mission Chief for Cyprus. She'll have some points to make and will answer your questions. But before that let me give you the context of this conference call. As you know, an IMF staff team, along with representatives of the European Commission and the European Central Bank, visited Nicosia for the last two weeks to discuss with authorities the set of policies that would lead to the conclusion of the fourth review of the economic program.

They concluded on Saturday and a joint statement was published. We couldn't do this conference call on Saturday, but we still wanted to talk to you, so that is why we are doing it today. Now, Delia will start with some talking points.

MS. VELCULESCU: Thank you, Angela, and thanks everyone for participating in this conference call. Let me say a few words on the conclusion of the fourth review mission which, as Angela said, ended this past Saturday.

The final assessment of the review will be undertaken by the IMF Executive Board around the end of June. Now, the key findings that you may have seen in our press statement are as follows.

The program is on track. First, on fiscal policy, as has been the case to date, fiscal performance remains better than expected, and targets were met with a comfortable margin in the first quarter of this year. This was due both to revenue over performance and also to continued prudent budget execution.

On macroeconomic performance, as you know, output in 2013 contracted by 5.4 percent. This was better than the 6 percent expected during the last review. At the same time, confidence has continued to improve. As a result, macroeconomic projections for the program have been revised. We now expect output this year to contract by 4.2 percent rather than 4.8 percent.

Over the medium term we expect a somewhat more gradual recovery, with growth at 0.4 percent in 2015, and gradually recovering thereafter, as the economy still has very high deleveraging needs thatwe expect to continue to weigh on domestic demand.

Finally, progress with policy implementation has continued. The cooperative credit sector has been recapitalized and consolidated into 18 institutions recently. Other banks are making progress with restructuring according to their respective plans. As a result, significant relaxations of domestic restrictions took place during the previous months.

On the structural reform agenda, the authorities are advancing their technical and legislative work toward the implementation of key reforms such as the welfare and revenue administration reforms, among others.

Looking forward, the staff team reached staff level agreement on key policy priorities. The first such priority is to deal with the high level of non-performing loans. The work stream in this area is on two fronts. On one front, the Central Bank of Cyprus has agreed to increase supervisory monitoring of banks' efforts to increase their operational capacity and put in place policies in accordance with existing arrears management frameworks to deal with the very large level of NPLs.

On the second front, the authorities agreed on the implementation of a comprehensive reform of the debt restructuring legal framework. This is needed to put in place adequate and also well-balanced incentives to renegotiate trouble loans and resolve these going forward.

The second priority and key objective of the program is to maintain fiscal sustainability. The authorities need to continue to prudently execute the budget and adhere to fiscal targets which, as I've noted before, they have successfully done so far.

In the medium term they will need to continue to gradually reduce the primary fiscal deficit and over time reach the 4 percent of GDP primary fiscal surplus target needed to place debt on a sustained downward path.

As a third priority, structural reforms need to accompany these fiscal efforts. The authorities agreed to implement a welfare reform this year to protect vulnerable groups during the downturn.

At the same time, there are continuing efforts to enhance the efficiency of revenue administration and revenue collections by fighting tax evasion and reforming the revenue administration. They are also advancing on the management of fiscal risks, including management of government guarantees and overall public sector debt management. Finally, implementation of their privatization plan is needed to increase the efficiency of the economy, attract investment, and lower public debt.

In sum, the authorities have continued to demonstrate strong implementation of the program through their fourth review. Given still high ongoing risks, thorough and timely implementation of the program remains essential to the restoration of economic growth.

QUESTIONER: Should Cyprus’s banks increase their share capital?

MS. VELCULESCU: At the moment, banks are undergoing a comprehensive assessment conducted at the pan-European level. While the results of this exercise are not yet known, we understand that Cyprus’s banks are already making efforts to prepare for it, as other banks in Europe are doing, in a preemptive fashion.

QUESTIONER: In light of speculation about how the Bank of Cyprus, and generally all banks, are moving to deal with non-performing loans, how do international creditors see the best road for banks to deal with them? There's been speculation about splitting the banks into good and bad ones, different strategies. I just wanted to sound out the IMF and the other creditors about this.

MS. VELCULESCU: Thanks for the question. Indeed, as I said earlier, dealing with NPLs is one key policy challenge going forward. The program includes policies to address this challenge. Specifically, the reform of the debt restructuring legal framework is a key element, and this will be necessary irrespective of whether NPLs are addressed within banks or in a separate entity.

Now, the current banking sector strategy under the program, which is reflected in the respective banks’ and coops’ restructuring plans is based on internal loan workout processes through specialized units. The rationale is very similar to asset management companies. NPLs are treated in separate units, and bank policies are being developed on the basis of the new arrears framework that the Central Bank has developed. The current strategy takes into account domestic considerations, including limited bank capital buffers, funding issues, and the still fragile public sector debt.

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

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