## 1cypea2021001 ## Source details **Canonical URL:** [1cypea2021001](https://www.imf.org/-/media/files/publications/cr/2021/english/1cypea2021001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2021/english/1cypea2021001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2021/english/1cypea2021001.pdf.json) --- ### Pre-COVID developments and lingering vulnerabilities - Cyprus was undergoing a strong recovery from the 2012–13 financial crisis supported by services and construction and financed by FDI. - Financial-sector cleanup pre-pandemic: disposal of distressed assets, capital increases, public interventions; banks entered the crisis with reduced NPLs, higher provisions and increased capital and liquidity buffers. - Remaining legacies and vulnerabilities: - NPLs remain high and hinder profitability and credit supply. - Private indebtedness is among the highest in the euro area. - Public debt remains high and the sovereign debt rating stands at the lowest investment grade. ### COVID-19 shock, epidemiology, containment and vaccination - Containment timeline and epidemiology: - First wave managed with strict containment in March 2020; most domestic businesses reopened by early summer. - As of April 19, 2021, Cyprus was in a third wave with renewed lockdowns. - Testing rate relatively high; vaccination pace had covered around 15 percent of the population (as of the data date). - Most cases concentrated among younger population; hospitalization and mortality rates remained relatively low. ### Macroeconomic impact and sectoral heterogeneity - GDP and short-run dynamics: - Economy contracted by 5.1 percent in 2020. - Real output plummeted by 12.6 percent (yoy, sa) in 2020:Q2. - Real output rebounded in 2020:Q3: 8.9 percent qoq, sa; -4.7 percent yoy, sa. - Private consumption grew 14.0 percent (qoq) in 2020:Q3. - GDP grew 1.4 percent (qoq, sa) in 2020:Q4 despite tightening containment measures. - Service-sector dependence and tourism: - International tourism revenue was 12½ percent of GDP in 2019. - Net exports declined following the sudden stop of international tourism since April 2020. - FDI inflows slowed; termination of the Cyprus Investment Program (CIP) reduced inflows. - External position: - Adjusted for SPEs, current account deficit widened to 11.6 percent GDP in 2020 from 6.8 percent of GDP in 2019. - Overall external position—adjusted for SPEs and temporary tourism and oil effects—was weaker than implied by medium-term fundamentals. ### Labor market and social impact - Job retention scheme helped contain job losses by maintaining worker-employer ties. - Working hours and wages were significantly reduced. - Unemployment rate increased to 8.0 percent in 2020:Q4 as wage support phased into narrower coverage. - Annex IV highlights: - LFS unemployment rose to 6.8 percent in 2020:Q2 from 6.4 percent in 2019:Q4. - Unemployment reached 8.2 percent and 8.0 percent in comparisons to 2019:Q3 and 2019:Q4. - Total hours worked declined by 10.5 percent in 2020:Q2 (yoy) and -7.2 percent (yoy) in 2020:Q4. - Compensation in private sector: -12 percent in 2020:Q2 (yoy) and -8 percent in 2020:Q4 (yoy). ### Inflation and prices - Weaker demand and declining energy prices led inflation to turn negative. - Exact inflation observations: - Headline inflation reached -2.9 percent and core inflation -2.2 percent in August 2020. - Inflation stood at around -1 percent since end-2020. ### Fiscal policy response: composition and costs - Total fiscal support: - 2020: Total measures implemented equal 3.9 percent of GDP. - 2021: Total measures (estimated) equal 3.6 percent of GDP. - 2020 fiscal measure breakdown (% of GDP): - Health Sector Support: 0.2 - Support for Employment: 1.2 - Tourism-targeted wage compensation schemes: 0.6 - Support for Households: 0.5 (Special Absence Leave 0.1; subsidized sick leave 0.1; overseas student allowance 0.1; repatriation scheme 0.05; schemes for self-employed/unemployed 0.2) - Support for Firms: 0.9 (subsidy for very small/self-employed 0.5; subsidies not subject to contributions 0.3; tourism support 0.1; VAT reduction 0.1) - Other Measures: 0.4 (NHS suspension 0.2; tax credit 0.2) - 2021 fiscal measure breakdown (% of GDP): - Health Sector Support: 0.6 - Support for Employment: 1.2 (January to June) - Support for Households: 0.2 (interest subsidy for housing loans 0.1; unemployment benefit 0.1) - Support for Firms: 1.5 (one-off grants 1.1; subsidies not subject to contributions 0.3; interest subsidy for new business loans 0.1) - Other Measures: 0.2 (reserve for emergency expenditures) ### Financial sector policies and NPLs - Supervisory/regulatory measures: - Temporary capital and liquidity relief; nine-month loan repayment moratorium from March 2020 for all performing borrowers; moratorium extended for targeted borrowers. - Around half of previously performing loans were under the moratorium in 2020. - Payment arrears in first two months of 2021 for selected banks were around 5 percent of loans previously under the moratorium. - NPL developments: - Large NPL sales and write-offs helped NPLs decline to 17.7 percent at December 2020 from 27.9 percent in February 2020. - Provision coverage of NPLs declined to 46.3 percent (near euro area average per source). - Bank capital ratios: Tier1 capital nearly 19 percent; capital ratios stable. - Credit trends: - Credit growth slowed substantially; new loans to NFCs and households contracted sharply since April 2020. - Credit decline eased in 2020:H2; credit growth remains among the weakest in the euro area. ### Policy implications and recommendations (near and medium term) - Near-term policy priorities: - Continue wage support schemes and targeted tourism measures to preserve jobs and support most affected sectors. - Maintain liquidity and loan repayment moratoria and supervisory relief to avoid immediate financial-sector destabilization. - Use interest subsidy schemes for housing and new business loans to support credit demand. - Withdrawal of support measures should be gradual and largely demand-driven to avoid cliff effects. - Medium-term priorities: - Address NPLs to strengthen banks and support credit growth; monitor capital buffer usage and provisioning flexibility. - Facilitate reallocation and rebuilding the growth model (develop education, ICT, shipping), and use RRF and InvestEU to front-load investment. - Recalibrate fiscal support to target viable firms and incentivize equity injections or well-designed state recapitalization for larger/strategic firms. - Modernize tax administration; consider reinstating immovable property tax and new excises; estimated carbon tax impacts: - A carbon tax of $35 will generate revenue of 0.7 percent of GDP for Cyprus by 2030. - A carbon tax of $75 will generate revenue of 1.3 percent of GDP by 2030. - Control public sector wage bill growth and reorient spending to R&D and active labor market policies. - NPL-specific measures: - Monitor and increase transparency on moratoria effects; update reporting to prevent evergreening. - Improve examinership and introduce out-of-court or hybrid restructuring procedures. - Preserve an effective foreclosure framework; avoid parliamentary proposals that weaken foreclosure threat. - Assess and, if appropriate, expand public AMC subject to EC state aid approval with safeguards to limit fiscal costs and moral hazard. - For Estia scheme: authorities estimated NPLs worth about €2 billion (10 percent of GDP) would benefit; as of March 5, 2021, NPLs of €165 million were approved (40 percent with CACs); take-up below expectations. ### Outlook, scenarios, and risks - Staff baseline projections and assumptions: - Recovery assumes effective vaccine/treatments widely distributed from mid-2021. - Tourism recovery assumptions: international tourist revenues recover to around 30 percent of 2019 level in 2021, 70 percent in 2022, 90 percent in 2023, and return to 2019 level in 2024. - Cyprus’s RRF grants amount to €1 billion (about 5 percent of 2020 GDP), spread 2021–26 with peak in 2023; growth impact estimated at 0.5 percent on average annually over 2022–26. - Key projection highlights: - Real GDP: 2020 = -5.1; 2021 = 3.0; 2022 = 3.9; 2023 = 3.1; 2024 = 2.8; 2025 = 2.6; 2026 = 2.5. - Current account deficit: 2020 = -11.9 percent of GDP; projected to narrow to -8.1 percent in 2021. - Public debt: 2020 = 119.1 percent of GDP; projected 2021 = 114.0; 2022 = 106.4; 2023 = 102.8; 2024 = 95.6; 2025 = 91.8; 2026 = 86.1. - Downside and adverse scenarios: - Upside risk: faster vaccine distribution could lead to earlier border reopening and faster tourism recovery. - Downside risks: new contagion waves; slower vaccine distribution; higher credit default rates by highly indebted firms; realization of contingent liabilities from banking system; higher-than-expected NHS costs; larger-than-expected drop in FDI following CIP termination. - Staff stylized downside: slower vaccine application could result in near-zero growth recovery in 2021. ### Debt sustainability, stress tests and contingent liabilities - Debt and financing stress scenarios (selected outcomes): - Combined macro-fiscal shocks: public debt peaks at 126 percent of GDP in 2023 before declining to 112.6 percent of GDP by 2026; gross financing needs peak at 16.2 of GDP in 2023. - Lower fiscal balance + contingent liabilities scenario: public debt rises to 117.7 percent of GDP in 2022 and declines to 105.4 percent in 2026; gross financing needs spike to 22.3 percent of GDP in 2022 and 12.4 percent in 2026. - Adverse macro-fiscal-CL scenario: public debt rises to 123 percent of GDP in 2023 and declines only slowly to 121 percent of GDP in 2026; gross financing needs spike to 23.7 percent of GDP in 2022 and average 13.6 percent of GDP over medium term. - External debt dynamics (selected figures): - External debt in 2020: 908 percent of GDP (287 percent excluding SPEs). - Government external debt in 2020: 100 percent of GDP. - Net debt for the economy: 369 percent of GDP in 2020; net debt after excluding SPEs: -4 percent of GDP. - Projected gross external debt: 1019 percent of GDP in 2021; 872 percent of GDP by 2026. - Banking-sector contingent liabilities assumed in adverse scenario: - 6 percent of GDP (from existing NPLs). - 1.5 percent of GDP (from 10 percent further increase in NPLs). ### Sectoral impacts: tourism, contact-intensive sectors, and housing - Tourism: - Tourism declined by 84 percent (yoy) in 2020. - Tourism receipts accounted for more than 18 percent of total exports in 2019. - More than 90 percent of borrowers in accommodation and food services were under moratorium. - UNWTO scenarios: return to 2019 levels in 2.5 to 4 years; Eurocontrol forecasts full recovery of air traffic in Europe by 2024 in most optimistic scenario. - Policy guidance: continue targeted support; consider liquidity support (guaranteed loans, lending rate subsidies) tied to bank viability assessments; enhance tourism sustainability and diversification. - Contact-intensive sectors: - Wholesale and retail trade, restaurants, transportation contributed 25 percent of GVA and 31 percent of total employment; experienced heavy tolls. - Housing and property: - Transaction-based property prices rising while sales declined due to fewer non-resident buyers. - Large share of bank loans are to highly leveraged households and SMEs concentrated in accommodation, food, retail—raising default and collateral recovery risks. - Maintain cap on overall stock of onboarded assets and ensure proper collateral valuation. ### Insolvency, restructuring and examinership - Moratoria: - Nine-month public moratorium launched April 2020 ended December 2020; take-up high at 48 percent of performing loans. - January 14, 2021 moratorium for six months targeted specific borrowers; not applicable to most loans that already benefited from 2020 moratorium. - Examinership: - Very limited use since introduction in 2015; only 19 applications up to March 2021; no examiner has been appointed in any case to date. - Limitations: complexity, cost, court capacity, delays, stigma, and procedural impediments. - Recommendations: - Implement EU Directive on Preventive Restructuring and Second Chance; consider out-of-court or hybrid restructuring procedures; complement examinership with accessible small enterprise rescue tools. ### Fiscal developments and medium-term fiscal strategy - Fiscal outcomes and 2020 table excerpts (selected exact figures, millions of euros and percent changes where provided): - Total Revenue: 9,176 | 8,524 | -7.1 - Current revenue: 9,086 | 8,410 | -7.4 - Indirect taxes: 3,329 | 2,872 | -13.7 - Direct taxes: 2,156 | 2,100 | -2.6 - Social security contributions: 2,378 | 2,404 | 1.1 - Capital revenue: 90 | 142 | 6.9 - Total Expenditure: 8,850 | 9,717 | 9.8 - Current expenditure: 7,853 | 8,954 | 14.0 - Goods and services: 984 | 908 | -7.7 - Subsidies: 705 | 787 | 24.8 - Social transfer: 3,007 | 3,552 | 18.1 - Capital expenditure: 997 | 763 | -23.4 - Overall Balance: 326 | -1,193 - (In percent of GDP) 1.5 | -5.7 - Fiscal projections and targets: - Primary deficit to decline to 2.4 percent of GDP in 2021 (staff estimate) from 3.6 percent of GDP in 2020. - Aim for a primary surplus of 1.9 percent of GDP by 2024 and gradual reduction of public debt-to-GDP ratio to around 96 percent (authorities’ objective). - 2021 budget envisages continued support and full