Transcript of a Conference Call on Cyprus
February 18, 2014Washington, D.C.
Tuesday, February 11, 2014
Delia Velculescu, Mission Chief for Cyprus
Ángela Gaviria, Communications Department
MS. GAVIRIA: Hello, everyone. I'm Angela Gaviria with the Communications Department of the IMF in Washington. This is the conference call on the preliminary conclusions of the mission that has visited Cyprus in the last two weeks to discuss with the authorities the third review of the Extended Fund Facility or EFF. The press release with the preliminary conclusions was issued a few minutes ago, and it's posted on IMF.org. Delia Velculescu is the Mission Chief for Cyprus and will be the main speaker in this call. She will start with some brief remarks and then she will take your questions.
MS. VELCULESCU: Thank you everyone for participating in this conference call. As Angela noted, I would like to talk about the main preliminary conclusions of our mission, reminding everyone that a final assessment of the review will be undertaken by the IMF Executive Board, the ESM Board, and he Eurogroup toward the end of March-- beginning of April.
Our mission’s main conclusion is that the program remains on track, although challenges remain. I would like to take you through some of the key findings of the mission in a bit more detail.
First, we have found that the macro-fiscal performance has been better than expected. Regarding growth, we expect output to have fallen by around 6 percent last year. This represents a deep and painful recession, which is coupled with falling wages and rising unemployment. Still, it remains close to 2 percentage points better than forecasted during the last review, and close to 3 percentage points better than the initial program forecast.
Turning to fiscal, the performance of the fiscal accounts has also exceeded program targets by a significant margin. This is as a result of both prudent execution of budgetary spending last year, and of better revenue performance due to the macroeconomic outturn.
Second, there are signs of stabilization in the banking sector. The two large banks have been recapitalized, and Bank of Cyprus is making progress in implementing its restricting plan while the cooperative sector has recently put in place a restructuring plan. All preconditions for the recapitalization of the cooperative sector have been fulfilled, and we expect the recapitalization of the sector to proceed shortly. Finally, deposit trends are showing signs of stabilization in recent months.
Third, I would like to speak about how we see the situation going forward, where important challenges remain.
The outlook for this year remains difficult, as the economy continues to adjust. At this point, we have not changed the program forecast for 2014 and beyond, which projects output to fall by 4.8 percent this year, and to modestly grow next year by about 0.9 percent. Given that the macroeconomic uncertainty surrounding the outlook remains large, the authorities will need to continue to implement the 2014 budget prudently, building on their strong fiscal performance to date.
In the financial sector one key challenge is dealing with a very high level of non-performing loans. In this regard, banks and cooperatives will need to put in place adequate arrears management frameworks, and the authorities will need to reform the debt-restructuring legal framework to provide incentives for borrowers and lenders to negotiate and reach solutions to workout debt.
Another key challenge is to normalize payment flows in the economy while safeguarding financial stability. The authorities have a milestone-based roadmap to guide this process. With key milestones now completed, the second stage of gradual relaxations of restrictions is expected to start shortly.
Turning to structural reforms, where the authorities' agenda is very ambitious, the challenge is to accelerate reform implementation. I will give a few examples. Given the currently difficult, but unavoidable, economic adjustment, a key priority is the implementation of the social welfare reform, which will introduce a guaranteed minimum income scheme to protect vulnerable households during the downturn.
Also important is to take measures to fight tax evasion to ensure that everyone pays their fair share, as well as to advance the broad reform of the revenue administration to increase both its efficiency and its effectiveness.
Public financial management also needs to be strengthened by adopting and implementing the new fiscal responsibility and budget systems law. Finally, the adoption of the privatization law is essential to kick-start the privatization process.
To sum up, the program is on track, but challenges and risks remain. Full and timely implementation of the program remains essential.
QUESTIONER: I'm just wondering when you said that you have not yet revised your economic output for this year and next year, is there any tendency that you might revise the forecast? Then you said in that risk pack that the budget for 2014 has to be implemented carefully or prudently. Can you go a little bit into detail on what you mean by that? Does it mean that Cyprus would relax a little bit the fiscal restraint or what do you think?
MS. VELCULESCU: Indeed at this point we have not revised the forecast for 2014 and beyond, in part due to a lack of data for this year. Even last year’s projection, the minus 6 percentage point decline in output, is not yet final, as we do not have the last quarter data for last year. At this point, we have remained prudent and have not changed the forecast going forward until we have more data. As you know, we come to Cyprus every quarter, we review macroeconomic and policy performance and we adjust projections as needed.
On budget implementation, we have assessed the budget approved late last year after our second review. It remains appropriately conservative and it needs to be implemented as approved. The authorities will need to continue remaining vigilant, observing how macroeconomics conditions evolve this year, so that they can continue the good performance that we have seen through the end of last year.
QUESTIONER: Two questions if I may. Could you elaborate on how you interpret this better than expected performance? Your original forecast for 2013, as you said, was worse than what we've seen, but the private sector was expecting far worse. So if you could just give us a little bit more detail, why do you think Cyprus has done better than what's expected?
