An International Monetary Fund (IMF) mission visited Nicosia during March
27–31, 2017, for the first post-program monitoring (PPM) discussions since
Cyprus exited the Extended Arrangement under the Extended Fund Facility.
PPM is part of the IMF’s regular monitoring of countries with significant
outstanding IMF credit, with a focus on capacity to repay the Fund. The IMF
mission coordinated with the post-program surveillance activities of the
European Commission and the European Central Bank, and the early warning
system of the European Stability Mechanism. At the conclusion of the visit,
the IMF mission issued the following statement:
“Since exiting the IMF program one year ago, Cyprus’s economic recovery has
gathered momentum, banks’ liquidity positions have improved, the
restructuring of nonperforming loans (NPLs) has accelerated and the fiscal
primary surplus has increased. These developments served to strengthen
Cyprus’s repayment capacity. Nonetheless, continued very high levels of
private sector indebtedness, nonperforming loans and general government
debt remain vulnerabilities. Decisive progress on repairing private balance
sheets, while upholding fiscal prudence and completing pending structural
reforms are essential to build resilience, reduce the risk of adverse
shocks to balance sheets and raise potential growth.
“Over the medium term, growth is expected to remain brisk, although
moderating gradually from the rapid pace of last year. For 2017, GDP growth
is forecast at around 2.5 percent on continued support from foreign demand
and external financing. Thereafter, growth is expected to ease marginally
as repayment of private sector debt picks up, stabilizing at just above 2
percent from 2020. Under these conditions, capacity to repay the Fund is
expected to be satisfactory, supported by sizable fiscal primary surpluses,
the back-loaded maturity profile of official debt and possible further
operations to smooth redemptions of market-based debt. However, repayment
capacity would be weakened in the event of a new boom-bust growth cycle, if
fiscal discipline is eroded or if risks in banks’ balance sheets
materialize.
“A decisive upfront reduction in public and private debt is needed to
rebuild policy buffers, cement confidence in macroeconomic fundamentals and
policy commitments, deliver balanced, sustainable growth, and support
balance sheet repair. This requires effort in three main areas:
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Accelerating NPL workouts and reducing excessive debt burdens
. Restructuring has gained momentum over the past year, but NPLs
remain very high and a portion of previously restructured loans
tend to re-default. High NPLs also weaken banks’ profits.
Restructuring progress across banks has been uneven, reflecting
differences in the structure of their loan portfolios, the
intensity with which various legal and other tools have been used,
as well as in banks' capacities to manage NPLs. Banks should be
further encouraged not to defer restructuring in the expectation
that future increases in output and property prices would
autonomously improve recovery rates. Instead, they should focus on
durable and sustainable loan work-outs, including through solutions
that reduce a borrower’s debt to affordable levels. Operational
barriers to NPL resolution, such as regulatory incentives
encouraging banks to delay recognition of losses or disposal of
collateral, remaining impediments in the legal framework and
capacity constraints in the courts, should be addressed. It is
important that newly-issued bank lending, which is providing
welcome support to the economy, is underpinned by robust lending
policies, strong business plans from borrowers and close monitoring
of credit risk.
-
Frontloading public debt reduction
. Accelerating public debt reduction would help to create a prudent
buffer and safeguard the downward trajectory of debt in the event
of adverse shocks. Recent fiscal outturns have been buoyed by
cyclical developments, despite a sizable weakening of the
underlying structural position since 2015. Targeting a primary
surplus of 3 percent of GDP (on a cash basis) for the next several
years while saving any over-performance and directing additional
resources to growth-enhancing investment would accelerate debt
reduction and bolster potential output without materially lowering
GDP growth. Guarding against fiscal slippages, including from the
envisaged national health service as well as from wage and social
benefit spending, will also be essential. Restarting the
privatization program would also contribute to lowering public
debt. Completing pending reforms in the areas of revenue
administration and public financial management, and adopting the
package of civil service reform bills would also help safeguard
public finances over the medium term.
-
Reinvigorating structural reforms
. Progress with macro-critical reforms has largely stalled.
Advancing the reform agenda would increase capacity to cope with
external shocks and create sustainable employment opportunities by
improving the business environment. Focus should be on expediting
judicial reform to strengthen legal enforcement of commercial
claims and speed up court procedures, restarting the privatization
program to increase economic efficiency and competition, and
streamlining business procedures to attract new service sectors.
“We would like to thank the Cypriot authorities, our European partners and
our private sector counterparts for informative discussions and their
cooperation and hospitality.”