implementation of NHS. - Use Next Generation EU Funds and SURE (€479 million total) and RRF grants (€1 billion) actively. - Financing and markets: - Government issued 5–30 year bonds totalling 4.5 billion euros in 2020 at yields ranging from 0.35 percent to 2.34 percent. - Cyprus received SURE loans amounting to €479 million (250 million first disbursement in 2020; 229 million in 2021). - ECB net purchases of Cyprus sovereign bonds under PEPP and PSPP amounted to €1.71 billion through end-January 2021 and €3.43 billion through end-February 2021, respectively. ### Structural policies, inclusiveness, digital agenda and green transition - Labor market and skills: - Transition from preserving jobs to facilitating reallocation; boost active labor market policies and retraining. - CEDEFOP European Skills Index 2020 rank: 28th out of 31 — need to improve vocational training and recent training. - Policies to support youth and female labor participation (childcare, flexible work) and consider targeted payroll subsidies. - Digital agenda: - Pandemic accelerated digital transformation; RRF funds should advance digital agenda and human capital development. - Green transition and NECP 2030 targets (exact objectives): - Emissions in non-ETS sectors to be reduced by 20.9 percent 1/ - Emissions in ETS sectors to be reduced by 24.9 percent 1/ - Share of RES in gross final energy consumption to reach 23 percent - Share of RES in gross final electricity consumption at least 26 percent - Share of RES in heating and cooling to reach 39 percent - Share of RES in the transport sector to reach 14 percent - Final Energy Consumption of 2.0 Mtoe, representing 13 percent reduction 2/ - Primary Energy Consumption of 2.4 Mtoe, representing 17 percent reduction 2/ - Achieve cumulative energy saving of 243.04 ktoe during 2021–2030 - Financing: RRF and European Investment Bank as key financiers. ### Institutional, AML/CFT and judicial priorities - AML/CFT: - Continue implementing 2019 MONEYVAL recommendations; increased transparency of beneficial owners; termination of CIP expected to mitigate ML/TF risks. - Judicial and insolvency institutions: - Recruit additional judges, complete civil procedure reforms, clear backlogs, launch e-justice, and strengthen insolvency professionals and land registry processes. *International Monetary Fund — Cyprus: Selected Issues chapter excerpt and staff report material (content unit).* ### 1. Sectoral Impact of the COVID-19 Pandemic ___________________________________________________ 14 ### 1. Sectoral Impact of the COVID-19 Pandemic ### Pre-COVID developments: strong recovery and lingering legacies - The Cypriot economy was undergoing a strong recovery from the 2012–13 financial crisis before the onset of the COVID-19 pandemic. - Real GDP growth remained strong, supported by the services and construction sectors, and financed by foreign direct investment. - Unemployment and income inequality declined to close to pre-crisis levels. - Cyprus repaid early the remaining balance of the outstanding credit to the Fund at end-February 2020 and successfully exited the Fund’s Post-Program Monitoring. - Financial-sector cleanup prior to the pandemic included disposal of distressed assets, capital increases, and public interventions; banks entered the crisis with reduced NPLs, higher provisions and increased capital and liquidity buffers. - Remaining legacies and vulnerabilities: - NPLs on bank balance sheets remain high, hindering profitability and the ability to supply new credit. - Private indebtedness is among the highest in the euro area. - Public debt also remains high and the sovereign debt rating stands at the lowest investment grade. ### The COVID shock: initial impact, infections, containment and vaccination - Cyprus managed the first wave in March 2020 with strict containment measures and reopened almost all domestic businesses by early summer. - As of April 19, 2021, Cyprus was in the midst of a third wave of new infections; new infections picked up again, leading to renewed lockdown measures. - Testing rate is relatively high; the pace of vaccination had covered around 15 percent of the population (as of the data date), on par with many EU peers. - Most cases concentrated among the younger population; hospitalization and mortality rates remained relatively low. ### Macroeconomic impact and sectoral heterogeneity - GDP and quarter details: - The economy contracted by 5.1 percent in 2020. - Real output plummeted by 12.6 percent (yoy, sa) in 2020:Q2. - Real output rebounded in 2020:Q3: 8.9 percent qoq, sa, -4.7 percent yoy, sa. - Private consumption grew 14.0 percent (qoq) in 2020:Q3. - GDP grew 1.4 percent (qoq, sa) in 2020:Q4 despite tightening containment measures. - High-frequency indicators suggested deterioration in 2021:Q1 amid reduced real incomes, surging infection rates and new lockdown measures. - Service-sector dependence and tourism: - International tourism revenue was 12½ percent of GDP in 2019. - Net exports continued to decline following the sudden stop of international tourism since April 2020. - FDI inflows slowed due to lower domestic investment and termination of the Cyprus Investment Program (CIP) scheme. - External position: - Adjusted for the effects of special purpose entities (SPEs), the current account deficit widened to 11.6 percent GDP in 2020, compared to 6.8 percent of GDP in 2019. - Overall external position—adjusted for SPEs and temporary tourism and oil effects—was weaker than the level implied by medium-term fundamentals and desirable policies in 2020. ### Labor market and social impact - Job losses were largely contained through a job retention scheme providing wage support that helped maintain worker-employer ties. - Working hours and wages were significantly reduced. - As the scheme entered its second phase from mid-June with narrower coverage, the unemployment rate increased, reaching 8.0 percent in 2020:Q4. - Annex IV reports labor market developments during COVID-19 (referenced in source). ### Inflation and prices - Weaker demand and declining energy prices led inflation to turn negative. - Specific inflation observations: - Headline inflation reached -2.9 percent and core inflation -2.2 percent in August 2020. - Declines reflected lower prices in restaurants and hotels, VAT cuts, and continued declines in transportation and gas prices. - Although the overall price level recovered somewhat since September, inflation stood at around -1 percent since end-2020, among the lowest levels within the euro area. ### Fiscal policy response: measures, composition and costs - Authorities rapidly deployed a series of fiscal measures, adapting them over time to mitigate the crisis impact. - Total fiscal support: - 2020: Total measures implemented equal 3.9 percent of GDP. - 2021: Total measures (estimated) equal 3.6 percent of GDP. - 2020 fiscal measure breakdown (% of GDP): - Health Sector Support: 0.2 - Support for Employment (operation suspension scheme providing wage compensation): 1.2 (March to June; re-introduced in November) - Three schemes providing wage compensation targeted to the tourism sector: 0.6 (June to October; extended in November) - Support for Households: 0.5 total across items (Special Absence Leave 0.1; subsidized sick leave 0.1; overseas student allowance 0.1; repatriation scheme 0.05; schemes for self-employed/unemployed 0.2) - Support for Firms: 0.9 total (subsidy scheme for very small and self-employed enterprises 0.5 April to May; subsidies not subject to contributions 0.3; additional budget and co-promotional program to support tourism 0.1; VAT reduction for tourist accommodations and restaurants 0.1 July to December) - Other Measures (suspending increased NHS contributions; tax credit equivalent to 50 percent of rent reduction): 0.4 (NHS suspension 0.2 April to June; tax credit 0.2 any three months in 2020) - 2021 fiscal measure breakdown (% of GDP): - Health Sector Support: 0.6 - Support for Employment (wage compensation to employees of businesses suspended due to lockdown): 1.2 January to June - Support for Households (interest subsidy for housing loans 0.1 for loans contracted till June 30; unemployment benefit 0.1) - Support for Firms (one-off grants to cover operating expenses: 1.1; subsidies not subject to contributions 0.3; interest subsidy for new business loans 0.1) - Other Measures: reserve for emergency expenditures 0.2 ### Financial sector policies and banking sector developments - Supervisory and regulatory measures included temporary capital and liquidity relief and a nine-month loan repayment moratorium from March 2020 for all performing borrowers; the moratorium was subsequently extended by a further six months for targeted borrowers. - Around half of previously performing loans were under the moratorium in 2020, helping to avoid an immediate surge in NPLs. - Liquidity strain was largely absent due to stable bank deposits. - Payment arrears following the end of the 2020 moratorium have been limited so far, partly reflecting a seasonal repayment schedule; payment arrears in the first two months of 2021 for selected banks were around 5 percent of loans previously under the moratorium. - Credit trends: - Credit growth has slowed substantially. - Euro area monetary easing led to a significant drop in interest rates on new loans. - New loans to both non-financial corporates (NFCs) and households contracted sharply since April 2020. - Low credit demand (limited mobility, reduced refinancing needs, high private indebtedness) and bank tightening of lending standards contributed to subdued credit growth. - Credit decline eased in 2020:H2 as activities resumed and demand for housing loans was boosted by interest subsidies. - Credit growth remains among the weakest in the euro area. ### Policy implications and targeted measures highlighted - Continued use of wage support schemes and targeted tourism sector measures to preserve jobs and support the most affected sectors. - Liquidity and loan repayment moratoria, combined with supervisory relief, were central to avoiding immediate financial-sector destabilization. - Interest subsidy schemes for housing and new business loans aimed at supporting credit demand. - Fiscal measures combined direct expenditure support, grants, tax reliefs, VAT deferrals, and targeted interest subsidy programs to support firms and households. *International Monetary Fund — 1. Sectoral Impact of the COVID-19 Pandemic (content unit).* ### 1. Allow banks to use certain capital buffers (P2G &CCB). ### 1. Allow banks to use certain capital buffers (P2G &CCB). ### Measures implemented (capital, liquidity, supervisory, and fiscal support) - Allow banks to use certain capital buffers (P2G & CCB). 2020- - Allow banks to temporarily operate below the minimum liquidity requirements (LCR). 2020- - Allow using lower quality own funds to meet Pillar 2 Requirements (P2R). 2020- - Delay of phasing-in of Jan. 1 2021 O-SII buffer (0.5percent for banks) by 12 months. 2021 - SME financing through Cyprus Entrepreneurship Fund (CEF). Co-financing and risk sharing (50 percent-50 percent) between the government and the participating banks. Pending the signing of the Agreement with the EIF* - New business loans: for all businesses facing pandemic related difficulties. June 30, 2021 (pending for approval by the EC* an extension up to December 31, 2021). - New mortgages: to support households for new home ownership. up to Dec. 31, 2020 - Public Covid-19 moratorium available to all customers with arrears of less than 30 days. April 2020–December 31, 2020 - Subsequent moratorium (January 2021) targeting specific borrower categories (secured by primary residence of OMV* less than €350,000, and SMEs whose operations have been suspended by the lockdown measures, and entities in the hotel industry). Application deadline: January 31, 2021. January - June, 2021. - The moratoria apply to both capital and interest, while interest continues to accrue, with maximum duration of the payment suspension of 9 months. - Not an automatic trigger for increased credit risk, and flexibility is allowed in related provisioning requirements. - Relaxation from the requirements of the Loan origination Directive of the CBC to specific existing customers of the banks for new short-term loans/overdrafts for a certain amount. Until March 31, 2021 - Credit institutions are recommended to refrain from distributing cash dividends or conducting share buy-backs, or to limit such distribution. 