The second question, with regards to Bank of Cyprus, is: could you tell us what the IMF's position is with regards to how ELA funding from the European Central Bank should be treated? Some shareholders have expressed concern about Laiki's ELA burden being transferred to Bank of Cyprus. Do you agree that this should be the case or do you think it should be treated differently?
MS. VELCULESCU: Let me respond to your first question, and I may need some clarification on your second question. At the time of our initial growth projections for the program, when we estimated negative growth of close to 9 percent last year, we were faced with incredible uncertainty about how consumers and how the economy would behave in the face of a very large shock. That shock was unprecedented, and there weren't any benchmarks to use at the time.
We had made our best assumptions looking at a variety of factors, including the capital restrictions that were imposed, the possible effect of the bail-in on domestic participants and their wealth perception, and the fiscal adjustment that was going to take place through the economy, and we came up with our estimate.
Fortunately, our estimate turned out to be too conservative. That is a positive factor. What has transpired looking at the data ex post is that indeed demand has held out better than expected. That's largely due to private sector consumption, which reacted relatively less negatively to the initial shock than we had expected, in large part due to consumption smoothing. On the supply side we have also seen more resilience of both the service sector, which is a key growth driver for this economy, and tourism.
On the second question, can you repeat or clarify what you asked?
QUESTIONER: Right. Since the program was implemented some people have been insisting that Bank of Cyprus should not take on the 9.6 billion euro ELA burden from Laiki Bank, and this has been a concern that has been voiced by former depositors, now shareholders, and others consistently since last spring. So I'm wondering what the IMF's position is with regards to burdening Bank of Cyprus with Laiki's ELA exposure?
MS. VELCULESCU: As you know, Cyprus is under a program financed both by the IMF and by the European Stability Mechanism. It is also a member of the Eurozone, and the Central Bank of Cyprus is a member of the Eurosystem. So within that context, ELA is a liability of individual banks, but also ultimately of the Central Bank of Cyprus toward the Eurosystem. This is an important consideration that one needs to take into account when looking at how the resolution of the two large banks was done at the time.
QUESTIONER: But do you think that's a good idea? Do you think it's fair? Do you think it's fair to shareholders that they've had their deposits turned into equity in a bank they didn't necessarily want to own, but the ELA liability remains intact in a new, healthy bank weighing it down, which surely will affect how this bank fares in the asset quality review and the other tests to go through?
MS. VELCULESCU: There are two separate issues there. One is the ELA itself, and that has to do with the capacity of the bank to have access to liquidity. The other one is regarding the deposit to equity conversion. This bank clearly needed capital. It had borrowed beyond its means, and it had made imprudent decisions as well. The bail in necessary to replenish its capital was not related to the ELA.
QUESTIONER: Do you think November's stress test could reveal capital shortfall for the Cypriot banks taking into account the increasing non-performing loans?
MS. VELCULESCU: It is too early to tell at this point. We will need to see the details of this exercise as they emerge. What I can say is that the banks have been recapitalized on the basis of very comprehensive independent assessments and stress tests that have been performed recently. Those are some of the same type of tests that the AQR will be performing.
QUESTIONER: You're saying that the tests performed in Cyprus banks are the same type of tests that the AQR will include? Does this mean that you have details of what the AQR tests will be exactly? Are you able right now to say that the tests you're doing of the Cypriot banks will be sufficient, and that the AQR won't turn up any nasty surprises?
MS. VELCULESCU: No. As I have said initially, we don't have the details. We just have the overall structure of the AQR, which is that it's going to be a base case applied to all the banks, and then there will be stress tests. This was the same philosophy, if you will, of the PIMCO analysis that was conducted early on, which was based on very conservative assumptions. Now, the assumptions will not be exactly the same in the AQR. We don't have the details yet; as you know, those have not all been released at this point.
I just wanted to make a second point here: for Bank of Cyprus, and also for the cooperative sector, after the PIMCO stress tests, there was a second analysis, a fair value assessment, which uses a different methodology. In both cases, the amount of capital needs came up very similar. This provides some comfort that the analysis done by PIMCO is resilient to a change of assumptions. But as I said, it's too early to conclude on the AQR at this point.
QUESTIONER: I just want to clarify a couple of points on your previous answer. Are you saying that the NPL growth in Bank of Cyprus is in line with what was expected? Secondly, regarding ELA, the question really is when does the credit crunch end and is that directly related to the ELA extension? Have you talked with the ECB about liquidity support for Bank of Cyprus after having decreased to 9.6 billion euro in ELA?
MS. VELCULESCU: Yes, what I mean on NPLs is that in fact what we have seen so far remains in line with the PIMCO projections.
On the question about the credit crunch, clearly after Bank of Cyprus exited resolution it became again eligible for liquidity from the ECB, and this has been provided under the existing rules of the ECB. But addressing the credit crunch goes beyond also has much to do with the banks’ ability to deal with the NPLs, which will take some time.
MS. GAVIRIA: We end this conference call here. Thanks everyone for participating.