2020- - Insurance and re-insurance companies, and Cyprus Investment Firms are recommended to refrain from underlying pay-outs. 2020- - The 2020 stress tests is postponed. - Adjusted timetables, including rescheduling on-site inspections, extending deadlines for certain non-critical supervisory measures and data requests. - Adjusted SREP process, recovery planning, digital operational resilience, and ICT risks. - Leeway for banks concerning the submission of supervisory reporting data. - Measures labeled: Capital and Liquidity Reliefs; Interest Rate Subsidies; Forbearance: Nine-Month Loan Moratorium; Restriction of Dividend Distributions, Bonus Pay-Outs and Share Buy-Backs Until September, 2021. ### Bank sector status, risks, and NPL developments - Liquidity remains abundant and capital ratios (with Tier1 capital at nearly 19 percent) have been stable. - Large NPL portfolio sales and sizable write-offs helped NPLs decline to 17.7 percent at December 2020 from 27.9 percent in February 2020. - Provision coverage of NPLs declined to 46.3 percent, near the euro area average. - Nearly half of legacy NPLs were terminated five years earlier, potentially requiring sizable write-downs. - Foreclosures have been suspended until end-July for smaller, collateralized loans; proposals under discussion in Parliament are expected to weaken the framework. - More than 80 percent of bank loans are to highly leveraged households and SMEs, concentrated in sectors like accommodation, food and retail, implying high risk of escalation of default rates and lower recovery value of assets after expiry of moratoria. - Banks are exposed to property market risks through real estate holdings and collateral valuation. - A stylized scenario with a 10 percent increase in NPLs that would push NPLs to some 19.5 percent of total loans from the current 17.7 percent: staff estimates that restoring capital and provisions to pre-pandemic levels would entail capital needs (explicit capital-need number truncated in source). ### Fiscal developments and sovereign financing - Total revenue declined by 7.1 percent in 2020. - Social contributions were stable because the National Health System (NHS) rate increases from June more than offset the adverse condition of the labor market. - Nominal expenditure increased by 9.8 percent due to the crisis-related spending and the implementation of the second phase of NHS. - The overall balance swung to -5.7 percent of GDP in 2020, compared with a surplus of 1.5 percent of GDP in 2019. - Public debt jumped from 94 percent of GDP in 2019 to 119 percent of GDP in 2020. - In 2020, the government issued 5–30 year bonds with the total amount of 4.5 billion euros at yields ranging from 0.35 percent to 2.34 percent for pre-financing and debt management operations. - Cyprus received loan amounts to 479 million euros under SURE: first disbursement of 250 million euros in 2020 and second disbursement of 229 million euros in 2021. - ECB’s net purchase of Cyprus’s sovereign bonds under PEPP and PSPP amounted to €1.71 billion through end-January 2021 and €3.43 billion through end-February 2021, respectively. - Fiscal table excerpts (2019–20, in millions of euros): - Total Revenue: 9,176 | 8,524 | -7.1 - Current revenue: 9,086 | 8,410 | -7.4 - Indirect taxes: 3,329 | 2,872 | -13.7 - Direct taxes: 2,156 | 2,100 | -2.6 - Social security contributions: 2,378 | 2,404 | 1.1 - Capital revenue: 90 | 142 | 6.9 - Total Expenditure: 8,850 | 9,717 | 9.8 - Current expenditure: 7,853 | 8,954 | 14.0 - Goods and services: 984 | 908 | -7.7 - Subsidies: 705 | 787 | 24.8 - Social transfer: 3,007 | 3,552 | 18.1 - Capital expenditure: 997 | 763 | -23.4 - Overall Balance: 326 | -1,193 - (In percent of GDP) 1.5 | -5.7 ### Economic outlook, scenarios, and risks - Staff’s baseline projections assume gradual and uneven recovery with persistent economic scarring; effective vaccine/treatments widely distributed from mid-2021 is assumed. - Tourism recovery assumptions: international tourist revenues will recover to around 30 percent of the 2019 level in 2021, and further rebound to 70 and 90 percent in 2022 and 2023, respectively, before returning to the 2019 level in 2024. - Cyprus’s receipt of grants from the EU Recovery and Resilience Facility (RRF) amounts to €1 billion (about 5 percent of 2020 GDP). Implementation assumed spread between 2021–26 with peak spending in 2023. Growth impact estimated at 0.5 percent on average annually over 2022–26. - Real GDP projections: - Output rebound to 3 percent in 2021 (near-term staff projection). - Real GDP expected to return to its pre-crisis level by 2022 but to remain 5.4 percent below the pre-crisis projected level by 2025. - Medium-term growth projected at 2.5 percent. - Current account deficit projected to narrow to 8.1 percent in 2021. - Upside risk: faster than expected vaccine distribution could lead to earlier border reopening and faster tourism recovery. - Downside risks: new contagion waves, slower vaccine distribution, higher credit default rates by highly indebted firms, realization of contingent liabilities from the banking system (including Asset Protection Scheme), higher-than-expected cost of the newly introduced National Health System, higher wage bill growth, larger-than-expected drop in FDI, and impacts from termination of the Cyprus Investment Program (CIP). - Staff’s stylized downside scenario: slower-than-expected application of the vaccine could result in a near-zero growth recovery in 2021. ### Sectoral impacts and policy implications - Contact-intensive and tourism-dependent sectors (wholesale and retail trade, restaurants, transportation) contributed 25 percent of GVA and 31 percent of total employment and have taken heavy tolls. - Manufacturing, mining, utility and construction (14.8 and 9.2 percent of GVA and employment, respectively) rebounded quickly in Q3 as lockdowns eased. - Corporates reduced leverage, accumulated higher deposits, and avoided wide-spread defaults owing to sizable policy support measures; however, high take-up of moratoria and employment support underscores substantial underlying stress. - Sectors with largest contractions are mostly SMEs in trade, hotels, restaurants and transport and are the largest borrowers, increasing risks of bankruptcies and macrofinancial feedback loops. - Degree of long-term scarring depends on preserving capacity, facilitating reallocation, and rebuilding the growth model; development of new sectors (education, ICT, shipping) is underway but not expected to replace lost output from declining sectors. ### Policy priorities and recommendations - Near term: focus on mitigating the impact of the crisis and risks to macro-financial stability; withdrawal of support measures should be gradual and largely demand-driven to avoid cliff effects. - Medium term: policies should facilitate a firm and sustained recovery by avoiding unnecessary bankruptcies and efficiently reallocating resources to minimize scarring and enhance growth potential. - Financial sector priorities: address NPLs to strengthen bank balance sheets and support credit growth; monitor capital buffer usage and provisioning flexibility; ensure orderly handling of moratoria expiries and potential foreclosure framework changes. - Authorities’ view: broadly agreed with staff’s growth outlook and risks; considered tourism could recover faster in 2021; agreed support measures should continue in the near term; from 2022 growth will be supported by RRF-funded projects, not additional fiscal measures; RRF funding should be used efficiently and promptly. *Sources: ECB, CBC and EBA. EIF stands for European Investment Fund. EC stands for European Commission. OMV stands for open market value.* *International Monetary Fund, Cyprus: Selected Issues chapter excerpt (content unit: 1cypea2021001).* ### 1.5 percent of GDP. ### 1.5 percent of GDP. ### Extensions of existing support measures and state-contingent design - Extend debt repayment forbearance on a targeted basis to individuals and business sectors most at risk to avoid cliff effects. - Continue existing interest subsidy schemes targeting SMEs to support new lending. - Use fiscal measures such as loan guarantees to incentivize banks to supply credit. - Formulate additional support measures to be state-contingent and fully utilize banks’ assessments of borrowers’ creditworthiness. ### Macroprudential buffers and bank loss-absorption capacity - Use released capital buffers (i.e., the capital conservation buffer and Pillar 2 guidance) flexibly to support restructuring and banks’ capacity to supply credit. - Encourage banks’ timely recognition of potential loan losses with updated risk assessments and maintaining adequate provisions. - Continue limiting dividend distribution and share buybacks to preserve buffers. - Buffers will help banks provide new credit and deal with legacy NPLs while maintaining financial stability. ### NPL strategies: monitoring, restructuring tools, and enforcement - Monitoring and transparency - The repayment moratorium masks borrowers’ underlying repayment capacity and risks under-provisioning of impaired loans. - Priorities: assess and address impact on asset quality and challenges from removal of temporary government and supervisory support. - Continue updating data reporting requirements to support enhanced supervisory monitoring, including loan restructuring data to prevent evergreening. - Examinership and restructuring tools (Annex VIII) - Current examinership use is limited due to complexity, lack of incentives for early debtor action, unavailability of financial information, and limited court capacity. - Ongoing transposition of the EU Directive on Preventive Restructuring and Second Chance is an opportunity to address obstacles. - Consider introducing an out-of-court or hybrid restructuring procedure to reduce complexity, cost, and duration for viable debtors. - Foreclosure framework - Effective foreclosure framework is critical to address strategic defaults and incentivize restructuring negotiations or insolvency tools. - Current parliamentary proposals risk reducing foreclosure threat and creating uncertainties, weakening prospects for collateral recovery and necessitating additional provisions and capital increases. - Address uncertainties from implementation of the 2019 amendments of the Foreclosure Law. - Estia scheme - Scheme: government covers one-third of eligible borrowers’ total monthly installments at the end of each year, over the next 10–25 years, subject to borrower continuation of payments; banks take a haircut up to the level of market price of underlying collateral. - Authorities estimated NPLs worth about €2 billion (10 percent of GDP) would benefit from the scheme. - As of March 5, 2021, NPLs of €165 million were approved, of which 40 percent were with CACs. - Take-up below expectations, likely reflecting strategic default behavior; banks should consider stepping up foreclosure on NPLs collateralized by primary residences if borrowers did not apply. - For applicants deemed unviable, authorities should ensure further burden-sharing or consider targeted support to protect living conditions of vulnerable borrowers. - Any scheme should consider fiscal and implementation costs and moral hazard implications. - Asset Management Company (AMC) and Credit Acquiring Companies (CACs) - CACs, including the public AMC, currently hold nearly two-thirds of the nation’s NPLs; oversight should continue to be strengthened. - Improve working environment for CACs, including access to the land registry database, to enable effective NPL workouts. - Subject to the EC’s state aid approval, authorities consider expansion of the public AMC; assess direct and contingent fiscal costs and implications for repayment behavior. - Ensure safeguards to identify willful defaults and non-cooperative borrowers; ensure transparency and sound governance if public AMC expands. ### Macro-financial risks and property market considerations - Closely monitor macro-financial risks from possible declines in property prices, given active use of debt-to-asset swaps in NPL resolution by banks and CACs. - Risks appear limited for now given stable residential price developments and limited size of commercial real estate transactions. - Use results of actual sales of repossessed collateral properties to review adequacy of valuation methodologies. - Maintain supervisory guidance to prevent excessive holding of repossessed collateral assets by banks. ### Authorities’ views (summarized) - Broad agreement with key priorities under the NPL strategy; banks under supervisory guidance have stepped up scrutiny and provisioning. - Work is ongoing to strengthen insolvency framework; authorities note out-of-court mechanisms should not freeze or delay existing legal processes. - Authorities recognize risks from reversal of foreclosure reforms and seek to mitigate damages ahead of the May parliamentary election. - On public AMC expansion: properly structured expansion could deal with socially sensitive portfolios and create buffers; fiscal costs will be carefully assessed to limit direct budgetary needs and avoid undermining payment culture; sound governance is crucial. ### Fiscal policy: near-term support, medium-term sustainability, and priorities - 2021 budget envisages continued policy support and a small improvement in the fiscal balance; full implementation of the National Health System (NHS) will be underway. - Staff estimates the primary deficit to decline to 2.4 percent of GDP in 2021, compared to 3.6 percent of GDP in 2020. - Fiscal balance is expected to improve considerably in 2022, supported by rebounding activity and expected phase-out of most crisis-related measures. - Goal: sustain deficit reduction trend to achieve a primary surplus of 1.9 percent of GDP by 2024 and gradually reduce public debt-to-GDP ratio to around 96 percent. - Near-term stance: continue focusing on health crisis and containing adverse economic impact; 2021 revised budget adds resources for health, extends targeted support, and provides new one-time measures. - COVID-related measures in 2021 expected to be similar to 2020; contingency measures should be formulated, including fully utilizing Next Generation EU Funds and SURE (€479 million in total). - Extremely low financing costs expected to persist, providing cushion; risk of premature fiscal tightening outweighs modestly delayed tightening. ### Fiscal policy recommendations and structural reforms - Recalibrate fiscal support and improve targeting to viable firms (e.g., in tourism) to maintain capacity and limit scarring. - Increase reliance on guaranteed/subsidized lending with banks’ viability assessments to support credit flows. - Incentivize private equity injections or capital increases (e.g., tax credits); consider well-designed state recapitalization for larger or strategic companies. - Connect short-term measures to longer-term objectives: improving human capital, facilitating digitalization, and transition to a green economy. - Front-load mature public investment projects and promote private investment using EU’s RRF and InvestEU. - When recovery is underway, shift focus to fiscal sustainability: mobilize revenues and improve expenditure composition. On the revenue side: - Modernize tax administration and strengthen tax collection: enact a new tax procedure code and a new IT system. - Consider new revenue sources: reinstate immovable property tax; increase excises on alcohol, tobacco, and other unhealthy food; increase fuel excise; introduce a gradually increasing carbon tax. - It is estimated that a carbon tax of $35 will generate revenue of 0.7 percent of GDP for Cyprus by 2030 and a carbon tax of $75 will generate revenue of 1.3 percent of GDP by 2030. On the expenditure side: - Control growth of the public sector wage bill; strengthen civil service reform and lower the share of wage bill in total spending. - Reorient spending to growth-friendly and inclusive areas: prioritize R&D and active labor market policies; speed up identification and implementation of RRF-prioritized investment projects. - Target measures to mitigate potential rise in inequality by focusing on groups most affected by the pandemic such as the young and women. - Implement local government reforms to enhance fiscal transparency, accountability, and service delivery. ### Transparency, oversight, and NHS fiscal risks - Establish platforms to provide clear and timely information on use of COVID-19 related spending; set and communicate transparent criteria for beneficiaries and eligible actions. - Oversight bodies should provide ongoing analysis and ex-post assessments of program effectiveness and investigate potential abuse. - Ensure transparency about distribution of relief funds and loans, including publishing beneficial ownership information and using open public procurement processes; conduct ex-post controls such as selective audits. - Containing fiscal risks from the NHS is a key challenge in the first year of full implementation: - Health contribution revenue estimated to be lower-than-budgeted by 14 percent due to suspension of contribution rate increases and pandemic impact. - Public hospitals (SHSO) lost non-COVID patients, reducing revenues; HIO has coped by temporarily reducing payments to providers and delaying second phase of (In-patient) services. - NHS includes mechanisms for financial sustainability: global budget, referral system, bulk purchasing, periodic reviews of contribution rates. - Measures needed: improve efficiency and competitiveness of SHSO during five-year transition; contain prices for essential medicines and healthcare services; review service coverage to handle rising healthcare demand from expanded coverage and population ageing. *Source: IMF staff report excerpt.* ### 32. The authorities agreed on the key policy priorities. In the near term, they considered that ### The authorities agreed on the key policy priorities ### Near-term support and fiscal policy - Current support measures considered sufficient before the expected recovery in the tourism sector mid-year. - Given the vaccine rollout, an adverse scenario is less likely, but regular support schemes for the tourism sector are in place if needed. - Authorities are open to: - A new loan guarantee scheme. - Other support instruments targeted to viable firms, including solvency support for strategic firms, provided sufficient safeguards against fiscal risks are in place. - Commitment to contain the growth of the public sector wage bill. - Recognition of fiscal risks from the NHS and agreement that more measures should be undertaken to enhance competitiveness and achieve financial autonomy of the SHSO. - Finalizing, under the RRF, plans to increase spending to: - Enhance human capital. - Encourage private sector R&D. - Facilitate the transition to digital and green economies. - Government working on a green tax reform and will review options of green taxation in a holistic way. - Importance of transparency of fiscal spending: authorities will publish the COVID-19 related spending. - Institutional processes (Internal Supervision, the Auditor General and European guidelines) are in place to assess COVID-19 related measures. ### NHS fiscal impact (percent of GDP) - NHS effects (percent of GDP) - Revenue - 2019: 1.7 - 2020: 2.7 - 2021: 3.2 - 2022: 3.2 - Social security contributions 3/ - 2019: 1.4 - 2020: 2.3 - 2021: 2.8 - 2022: 2.8 - Other revenue 3/ - 2019: 0.4 - 2020: 0.4 - 2021: 0.4 - 2022: 0.4 - Expenditure - 2019: 1.3 - 2020: 4.0 - 2021: 5.5 - 2022: 5.7 - Compensation - 2019: 0.2 - 2020: 0.5 - 2021: 0.5 - 2022: 0.5 - Intermediate consumption 3/ - 2019: 0.2 - 2020: 0.5 - 2021: 0.6 - 2022: 0.6 - Social transfer - 2019: 0.9 - 2020: 2.9 - 2021: 4.3 - 2022: 4.6 - Other expenditure 4/ - 2019: 0.0 - 2020: 0.1 - 2021: 0.1 - 2022: 0.1 - Balance - 2019: 0.5 - 2020: -1.3 - 2021: -2.3 - 2022: -2.5 - Notes from source: - 1/ 2019 revenue reflects the collection of contributions starting from March 2019. 2019 expenditure reflects the implementation of phase I services from June 2019. - 2/ 2020 revenue reflects the increases of contribution rates starting from March 2020 and the 3-month suspension of the increases from April to June. 2020 expenditure reflects the implementation of phase II services starting from June 2020. - 3/ Excludes government contributions as the third party and grants and payments from the HIO to SHSO. - 4/ Excludes expected investments to upgrade SHSO infrastructure during the transition period. ### Structural policies: labor market, skills, and inclusiveness - Labor market policy priorities: - Transition from preserving jobs towards facilitating efficient labor reallocation. - Boost active labor market policies such as retraining and public employment services. - Address skills gap: Cyprus ranks 28th out of 31 countries on CEDEFOP’s European Skills Index 2020, attributed to low performance in skills development (vocational educational and training, recent training, and reading math and science scores). - Increase spending on training and direct job creation (spending historically among the lowest in the EU). - Education spending should be more efficient; update curricula and enhance teacher training to close mismatch between education and labor market. - Greater investment in reskilling and upskilling for digital skills and vocational skills for a green economy. - Mitigating inequality and supporting vulnerable groups: - Priority to mitigate repercussions of the crisis on inequality. - The distributional impact of job losses has been uneven, with more adverse impact on young people and women. - High share of youth not in employment, education or training. - Policies should enhance female labor participation by improving childcare and flexible working arrangements. - For young people: job search assistance, incentives for part-time work, payroll subsidies for newly-hired staff. - Any consideration of a national minimum wage should consider impact on competitiveness and youth work opportunities. - Authorities’ measures: - Mixture of targeted active labor market policies and wage support schemes partially financed by SURE funds. - Vocational trainings for the unemployed and children’s daycare for young and women. - Proposed Digital Academy to enhance digital skills. ### Digital agenda and RRF utilization - Pandemic accelerates transformation to a digital economy. - Deputy Ministry of Research, Innovation and Digital Policy (DMRID) has provided digital platforms for government support payments and mobility monitoring. - RRF funds should be fully utilized to advance the digital agenda, including: - Human capital development (see labor market priorities). - Connectivity improvements where Cyprus lags European peers. ### Green transition and National Energy and Climate Plan (NECP) objectives for 2030 - NECP main objectives for 2030: - Reducing greenhouse gas emissions and environmental objectives - Emissions in the non-ETS sectors to be reduced by 20.9 percent 1/ - Emissions from land use, land use change or forestry are offset by at least an equivalent removal of CO₂ from the atmosphere - Emissions in ETS sectors to be reduced by 24.9 percent 1/ - Increasing the share of RES in energy consumption - Share of RES in gross final energy consumption to reach 23 percent - Share of RES in gross final electricity consumption can reach at least 26 percent - Share of RES in heating and cooling to reach 39 percent - Share of RES in the transport sector to reach 14 percent - Improving Energy Efficiency - Final Energy Consumption of 2.0 Mtoe, representing 13 percent reduction 2/ - Primary Energy Consumption of 2.4 Mtoe, representing 17 percent reduction 2/ - Achieving cumulative energy saving of 243.04 ktoe during 2021–2030 - Policy priorities and investments: - Focus on renewable energy, promoting natural gas, technological research, and major investment in energy and transport infrastructures. - Need for more investments to improve electricity network to support renewable energy penetration and promote energy saving projects, including energy-efficient renovation of buildings. - Consider a feebate system and scale up investment in green infrastructure and public transportation to facilitate green vehicles and public transport use. - Financing: - Investments in the energy sector largely financed by the RRF and European Investment Bank. ### Financial sector, NPLs, and resolution - Financial sector priorities: - Extend targeted support measures and effectively resolve legacy and potential new NPLs by banks and CACs. - Targeted credit support measures needed: interest subsidy schemes for SMEs and guaranteed loans to incentivize bank lending. - Support measures should target viability of firms using banks’ creditworthiness assessments. - Supervisory guidance encouraging flexible use of capital buffers and continued limits on dividend distributions is welcome. - NPL resolution and insolvency: - Timely restructuring of viable businesses to preserve production capacity. - Continued judicial reforms needed to improve collateral execution and incentives for debt workouts. - Avoid reversal of reforms to the foreclosure framework. - As Estia scheme approaches conclusion, banks should consider stepping up foreclosure on NPLs of borrowers who did not apply, while authorities should ensure further burden sharing or consider targeted support for applicants deemed unviable. - Strengthen oversight of CACS. - Carefully assess proposed expansion of the public AMC (subject to EC state aid approval) with respect to costs, benefits, and impact on repayment behavior. ### AML/CFT, judicial reform, and institutional improvements - AML/CFT framework: - Continue implementing measures from the 2019 MONEYVAL AML/CFT assessment report, in particular improving financial sector supervision and preventive measures and increasing transparency of beneficial owners. - Council of Ministers’ decision to terminate the CIP should positively mitigate ML/TF and reputational risks. - Judicial and institutional reforms: - Ongoing recruitment of additional judges welcome; complement with completion of reforms of civil procedure rules, clearance of case backlogs, and launch of e-justice system. - Strengthen institutional framework for insolvency service and professionals. - Ensure efficient system for issuance and transfer of title deeds and clear related backlogs. ### Staff appraisal and macro outlook - Pandemic management and outcomes: - Cyprus managed the COVID-19 pandemic shock relatively well: swift containment measures and high testing kept hospitalization and mortality rates relatively low. - Wide-spread defaults and high unemployment largely avoided so far, supported by timely policy support and pre-crisis balance sheet buffers. - Near-term outlook and risks: - Growth projected to recover moderately to 3 percent in 2021 after output fell by 5.1 percent in 2020. - Key uncertainties: pace of vaccine rollout and potential new waves of infection. - Further risks: weakening underlying fiscal position leading to increased risk premia and a larger than expected drop in foreign direct investment inflows due to termination of the Cyprus Investment Program. - Given exposure to tourism and related sectors, risks of wider bankruptcies and loan repayment difficulties leading to permanent scarring are high if policy support is withdrawn prematurely or if tourism recovery lags. - Policy sequencing: - Near-term: focus on mitigating crisis impact, rapid vaccine distribution, gradual withdrawal of broad support measures. - As recovery takes hold: shift to sustainable and inclusive growth, support efficient reallocation of resources to minimize scarring and enhance growth potential. - Fiscal stance and recommendations: - Avoid premature withdrawal of fiscal support given high uncertainties; fiscal stance in 2021 with continued sizeable policy support is appropriate. - Recalibrate fiscal support to target viable but vulnerable firms (e.g., in tourism) to avoid unnecessary bankruptcies. - Encourage equity increases to address potential solvency problems. - Front-load mature public investment projects and promote private investment through the EU’s RRF. - Provide transparency and accountability on COVID-19 related spending. - As recovery progresses, maintain fiscal sustainability: modernize tax administration, contain public wage bill growth, reorient spending toward human capital, digitalization, and green transition. - Contain fiscal risks from the NHS as it embarks on the first year of full implementation of NHS reform. - Structural reform priorities reiterated: - Transition labor market policies from preserving jobs to facilitating efficient reallocation (active labor market policies and public employment services). - Improve digital infrastructure and upgrade digital skills to enhance competitiveness. - Implement climate-friendly policies and facilitate green economy transition (greater investment in renewable energy and green taxation) to meet 2030 NECP emission targets. - Inclusive recovery emphasis: - Priority to mitigate repercussions of the crisis on inequality, focusing on young people and women. - Enhance female labor participation and youth job search. - Any national minimum wage consideration should account for competitiveness and youth employment impacts. *Source: IMF staff report on Cyprus (excerpts provided).* ### 49. It is proposed that the next Article IV consultation take place on the standard ### 1cypea2021001 - 49. It is proposed that the next Article IV consultation take place on the standard ### Macroeconomic performance (Figure 3) - 2020: real economy contracted sharply, mainly driven by investment and net exports; public spending mitigated the contraction. - Sectoral impact: - Service sectors such as retail trade and hotels were hit hard. - Contribution to GDP growth (value added): Trade, Hotels, & Communication; Financial & Insurance; Prof., Admin., Edu, & Arts; Others. - Cumulative contributions to real GDP growth (2002–2020): - Private consumption remained the major contributor. - Tourism contribution declined. - Households: - Net financial assets of households remain large (Domestic Financial Balances of Households measured in Billions of euros). - Household savings increased during the crisis. - Charts and metrics displayed: Contributions to GDP Growth—Expenditure (Y-O-Y percentage change); Contributions to GDP Growth—Value Added (Y-O-Y percentage change); Household Saving Rate and GDP Growth (Percent; Year-on-year percent change). ### Inflation and labor market (Figure 4) - Inflation: - Headline and core inflation turned negative since the Covid-19 pandemic. - Inflation levels are much lower compared with European peers. - HICP (period average) and HICP (end of period) series shown. - Contributions to HICP Inflation by category: Food, beverage, clothing; Utilities; Transport/Comm.; Recreation/Hotel; Others. - Labor market: - Job losses concentrated in trade and tourism-related sectors, pushing up unemployment especially among the youth. - Unemployment rates: Total unemployment rate and Youth unemployment rate (RHS) plotted (data to Feb-21/Mar-21). - Real compensation per employee dipped; unit labor costs picked up as productivity fell. - Indicators displayed: Contribution of sectors to employment growth; Real Compensation per Employee (Annual percentage change); Unit Labor Costs (2009Q1 = 100); HICP Inflation (Percent); Unemployment Rate (Percent). ### External indicators (Figure 5) - Current account and external position: - Underlying current account deficit widened. - Current Account (Percent of GDP) series shows deterioration (2008–2020). - Net IIP remains highly negative, reflecting large negative IIP position of the government and the private sector (SPEs). - Exchange rate and capital flows: - Real effective exchange rate increased from the post-crisis low (REER index 2009=100). - Net capital inflows to the private sector declined; mitigated by net capital inflows into the government. - Financial Flows by Sector (4-quarter sum, percent of GDP) shown for 2020Q4. - Gross external debt: - Gross external debt is near post-crisis low, with SPEs accounting for the major share. - Gross External Debt (Percent of GDP) by sector charted (2020Q4). ### Credit and balance sheets (Figure 6) - Credit dynamics: - Domestic credit growth increased, mainly due to a moratorium on debt repayments. - Growth of pure new loans to households and NFCs accelerated in the second half of the year. - Domestic Credit Growth (Annual percentage change) to Feb-21 illustrated. - Sectoral balances and instruments: - NFCs and the general government remain in large net debt position; loans are the largest component of net financial liabilities. - Domestic Economy Financial Balances by Sector (Billions of Euros) and Domestic Financial Balances by Instrument displayed. - Debt levels: - Household debt as percent of GDP is one of the highest among euro area countries (Debt of Households, 2020Q4). - NFC debt remains high despite deleveraging (Debt of Nonfinancial Corporations, 2020Q4). ### Banking sector (Figure 7) - Deleveraging and profitability: - Banks have continued to deleverage. - Total profit of the banking sector declined to near zero as net interest income shrank. - Banking Sector Profits (Billions of Euros) and Balance Sheet of the Banking Sector (Billions of Euros) shown. - Deposits and NPLs: - Total customer deposits of locally active banks were broadly stable after an initial decline; residents’ deposits increased offsetting non-resident deposits. - Deposits by residency and system-wide customer deposits (Billions of euro) plotted to Mar-21. - NPL ratio declined reflecting new NPL sales and write-offs; NPL ratio to total loans and Provisioning coverage ratio to NPLs series shown. - Additional notes: - At end-2014 the CBC adopted the European Banking Authority's definition of NPLs. ### Housing market (Figure 8) - Prices, sales, and activity: - Transaction-based property prices are rising while property sales have declined due to lower sales to non-residents. - Cyprus: Property Sales (Thousand units) and Residential property price index (2010Q1 = 100) to 2020Q4 displayed. - Construction and loans: - Growth in construction activities rebounded after initial lockdown dip. - Stock of housing loans is gradually declining in line with reduced external loans; domestic loans are stable. - Housing Loans (Stock, Bn Euro), Mortgage Interest Rate (Percent), and Building Permits (Million Sq. M) shown (2020Q4). - Mortgage environment: - Mortgage interest rates continue to decline. - Issuance of building permits resumed after a temporary drop in Q2. ### Fiscal developments (Figure 9) - Fiscal balances and debt: - Fiscal balance worsened sharply in 2020 as expenditure increased significantly due to crisis-related spending and implementation of NHS. - Underlying primary balance = -3.6 (2020). - Public debt increased significantly (Public Debt Percent of GDP series to 2020). - Revenues and expenditures: - NHS contributions helped stabilize revenue. - Expenditure by main component (Percent of GDP) for 2020 shows large increases in Social Transfers and other components. - Revenue by main component (Percent of GDP) for 2020 displayed. - Market indicators: - Market conditions stabilized from earlier spike in spreads in 2020Q2. - 3-month T-bill yields remain negative reflecting accommodative Euro area conditions. - 10-Year Government Bond Yields and Spreads (Percent) and 3-Month T-Bill Yields (Percent) charts included. ### Growth inclusiveness indicators (Figure 10) - Unemployment and long-term unemployment: - Unemployment rates approached pre-crisis low in 2019; long-term unemployment increased moderately in 2020. - Long-term unemployment and very long-term unemployment (>24m) series displayed (2020Q4). - Labor market composition and social indicators: - Share of part-time employment and temporary workers continued declining trend (Part-time and temporary contract Percent of total employment, 2020Q4). - Poverty level in Cyprus remained below euro area average (At-Risk-Poverty Rate, 2019). - Gini Coefficient of Equivalized Disposable Income, 2019 shows income equality comparable to European peers. - NEET Youth from 15 to 29 years, 2019 indicates young inactive population relatively large. ### Key projections and macro aggregates (Table 3: Selected Economic Indicators, 2018–2026) - Real economy: - Real GDP: 2018 = 5.2; 2019 = 3.1; 2020 = -5.1; 2021 = 3.0; 2022 = 3.9; 2023 = 3.1; 2024 = 2.8; 2025 = 2.6; 2026 = 2.5. - Domestic demand: 2018 = 2.6; 2019 = 5.1; 2020 = 0.8; 2021 = 1.2; 2022 = 3.4; 2023 = 2.5; 2024 = 2.1; 2025 = 1.9; 2026 = 1.8. - HICP (period average): 2018 = 0.8; 2019 = 0.6; 2020 = -1.1; 2021 = 0.5; 2022 = 0.8; 2023 = 1.2; 2024 = 1.4; 2025 = 1.7; 2026 = 1.9. - Unemployment rate (percent, period average): 2018 = 8.4; 2019 = 7.1; 2020 = 7.6; 2021 = 7.5; 2022 = 7.0; 2023 = 6.5; 2024 = 6.0; 2025 = 5.5; 2026 = 5.1. - Public finance: - General government balance: 2018 = -3.5; 2019 = 1.5; 2020 = -5.7; 2021 = -4.8; 2022 = -1.1; 2023 = -0.4; 2024 = 0.1; 2025 = 0.6; 2026 = 0.8. - Revenue: 2018 = 39.5; 2019 = 41.2; 2020 = 40.9; 2021 = 42.9; 2022 = 44.0; 2023 = 44.2; 2024 = 44.1; 2025 = 44.0; 2026 = 43.6. - Expenditure: 2018 = 43.0; 2019 = 39.7; 2020 = 46.6; 2021 = 47.6; 2022 = 45.0; 2023 = 44.6; 2024 = 44.0; 2025 = 43.4; 2026 = 42.8. - General government debt: 2018 = 99.2; 2019 = 94.0; 2020 = 119.1; 2021 = 114.0; 2022 = 106.4; 2023 = 102.8; 2024 = 95.6; 2025 = 91.8; 2026 = 86.1. - Balance of payments: - Current account balance (Percent of GDP): 2018 = -3.9; 2019 = -6.3; 2020 = -11.9; 2021 = -8.1; 2022 = -6.0; 2023 = -5.1; 2024 = -4.7; 2025 = -4.0; 2026 = -3.7. - Exports of goods and services: 2018 = 75.2; 2019 = 71.9; 2020 = 67.7; 2021 = 66.4; 2022 = 67.5; 2023 = 68.7; 2024 = 70.2; 2025 = 70.2; 2026 = 69.1. - Gross capital formation (Percent of GDP): 2018 = 19.2; 2019 = 19.4; 2020 = 20.3; 2021 = 21.9; 2022 = 21.7; 2023 = 21.4; 2024 = 21.1; 2025 = 20.8; 2026 = 20.5. - Memorandum: - Nominal GDP (billions of euros): 2018 = 21.4; 2019 = 22.3; 2020 = 20.8; 2021 = 21.5; 2022 = 22.7; 2023 = 23.9; 2024 = 25.0; 2025 = 26.3; 2026 = 27.6. - Net IIP: 2018 = -125.8; 2019 = -122.3; 2020 = -128.1; 2021 = -131.8; 2022 = -130.8; 2023 = -129.4; 2024 = -127.8; 2025 = -125.7; 2026 = -123.0. ### Fiscal development and projections (Table 4) - Revenue and expenditure (Percent of GDP): - Revenue series: 2018 = 39.5; 2019 = 41.2; 2020 = 40.9; 2021 = 42.9; 2022 = 44.0; 2023 = 44.2; 2024 = 44.1; 2025 = 44.0; 2026 = 43.7. - Expenditure series: 2018 = 43.0; 2019 = 39.7; 2020 = 46.6; 2021 = 47.6; 2022 = 45.3; 2023 = 44.8; 2024 = 44.2; 2025 = 43.5; 2026 = 42.8. - Key fiscal balances: - Overall balance: 2018 = -3.5; 2019 = 1.5; 2020 = -5.7; 2021 = -4.8; 2022 = -1.2; 2023 = -0.6; 2024 = 0.0; 2025 = 0.5; 2026 = 0.9. - Primary balance: 2018 = -1.1; 2019 = 3.8; 2020 = -3.6; 2021 = -2.4; 2022 = 1.0; 2023 = 1.3; 2024 = 1.7; 2025 = 2.1; 2026 = 2.3. - Underlying primary balance 3/: 2018 = 6.2; 2019 = 3.8; 2020 = -3.6; 2021 = -2.4; 2022 = 1.0; 2023 = 1.3; 2024 = 1.7; 2025 = 2.1; 2026 = 2.3. - Public debt (Percent of GDP): 2018 = 99.2; 2019 = 94.0; 2020 = 119.1; 2021 = 114.0; 2022 = 106.4; 2023 = 102.8; 2024 = 95.6; 2025 = 91.8; 2026 = 86.1. - Memorandum: Public debt net of cash holding: 2018 = 96.8; 2019 = 89.8; 2020 = 101.8; 2021 = 103.3; 2022 = 99.0; 2023 = 94.6; 2024 = 90.1; 2025 = 85.3; 2026 = 80.2. ### General government financing (Table 5) - Gross borrowing needs (Millions of Euros): 2020 = 3,645; 2021 = 3,227; 2022 = 2,484; 2023 = 1,781; 2024 = 2,626; 2025 = 1,904; 2026 = 2,454. - Overall deficit (Millions of Euros): 2020 = 1,238; 2021 = 1,026; 2022 = 239; 2023 = 95; 2024 = -31; 2025 = -160; 2026 = -226. - Amortization (Millions of Euros): 2020 = 2,407; 2021 = 2,201; 2022 = 2,245; 2023 = 1,687; 2024 = 2,657; 2025 = 2,064; 2026 = 2,679. - Cash holding (eop, Millions of Euros): 2020 = 3,616; 2021 = 2,318; 2022 = 1,684; 2023 = 1,952; 2024 = 1,376; 2025 = 1,722; 2026 = 1,618. - General government debt (eop, Millions of Euros): 2020 = 24,829; 2021 = 24,557; 2022 = 24,162; 2023 = 24,525; 2024 = 23,918; 2025 = 24,104; 2026 = 23,774. - General government debt (eop, percent of GDP): 2020 = 119.1; 2021 = 114.0; 2022 = 106.4; 2023 = 102.8; 2024 = 95.6; 2025 = 91.8; 2026 = 86.1. ### Balance of payments and external financing (Tables 6–7) - Balance of Payments (Percent of GDP) highlights (Table 6): - Current Account Balance: 2018 = -3.9; 2019 = -6.3; 2020 = -11.9; 2021 = -8.1; 2022 = -6.0; 2023 = -5.1; 2024 = -4.7; 2025 = -4.0; 2026 = -3.7. - Services Balance: 2018 = 22.7; 2019 = 19.7; 2020 = 13.8; 2021 = 18.2; 2022 = 18.4; 2023 = 20.0; 2024 = 21.4; 2025 = 21.8; 2026 = 20.8. - Financial Account ( - financing): 2018 = -3.7; 2019 = -6.0; 2020 = -10.4; 2021 = -7.9; 2022 = -5.8; 2023 = -4.8; 2024 = -4.5; 2025 = -3.8; 2026 = -3.6. - Gross External Debt: 2018 = 900.2; 2019 = 849.0; 2020 = 909.0; 2021 = 1018.6; 2022 = 984.2; 2023 = 956.0; 2024 = 931.7; 2025 = 903.0; 2026 = 872.3. - External financing needs and sources (Table 7, Millions of Euros): - GROSS FINANCING REQUIREMENTS: 2018 = 54,760; 2019 = 47,797; 2020 = 45,795; 2021 = 48,326; 2022 = 50,590; 2023 = 52,572; 2024 = 55,729; 2025 = 58,743; 2026 = 61,393. - New borrowing and debt rollover: 2018 = 52,646; 2019 = 43,215; 2020 = 48,435; 2021 = 50,361; 2022 = 52,542; 2023 = 55,051; 2024 = 58,685; 2025 = 60,663; 2026 = 60,942. - ROLLOVER RATES examples: - General government: 2018 = 212%; 2019 = 120%; 2020 = 89%; 2021 = 99%; 2022 = 1637%; 2023 = 133%; 2024 = 151%; 2025 = 85%; 2026 = 149%; 2027 = 179% (as tabulated). ### Financial soundness indicators (Table 8) - Capital adequacy: - Total capital ratio: 2012 = 7.3; 2013 = 13.5; 2014 = 15.3; 2015 = 16.6; 2016 = 16.8; 2017 = 16.3; 2018 = 17.5; 2019 = 19.9; 2020 = 20.1. - Tier I capital ratio: 2012 = 6.3; 2013 = 12.3; 2014 = 14.6; 2015 = 16.0; 2016 = 16.4; 2017 = 15.4; 2018 = 16.5; 2019 = 19.0; 2020 = 19.0. - Asset quality: - NPLs to total gross loans (EBA definition): 2012 = 27.1; 2013 = 44.4; 2014 = 47.5; 2015 = 45.3; 2016 = 46.4; 2017 = 42.5; 2018 = 30.5; 2019 = 28.0; 2020 = 17.7. - Provisions to NPLs: 2014 = 33.9; 2015 = 38.3; 2016 = 42.1; 2017 = 47.2; 2018 = 51.6; 2019 = 55.2; 2020 = 49.7. - Earnings and profitability: - Return on assets (annual): 2012 = -3.4; 2013 = -4.3; 2014 = -0.6; 2015 = -0.6; 2016 = -0.3; 2017 = -1.1; 2018 = 0.2; 2019 = 0.4; 2020 = 0.0. - Return on equity (annual): 2012 = -69.5; 2013 = -69.5; 2014 = -8.1; 2015 = -7.4; 2016 = 1.7; 2017 = -11.2; 2018 = 6.4; 2019 = 4.3; 2020 = -1.5. - Net interest margin: 2012 = 2.3; 2013 = 2.4; 2014 = 2.9; 2015 = 2.8; 2016 = 2.6; 2017 = 2.3; 2018 = 1.8; 2019 = 1.9; 2020 = 1.8. - Liquidity and other ratios: - Cash, trading and AFS assets to total assets ratio: 2012 = 8.6; 2013 = 7.0; 2014 = 14.4; 2015 = 19.8; 2016 = 22.9; 2017 = 27.9; 2018 = 27.6; 2019 = 29.3; 2020 = 27.6. - Total loans and advances to total assets ratio: 2012 = 82.9; 2013 = 83.6; 2014 = 73.4; 2015 = 73.6; 2016 = 69.1; 2017 = 64.1; 2018 = 54.6; 2019 = 53.8; 2020 = 51.4. - Total deposits (other than from credit institutions) to total assets ratio: 2012 = 71.7; 2013 = 63.8; 2014 = 63.0; 2015 = 65.1; 2016 = 74.9; 2017 = 75.6; 2018 = 79.2; 2019 = 82.8; 2020 = 80.2. *Sources: Central Bank of Cyprus; ECB; Eurostat; Haver Analytics; Cystat; Ministry of Finance; Bloomberg Finance LP; IMF staff estimates and IMF staff calculations.* ### Annex I. Status of Article IV Recommendations ### Annex I. Status of Article IV Recommendations ### Strengthen Financial Sector Policies - Past Policy Recommendation: - Reduce private sector debt and high NPLs, including by: - (i) addressing impediments in the foreclosure and insolvency frameworks and asset sales legislation; - (ii) relying on a broad set of tools that includes burden sharing and keeps banks well provisioned and capitalized; and - (iii) strengthening supervisory and governance framework for credit-acquiring companies (CACs), including the government-owned CAMC. - Policy Actions: - The amendments to the foreclosure and insolvency legislation and the sales of loans law as well as the adoption of a law on securitization have enhanced the toolkit to address NPLs (2018). - Banks have made significant progress in offloading NPLs. - However, their successful workout outside of the banking system is still needed, Parliament recently made further amendments to foreclosure law to weaken the effectiveness of its framework. - A subsidy scheme aimed at encouraging vulnerable borrowers to start servicing their loans through burden sharing is about to be implemented, but its coverage is rather broad. - CAMC has yet to become fully operational. ### Ensure Fiscal Sustainability and Avoid Procyclicality - Past Policy Recommendation: - Cap fiscal spending and wage bill by medium term GDP growth and nominal GDP growth, respectively, to avoid procyclical policies, prevent structural loosening and mitigate risks stemming from the high level of public debt. - Mitigate fiscal risks from the introduction of a public health insurance system. - Focus on implementing key reforms in public financial management (PFM) and revenue administration (RA); pass the law on creation and functioning of SOEs. - Policy Actions: - The authorities have contained fiscal spending and wage bill within medium term GDP growth and nominal GDP growth, respectively. - Some fiscal loosening took place during 2017–2019. - A more durable mechanism to keep the public-sector wage bill in check has not been adopted by Parliament. - The government has decided to reverse crisis-era public wage cuts gradually starting in 2018. - Reforms are ongoing to make the public health sector more competitive. - PFM and RA reforms are being implemented, supported by Fund technical assistance. - Legislative reform of SOEs, however, has stalled. ### Implement Structural Reforms - Past Policy Recommendation: - Strengthen judicial efficiency and commercial claims enforcement. - Strengthen central bank governance and undertake Local government and civil service reforms. - Continue to improve the AML/CFT framework, including by ensuring effectively mitigating inherent AML/CFT risks. - Policy Actions: - The legislation for the establishment of a commercial court is [currently undergoing legal vetting]. - An action plan is being drawn based on issues identified in a functional review of the Cyprus’s Court System prepared by the Irish Institute of Public Administration. - The amending legislation to strengthen the governance and autonomy of the CBC is [undergoing legal vetting]. - A draft law on local government reform is currently being prepared [under discussion in Parliament]. - Civil service reform has largely stalled. - A cap on the number of citizenships granted under the CIP has been introduced and the required period for holding investment lengthened; The CIP scheme has been terminated from end-Nov 2020. *Source: Annex I. Status of Article IV Recommendations (content unit: 1cypea2021001)* ### 89.1 percent of GDP, respectively. ### 1cypea2021001 - 89.1 percent of GDP, respectively. ### Scenarios and Debt Projections: combined and contingent shocks - Combined macro-fiscal shocks (growth + interest rate + primary balance): - Public debt peaks at 126 percent of GDP in 2023 before declining to 112.6 percent of GDP by 2026. - Gross financing needs peak at 16.2 of GDP in 2023 before falling back. - Scenario with lower fiscal balance and realization of contingent liabilities from government guarantees: - Primary fiscal balance assumed permanently lower than baseline by ½ standard deviation. - Interest rate higher than under baseline by 285 basis points in 2022 and 42– 64 basis points thereafter. - Public debt rises to 117.7 percent of GDP in 2022 and thereafter declines to 105.4 percent in 2026. - Gross financing needs spike to 22.3 percent of GDP in 2022 before declining to 12.4 percent in 2026. - Adverse macro-fiscal-contingent liability (CL) scenario (lower growth and primary balances + banking sector CLs): - Real GDP growth and primary fiscal balance assumed permanently lower than baseline by ½ standard deviation. - Further realization of contingent liabilities from the banking sector assumed: 6 percent of GDP from the existing NPLs and 1.5 percent of GDP from 10 percent further increase in NPLs in 2022 (on top of support already provided to the CCB). - Under this adverse scenario: - Public debt rises to 123 percent of GDP in 2023 and declines only slowly to 121 percent of GDP in 2026. - Gross financing needs spike to 23.7 percent of GDP in 2022 before declining to 13.6 percent of GDP over the medium term. - Note on contingent liabilities from banking sector (components): - (i) 50 percent default rate for loans covered by the APS and 50 percent loss-given-default rate; - (ii) 75 percent loss from gross book value of NPLs minus provisions of the banking system; - (iii) capital needs of 1.5 percent of GDP from 10 percent increase in NPLs. ### External debt dynamics and projections - Historical and baseline projections: - In 2020, Cyprus’s external debt increased to 908 percent of GDP (287 percent of GDP excluding SPEs). - In 2020, government external debt increased slightly to 100 percent of GDP. - Net debt was much lower than gross debt at 369 percent of GDP for the economy and negative after excluding SPEs (-4 percent of GDP). - Gross external debt projected to increase to around 1019 percent of GDP in 2021, then decline gradually to 872 percent of GDP by 2026. - Government external debt projected to be 86 percent of GDP in 2021, then decline to around 70 percent of GDP over the medium term. - Vulnerabilities and financing needs: - Gross financing needs declined from over 400 percent of GDP in 2012 and 2013 to 216 percent of GDP in 2020. - Gross external financing needs are projected to increase in the near term then decline, but remain elevated (over 200 percent of GDP) through the projection period due to sizable short-term private sector debt. - External debt increases from an already high level leave Cyprus vulnerable to shocks; shocks to interest rates and economic growth would significantly impede debt reduction. - Standardized current account deficit shocks have a more limited impact on the debt ratio. ### Stress tests and DSA outcomes - Baseline public DSA (selected figures, as of March 25, 2021): - Nominal gross public debt: 90.5 (2019), 94.0 (2020), 119.1 (2021), 114.0 (2022), 106.4 (2023), 102.8 (2024), 95.6 (2025), 91.8 (2026), 86.1 (projection year). - Public gross financing needs: 12.0 (2019), 13.3 (2020), 17.3 (2021), 15.0 (2022), 10.9 (2023), 7.5 (2024), 10.5 (2025), 7.3 (2026), 8.9 (projection year). - Real GDP growth (in percent): 1.2 (2019), 3.1 (2020), -5.1 (2021), 3.0 (2022), 3.9 (2023), 3.1 (2024), 2.8 (2025), 2.6 (2026), 2.5 (projection year). - Primary deficit (cumulative impact and flows noted): primary deficit entries include 0.0 (2019), -3.8 (2020), 3.6 (2021), 2.4 (2022), -1.2 (2023), -1.5 (2024), -1.9 (2025), -2.3 (2026), -2.4 (projection year); cumulative primary deficit -6.9. - Automatic debt dynamics (cumulative): 1.3 (-2019), -1.5 (2020), 8.7 (2021), -1.5 (2022), -3.6 (2023), -3.2 (2024), -3.0 (2025), -2.8 (2026), -3.0 (projection) with cumulative -17.1. - Stress test scenarios highlighted in figures and text: - Primary Balance Shock, Real GDP Growth Shock, Real Interest Rate Shock, Real Exchange Rate Shock, Combined Macro-Fiscal Shock, Contingent Liability Shock, Adverse macro-fiscal-CL scenario. - Under combined and contingent shocks, gross nominal public debt and public gross financing needs spike markedly (examples above under Scenarios). ### Key messages, risks, and policy recommendations - Key messages: - Cyprus’s public debt and external debt remain at high levels and debt sustainability risks have increased through the impact of the pandemic. - Extremely low financing costs—which are expected to persist—provide considerable cushion for some time. - Risks: - Debt reduction is susceptible to growth shocks and realization of contingent liabilities. - Continued large gross financing needs expose the economy to liquidity and other risks. - Large size of external debt increases debt service costs and reduces denominator effects on debt ratios when growth falters. - Policy recommendations: - Ensure strong underlying fiscal surpluses when recovery is underway and gradually shift policy focus to maintaining fiscal sustainability. - Maintain prudent fiscal policy post-pandemic that avoids procyclicality to safeguard the downward path of external public debt and create space to absorb possible contingent fiscal shocks. - Implement sound financial sector policies and structural reforms to contain banking sector risks and support a more diversified economy. - Closely align the maturity and currency composition of external assets and liabilities. ### Selected numeric highlights and indicators (preserve exact figures) - Public debt projections and peaks: - 126 percent of GDP (peak under combined macro-fiscal shocks in 2023). - 112.6 percent of GDP (decline by 2026 under combined shocks). - 117.7 percent of GDP (public debt in 2022 under lower fiscal balance + contingent liabilities scenario). - 105.4 percent of GDP (public debt in 2026 under that scenario). - 123 percent of GDP (public debt in 2023 under adverse macro-fiscal-CL scenario). - 121 percent of GDP (public debt in 2026 under adverse macro-fiscal-CL scenario). - Gross financing needs: - 16.2 of GDP (peak in 2023 under combined shocks). - 22.3 percent of GDP (spike in 2022 under lower fiscal balance + contingent liabilities scenario). - 12.4 percent of GDP (in 2026 under that scenario). - 23.7 percent of GDP (spike in 2022 under adverse macro-fiscal-CL scenario). - 13.6 percent of GDP (over the medium term under adverse macro-fiscal-CL scenario). - External debt and related measures: - 908 percent of GDP (external debt in 2020). - 287 percent of GDP (external debt excluding SPEs in 2020). - 100 percent of GDP (government external debt in 2020). - 369 percent of GDP (net debt for the economy in 2020). - -4 percent of GDP (net debt after excluding SPEs in 2020). - 1019 percent of GDP (projected gross external debt in 2021). - 872 percent of GDP (projected gross external debt by 2026). - 86 percent of GDP (government external debt in 2021). - 70 percent of GDP (government external debt around medium term). - Gross financing needs levels: over 400 percent of GDP (2012 and 2013 peak); 216 percent of GDP (2020). - Banking-sector contingent liabilities assumed in adverse scenario: - 6 percent of GDP (from existing NPLs). - 1.5 percent of GDP (from 10 percent further increase in NPLs). *Source: IMF staff, Cyprus public and external DSA material in the provided chapter.* ### Annex IV. Labor Market Developments During COVID-19 ### Annex IV. Labor Market Developments During COVID-19 ### Overview and headline developments - After a five-year decline, the LFS-based unemployment rate rose to 6.8 percent in 2020:Q2 from 6.4 percent in 2019:Q4. - As job retention support measures were phased out in 2020:Q3 and 2020:Q4, the unemployment rate increased by 1.5 percentage points and 1.7 percentage points compared to 2019:Q3 and 2019:Q4, reaching 8.2 percent and 8.0 percent, respectively. - Total hours worked: declined by 10.5 percent in 2020:Q2 (yoy), recovering to -7.2 percent (yoy) in 2020:Q4. - Job vacancy postings declined by 19 percent in 2020:Q2 (yoy). - Compensation for employees in the private sector: dropped by 12 percent in 2020:Q2 (yoy) and 8 percent in 2020:Q4 (yoy). ### Sectoral and distributional impacts - Contact-intensive sectors (trade and hospitality) were disproportionately impacted by travel and mobility restrictions. - Construction held up well where restrictions were lifted early. - Job losses concentrated among temporary workers with more flexible contracts. - Youth (15-24 years old): - Job losses were more significant, broadly in line with European averages. - The young exited the labor market to a larger extent but reentered in 2020:Q3. - Women: - Unemployment rate for women has not changed significantly compared to last year. - Women have tended to drop out of the labor force at a faster pace due to school closings and childcare responsibilities. ### Labor market slack and working hours - Considerable slack remains despite a modest recovery. - Working-hours dynamics: - Hours worked per worker fell more sharply than job counts, driving the larger declines in total hours worked. - Sectoral contribution to hours/job changes: - Contact-intensive sectors account for nearly a third of the workforce, increasing the risk of scarring if the shock persists. ### Vulnerabilities and prospects for reallocation - Vulnerability to the COVID-19 shock is very high because nearly a third of the workforce are concentrated in tourism-related sectors (accommodation, food services, transport, and trade). - Tourism sector recovery expectation referenced: "tourism sector is not expected to recover to pre-pandemic levels until 2024 (Annex VII)." - Rapid growth in recent years in non-tourism services: professional and administrative services, education, and ICT. - CEDEFOP Skills Forecast (2020) indicates fastest employment growth in: - transport; - business and other (professional and administrative) services; - followed by non-market services such as health and education. - Flexibility of the labor market to reallocate resources across sectors is essential to mitigate scarring. ### Labor market institutions and competitiveness - ILO’s Employment Flexibility Indicator rank: 16 out of 41 EU and OECD countries, and 11 out of 27 EU countries. - Tax wedge on labor: relatively low. - Cyprus does not have a statutory minimum wage (required for certain occupations). - Share of part-time and temporary workers: relatively low. - A significant share (23 percent) of the labor force comprises foreign nationals and seasonal workers. - Unit labor cost remained low until 2019; labor productivity level and growth relatively weak, wages contained. - Long-term unemployed: declined from a peak of over 7 percent following the financial crisis to around 2 percent of active population in 2020:Q2. ### Skills gaps and constraints on reallocation - CEDEFOP’s European Skills Index 2020 rank: 28th out of 31 countries — attributed to low performance in: - skills development (particularly vocational educational and training); - recent training; - reading, math and science scores. - Spending on active labor market policies: low. - Skills matching issues: overqualification and under-employed part-timers. - EC’s Digital Economy and Society Index Report rank: 23rd out of 28 EU countries in digital skills (weakness in basic digital skills and advanced ICT specialized skills). - Risk of increasing skills mismatch is high as economic transformation proceeds. ### Policy recommendations: from protecting jobs to protecting people and fostering reallocation - Reskilling and active labor market policies: - Nearly 3/4 of labor market interventions are directed towards passive labor market policies supporting income replacement for the unemployed. - Spending on active labor market policies (training, private sector employment incentives, public employment services) is relatively limited. - Need for reskilling and upskilling to improve digital skills, vocational skills for a greener economy, and energy-efficiency related skills. - Youth-targeted measures: - Job search assistance. - Incentives for part-time work. - Payroll subsidies for newly-hired staff. - Opportunities for entrepreneurship via start-up incentives (grants and advisory support). - Policies to facilitate women’s re-entry: - Support for childcare and balancing work and family responsibilities. - Social protection and labor standards: - Ensure sufficient safety nets to avoid trapping people in low-wage, low-security informal or gig-economy work. ### Job retention scheme details (as described in source footnote) - First phase (March-June): government provided 70 percent wage subsidy for businesses that lost turnover by over [80] percent and required workers to be retained at least for the additional same duration as the period when the benefits were utilized. - Scheme was subsequently extended in a more targeted basis to tourism sectors through October 2021. - With the advent of the second wave, another wage subsidy scheme was introduced through March 2021. *Sources: Central Bank of Cyprus; Eurostat; Haver Analytics; IMF and IMF staff calculations.* ### 2. The disposal of NPLs have relied mainly on write-offs and sales to third parties. Of the ### 1cypea2021001 - 2. The disposal of NPLs have relied mainly on write-offs and sales to third parties. Of the ### NPL disposal routes and observed outcomes - Of the cumulative NPL outflows between 2016 and 2020, around 55 percent are attributed to NPL sales and write-offs. - Banks relied on onboarding of properties, either through Debt to Asset swaps or foreclosure processes. - Auction data suggest a persistent below-market recovery rate, indicating potential overvaluation of collateral values. - The impact of loan restructuring on net NPL migration into performing status has been modest, with high redefault rates. - A key challenge to viable restructuring has been the uneven progress with claims enforcement and collateral recovery due to lengthy judicial processes and lack of a credible threat of foreclosure. - Following the 2018 legal amendments to the foreclosure framework, the threat of foreclosure has incentivized greater cooperation for cash repayments and bilateral restructurings. - The COVID crisis has delayed the foreclosure process, and the 2019 amendments to the foreclosure legislation have introduced uncertainties. - The value of property recovered through foreclosures remains low. ### Quantitative snapshot: Cyprus NPLs (as presented) - Total NPLs 28.4 -1.1 -3.0 -3.4 -10.5 -1.3 -3.9 5.1 - HHs 12.8 -0.1 -0.7 -1.1 -5.8 -0.5 -1.9 2.8 - NFCs 14.4 -0.5 -2.2 -2.2 -4.6 -0.8 -1.9 2.2 - Large enterprises 5.3 -0.7 -3.1 -0.5 -0.3 -0.2 -0.2 0.4 - SMEs 9.0 0.1 0.9 -1.7 -4.3 -0.7 -1.7 1.8 - NFCs by sector: - Tourism and trade 4.0 -0.1 -0.3 -0.6 -0.9 -0.2 -0.9 0.8 - Construction 5.1 -0.2 -1.1 -0.7 -1.8 -0.3 -0.5 0.5 - Real estate 2.4 0.0 -0.3 -0.5 -0.9 -0.2 -0.2 0.3 - Manufacturing 0.9 0.0 -0.1 -0.1 -0.3 -0.1 -0.1 0.2 - Others 2.0 -0.1 -0.3 -0.3 -0.6 -0.1 -0.2 0.3 - Other financial corporates and government 1.2 -0.5 -0.2 -0.1 -0.2 0.0 -0.1 0.2 - Note: Cyprus: Non-Performing Loans in the Banking System (Billions of euro). Source: Central Bank of Cyprus and IMF staff calculations. ### Cumulative outflows composition (2016–2020) - Debt instruments held for sale: (chart component listed) - Net Migration into performing: (chart component listed) - Write-offs: (chart component listed) - NPL cash repayment: (chart component listed) - D2A/E swaps: (chart component listed) - Unpaid interest accrued on NPLs: (chart component listed) - Sources: Central Bank of Cyprus; and IMF staff calculations. ### Current NPL resolution strategy and limitations - Three key pillars of the strategy: - NPL sales to third parties (primary channel). - State subsidy scheme (Estia) for NPL portfolios collateralized by primary homes. - Further organic reduction via restructuring and Debt to Asset swaps for highly collateralized but sub-performing portfolios. - Limitations and observations: - Applications for the Estia subsidy scheme represent only half of the potentially eligible amount, partly reflecting strategic default behavior and indicating its ability to solve only a small share of the NPL portfolio. - For ineligible and vulnerable applicants to Estia, a different burden sharing agreement between state, creditors, and debtors is likely to be offered. - A large share of the portfolio represents legacy/terminated loans with limited prospect for restructuring and consensual agreements, unless there are larger write-downs. ### Policy recommendations on NPL resolution and provisioning - The NPL resolution strategy will depend crucially on the viability of borrowers and the recoverable value of collateral. - Given the aged portfolio, adequate provisioning is key to facilitate the process. - EC’s prudential (Pillar 1) backstop and SSM’s Pillar 2 approach are welcomed. - Supervisors should ensure Pillar 2 bank-specific phase-in paths to be sufficiently ambitious, yet credible. - Given the large share of secured housing loans: - Focus on determining borrower viability, present recoverable value of collaterals, and finalizing loan modification/restructuring options. - If borrowers are unviable or uncooperative, step up efforts towards collateral execution. - For non-performing loans to viable SME borrowers: - Encourage greater use of existing resolution tools or additional restructuring modalities (e.g., “pre-packaged” restructuring plans and out-of-court procedures) to finalize loan modification. - For non-performing loans to SMEs where recovery prospects are minimal: - Supervisors should increasingly force loss recognition on banks through write downs/write offs. - To address real estate risks: - Maintain a cap on the overall stock of onboarded assets and ensure proper collateral valuation. --- ### Tourism sector: impact of Covid-19 and recovery prospects - Tourism in Cyprus experienced an unprecedented collapse since the pandemic, declining by 84 percent (yoy) in 2020. - Tourism receipts accounted for more than 18 percent of total exports in 2019. - Tourism and related industries provide a large contribution to total employment and GDP. - More than 90 percent of borrowers in the sectors of accommodation and food services were under loan repayment moratorium. - Based on a heatmap analysis using macroeconomic indicators, Cyprus is in the top quintile of overall economic vulnerability to tourism among European countries. - Cyprus reliance and structural features: - Arrivals of foreign tourists reached around 5 times of domestic tourists in 2019. - Tourist accommodation relies exclusively on hotels and similar accommodations. - Health and recovery indicators: - Cyprus ranks relatively well in terms of health conditions, with relatively fewer reported COVID cases and more tests and faster vaccination than most other EU countries. - The UNWTO scenarios show a return to 2019 levels in 2.5 to 4 years. - The Eurocontrol forecasts that the air traffic in Europe will fully recover by 2024 in the most optimistic scenario. - Policy guidance: - Continued targeted support measures to the tourism sector are warranted in the near term. - Liquidity-type support (guaranteed loans, lending rate subsidies) could be considered to mitigate long-term scarring, allowing public support to benefit from a viability assessment by banks. - Increased access to SME restructuring tools, with possible public support, to avoid costly bankruptcies. - For larger, strategic businesses, equity-type support could provide potential upside for the government. - Longer-term policies should aim to enhance tourism sustainability: smaller-scale, regionally more diverse, higher-end tourism focused on environmental sustainability, quality of services, and non-price competitiveness. ### Restructuring tools and insolvency framework (COVID-19 context) - The nine-month public moratorium launched in April 2020 ended in December 2020. - The take-up of this moratorium was high at nearly half of performing bank loans. - Another public moratorium issued on January 14, 2021 for six months is not applicable for most loans that already benefitted from the 2020 moratorium for 9 months. - Loans with potential new delinquencies differ from legacy NPLs: they were performing until recently and have higher potential for viable business recovery via reorganization and restructuring tools. - Objective: restructure as many potentially viable companies as possible and swiftly liquidate those unable to regain viability. - Examinership (introduced 2015) is a corporate reorganization procedure modeled after Irish law: - Company, creditors, or shareholders can petition the court to appoint an independent expert examiner for a fixed period to prepare a restructuring plan. - Once approved by the required majority of creditors and confirmed by the court, the plan becomes binding on all creditors. - Limitations of examinership: - Very limited use since introduction. - Complexity, multiple steps and deadlines, accessibility and cost barriers. - Duration: law foresees conclusion within four to six months, but in practice courts are unable to process applications sufficiently quickly. - Debtors often delay seeking help; stigma of insolvency and motives to halt receivership/liquidation affect use. - Creditors often lack necessary financial information and perceive examinership as a tool for debtors to forestall other procedures; secured creditors prefer receivership or foreclosure. - Procedural impediments (e.g., notice periods, viability assessments by independent expert) add to delays; creditor challenges to viability assessments can consume the entire four months protection period. - Institutional constraints: limited case volume has not allowed development of expertise among judges and insolvency professionals; lack of clarity on monitoring agency limited data availability. - Opportunities and suggested directions: - Implementation of the EU Directive on Preventive Restructuring and Second Chance offers an opportunity to reform examinership. - Examine interplay between examinership and receivership; balance between individual enforcement (receivership) and collective reorganization (examinership). - Consider complementing the toolkit with out-of-court or hybrid restructuring procedures to reduce complexity, duration and cost (e.g., company voluntary arrangements). - Ensure procedures are well suited and adapted to national characteristics of Cyprus; careful analysis of Directive options and tradeoffs required. *Source: Central Bank of Cyprus and IMF staff calculations.* ### 7. Alongside these efforts on the development of the restructuring toolbox, prudential ### 1cypea2021001 - 7. Alongside these efforts on the development of the restructuring toolbox, prudential ### Prudential policy guidance and macroprudential stance - Macroprudential policies should support banks to constructively engage with borrowers, by ensuring capital buffers available to continue lending to restructured businesses and absorb associated losses. - Guidance to encourage the use of capital buffers and to limit dividend distributions should be maintained until uncertainties from the pandemic dissipate sufficiently. - Enhanced supervisory monitoring and analyses are crucial to ensure: - timely and accurate provisioning by banks, and - reliable collateral valuation to avoid abrupt capital losses. - References to IMF Special Series guidance: “Special Series on COVID-19: Main Operational Aspects for Macroprudential Policy Relaxation”; “Special Series on COVID-19: Unwinding COVID-19 Policy Interventions for Banking Systems” (forthcoming); and “Special Series on COVID-19: Private Debt Resolution Measures in the Wake of the Pandemic”. ### Insolvency framework, pre-insolvency, and restructuring procedures - Pre-insolvency procedures and formal reorganization procedures have separate spaces in an insolvency system. - The Directive seeks to complement formal insolvency frameworks (reorganization and liquidation). - Implementation options noted: - Introduce a restructuring procedure that stands side by side with existing procedures under national insolvency law to preserve the space between informal out-of-court and formal reorganization procedures. - If countries implement the Directive by just adapting their reorganization procedures to its requirements, they risk missing the space between informal out-of-court and formal reorganization procedures. - Country examples and reforms: - Ireland: Introducing a new restructuring procedure, separate from the examinership, for the rescue of small enterprises that meet certain criteria; expected process will involve no/minimal court intervention and be significantly less expensive than the examinership. - United Kingdom: Recent reforms include the possibility for a company (that meets certain requirements) to apply to the court for a moratorium to give it a statutory breathing space from creditor action within which to formulate a rescue plan; the moratorium can give breathing space while a company voluntary arrangement is considered, and is automatically extended until the proposal is implemented, rejected, or withdrawn. ### Moratorium take-up and loan composition (Cyprus, 2020, as of September 2020) - The take-up rate was high among performing loans at 48 percent. - SMEs took the largest share (44 percent) of the bank loans granted the 2020 moratorium. - By industry, the tourism sector took the largest share (27 percent) of the NFC loans granted the moratorium. - The share of collateralized loans is slightly higher among the loans granted the moratorium, especially for NFC loans. - Charted figures (as presented): - Bank Loans granted the Moratorium (in Euro Billions, as of September 2020): visual breakdown by All / Performing / Nonperforming and by sector (Non-financial corporates, Households) — note: underlying numeric bars shown in figure were not transcribed as explicit numbers other than summary percentages above. - Share of Collateralised Bank Loans (as of September 2020): Loans - all vs Loans - granted the moratorium (specific percentages indicated visually; text notes share is slightly higher among moratorium loans). - Moratorium: Industry Share (percent, as of September 2020): Accommodation and food service 27%; Real estate 18%; Construction 17%; Other 38%. - Moratorium: Sector Share (percent, as of September 2020): Non-financial corporates: SME 44%; Non-financial corporates: non-SME 15%; Households 37%; Other 4%. ### Examinership applications in Cyprus - Table: Examinership Applications in Cyprus — Total Examinership Applications - Up to June 2017: 3 - Up to September 2018: 17 - Up to August 2019: 18 - Up to March 2021: 19 - Footnote: To date, no examiner has been appointed in any examinership case, which means in no case has the procedure been completed from beginning to end. For the joint personal repayment plan/micro-SME examinership, there have been no applications initiated to date. ### IMF — Fund relations, financial arrangements, and safeguards (Cyprus) - Membership Status: Joined December 21, 1961; Article VIII. - General Resources Account (SDR Million / Percent of Quota): - Quota 303.80 100.00 - IMF’s Holdings of Currency 218.75 72.00 - Reserve Tranche Position 85.06 28.00 - Lending to the Fund: New Arrangements to Borrow 9.72 - SDR Department (SDR Million / Percent of Allocation): - Net cumulative allocation 132.80 100.00 - Holdings 48.10 36.22 - Outstanding Purchases and Loans: None. - Financial Arrangements (type, approval date, expiration date, amount approved, amount drawn): - EFF May 15, 2013 Mar 6, 2016 891.0 792.00 - Stand-By Jul 16, 1980 Jul 15, 1981 8.5 8.5 - Projected Payments to the Fund (SDR millions; Projected from 2021): - 2021 Principal 0 Charges/Interest 0.04 Total 0.04 - 2022 Principal 0 Charges/Interest 0.04 Total 0.04 - 2023 Principal 0 Charges/Interest 0.04 Total 0.04 - 2024 Principal 0 Charges/Interest 0.04 Total 0.04 - 2025 Principal 0 Charges/Interest 0.04 Total 0.04 - Exchange Rate Arrangement: Cyprus is a member of the euro area; currency is the euro and floats freely and independently against other currencies. Cyprus has accepted the obligations of Article VIII, Sections 2, 3, and 4. - Historical program and PPM notes: - Cyprus’s three-year, SDR 891 million (293 percent of current quota) Extended Arrangement under the EFF was approved on May 15, 2013. Total drawn SDR 792 million (260.7 percent of quota). The EFF arrangement was cancelled by the authorities on March 7, 2016. - Early repurchase on July 11, 2017 reduced outstanding Fund credit to SDR 570 million (187.5 percent of quota). Cyprus repaid its remaining balance of EFF credit in February 2020 and exited PPM. - Safeguards: A safeguards assessment in August 2013 found a weak governance framework at the CBC and a strained balance sheet given large ELA exposure. The CBC addressed most recommendations; legislative efforts underway expected to address remaining recommendations. ### Technical assistance (selected items and timing) - Multiple IMF department TA missions and workshops listed with purposes and dates, including: - FAD Revenue administration October–November 2014; January–February 2015; March 2017; October 2016; March–April 2016; April–May 2016; October 2017; December 2017; September 2018; September 2019. - MCM Cooperative credit sector restructuring February–March 2015; MCM NPL management August–September 2015; September 2015; July 2017; November 2017; December 2017; June–July 2016; May–June 2016; December 2020; December 2020. - LEG Insolvency legal framework workshop September 2017; Judicial Training Workshop on Insolvency December 2019. - STA Balance of payments March–April 2015; Sectoral Accounts and Balance Sheets January 2017; Statistical aspects of reunification December 2015; February 2016; May 2016. - Additional TA on Public financial management, Debt management, Macro-prudential policy, Stress Testing, Debt and Cash Management, Policy Based Budget, Debt Portfolio Risk Management across 2015–2020. - Two FAD long-term resident advisors provided TA on public financial management (February 2014 to October 2016) and on revenue administration (July 2015 to December 2016). ### Statistical issues and data adequacy (as of April 19, 2021) - Assessment: Data provision to the Fund is adequate for surveillance purposes. - National accounts and real sector: - Since September 2014 CYSTAT publishes a full set of national accounts based on ESA 2010, including quarterly GDP estimates from Q1 1995. - CYSTAT publishes CPI and HICP; Eurostat supervision ensures control and quality assessment. - CBC publishes a Residential Property Price Index based on property valuation data since 2006; agency is enhancing the index and assessing transactions data use; Commercial Property Price Index and Land Price Index are being finalized (unpublished). - Fiscal sector: Ministry of Finance publishes monthly cash budget data based on ESA 2010 for general government and breakdowns. - External sector: CBC compiles and disseminates BOP and IIP quarterly and annually per BPM6 with roughly one-quarter lag; SPEs treated as residents since July 2014; full data coverage of SPEs achieved in September 2019. - Monetary and financial sector: Central bank balance sheet and key indicators available and comply with European standards; monthly monetary statistics provided to IMF through ECB. - Reporting gaps and breaks: - Structural break for some financial sector data due to migration to Basel III (2014:Q1) and adoption of EBA definition of non-performing loans (2014:Q4). - Cyprus reported all twelve core FSIs and all thirteen encouraged FSIs for deposit takers on quarterly basis up to 2016:Q1; some FSIs have been missing or only partly reported since then; encouraged FSIs for other sectors are not available. - Data dissemination standards: Cyprus subscribes to the IMF’s SDDS since December 2009; metadata posted on the Dissemination Standards Bulletin Board. - Table of Common Indicators Required for Surveillance (as of April 21, 2021) — sample latest observations and received dates: - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of Latest Observation Mar. 2021; Date Received Apr. 2021; Frequency MMM. - Reserve/Base Money: Date of Latest Observation Feb. 2021; Date Received Mar. 2021; Frequency MMM. - Broad Money: Feb. 2021 / Mar. 2021 / MMM. - Central Bank Balance Sheet: Feb. 2021 / Mar. 2021 / MMM. - Consolidated Balance Sheet of the Banking System: 2020:Q4 / Apr. 2021 / QQQ. - Consumer Price Index: Mar. 2021 / April. 2021 / MMM. - External Current Account Balance: 2020: Q4 / Mar. 2021 / QQQ. - GDP/GNP: 2020:Q4 / Mar. 2021 / QQQ. - Gross External Debt: 2020: Q4 / Mar. 2021 / QQQ. - International investment position: 2020: Q4 / Mar. 2021 / QQQ. - Notes: - 1/ Includes reserve assets pledged or otherwise encumbered as well as net derivative positions. - 2/ Both market-based and officially-determined rates. - 3/ Foreign, domestic bank, and domestic nonbank financing. - 4/ General government consists of the central government, social security funds and local governments. - 5/ Including currency and maturity composition. - 6/ Includes external gross financial assets and liability positions vis-à-vis nonresidents. - 7/ Frequency codes: Daily (D), Weekly (W), Monthly (M), Quarterly (Q), Annually (A); Not Available (NA). *Prepared By European Department (In consultation with other departments); informational annex as of April 30, 2021.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1cypea2021001.pdf_