## 1. Macroeconomic Forecasts and Policy Advice to Manage a Severe Scenario ## Source details **Canonical URL:** [1. Macroeconomic Forecasts and Policy Advice to Manage a Severe Scenario](https://www.imf.org/-/media/files/publications/cr/2026/english/1cypea2026001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2026/english/1cypea2026001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2026/english/1cypea2026001.pdf.json) --- ### Context and Background - Cyprus recovered from the 2013 crisis and "fully recovering GDP per capita relative to the EU." - Strengths: strong labor market, restored financial sector profitability and buffers, resilient growth from tourism and ICT. - Remaining vulnerabilities: still-large legacy NPLs outside banks, a relatively dormant banking sector, an inefficient judiciary, and an oil-dependent energy sector. - Fiscal turnaround: fiscal balance improved from almost -9 percent of GDP in 2014 to 2 percent by 2017; public debt declined from over 110 percent of GDP in 2014 to below 60 percent in 2025. ### Recent Economic Developments (2025) - Growth and demand: - Real GDP growth: 3.8 percent in 2025. - Growth drivers: robust private consumption, high employment, strong real wage growth, declining interest rates, export-oriented services (ICT), and resilient tourism. - Investment: signs of recovery in 2025 once ship imports are excluded, supported by monetary loosening. - Inflation: - Headline inflation: 0.8 percent in 2025. - Goods inflation: -2 percent in 2025. - Services inflation: 4.3 percent in 2025. - VAT policy: temporary reduction of VAT on household electricity from 19 to 9 percent effective April 2025; VAT rate further reduced from 9 to 5 percent from March 2026 until March 2027. - Flash estimate of year-over-year inflation in April: 3 percent. - Labor market: - Unemployment: 4 percent in 2025Q4. - Real wage growth: 3.5 percent year-over-year. - Job vacancies: elevated, particularly in services. - Fiscal sector: - Fiscal balance: fiscal surplus narrowed to 3.4 percent of GDP in 2025 from 4.1 percent in 2024. - Spending increases: mainly due to acceleration in EU-funded investment (RRF) and higher wages and social transfers. - Public debt: fell to 55 percent of GDP in 2025. - RRF disbursements: around €0.6 billion to date, totaling 58 percent of the total grant envelope; final deadline for remaining investments and reforms is end-August 2026 to secure full disbursement by year-end. - External sector: - Current account deficit: narrowed to 6.4 percent of GDP in 2025. - Trade balance improvement: expansion in net service exports (ICT, use of intellectual property, tourism) and contained goods imports. - Financial and real estate: - Financial conditions: easing in 2025 with declining lending rates and domestic credit growth turning positive. - Legacy NPLs outside banking sector: declined from €19.9 billion in 2023 to €18.2 billion in December 2025 (around 50 percent of GDP). - Housing market: stabilized; house price growth moderated since 2024 and property sales growth broadly stable since 2022. - Banking sector: well-capitalized, highly liquid, profits strong though declined with falling interest rates; NPL ratio continued to decline. ### Outlook and Risks (Staff Baseline and Authorities’ Views) - Baseline staff forecasts (2025–2028): - Real GDP: 3.8 (2025), 2.6 (2026), 3.0 (2027), 3.0 (2028). - HICP (period average, SA): 0.8 (2025), 3.5 (2026), 1.5 (2027), 2.0 (2028). - General government balance (percent of GDP): 3.4 (2025), 2.3 (2026), 2.6 (2027), 2.5 (2028). - General government debt (percent of GDP): 55.0 (2025), 50.5 (2026), 46.2 (2027), 42.2 (2028). - Current account balance (percent of GDP): -6.4 (2025), -8.2 (2026), -8.3 (2027), -8.6 (2028). - Nominal GDP (billions of euros): 36.5 (2025), 38.9 (2026), 40.8 (2027), 43.0 (2028). - Near-term outlook: - Growth expected to moderate to 2.6 percent in 2026 due to higher energy prices, temporary decline in tourism, and cyclical slowdown. - Inflation expected to average 3.5 percent in 2026 and decelerate below 2 percent in 2027 as oil prices normalize. - Medium-term growth: staff expects growth to remain at potential (~3 percent). - Authorities’ projections: - Growth: project slowdown to 2.7 percent in 2026 then stabilizing at 3 percent thereafter. - Inflation forecasts range from 2.5 to 4.5 percent depending on assumptions. - Risks: - Near-term risks tilted to the downside, notably a more prolonged war in the Middle East that would raise inflation and damage growth (impact on tourism and spillovers to shipping). - Other risks: slowdown in major partners, escalation of trade conflicts, cyber-risks, global geopolitical fragmentation, infrastructure constraints. - Medium–long-term risks balanced; expansion into digital-economy industries presents upside. ### Severe Scenario (April 2026 IMF WEO Severe Scenario) — Key Effects - Scenario description: Intensification and prolongation of the war in the Middle East leading to global supply disruptions, spike in oil and gas prices, amplified second-round inflationary pressures, and risk-off episodes in global financial markets. - Main channels for Cyprus: - Energy price shock and tourism downturn erode real household incomes and constrain growth; negative spillovers to shipping and other sectors. - Fiscal and external positions deteriorate versus baseline: higher inflation temporarily supports revenues, but weaker activity reduces tax base and higher indexed wages and prices increase expenditure; external balance worsens with higher energy import bills and weaker tourism. - Cyprus’s resilience: strong fundamentals (robust growth, low inflation pre-shock, high primary surplus, ample financial sector buffers) allow focus on sustaining growth and protecting vulnerable groups. - Severe Scenario: Selected indicators (2025–27) - Real GDP growth (percent, yoy): 3.8 (2025), 1.7 (2026), 1.9 (2027). - HICP inflation (period average): 0.8 (2025), 4.6 (2026), 4.5 (2027). - Fiscal balance (percent of GDP): 3.4 (2025), 2.0 (2026), 1.9 (2027). - Percentage point deviation from baseline: - Real GDP growth: 0.0 (2025), -0.8 (2026), -1.1 (2027). - HICP inflation (period average): 0.0 (2025), 1.1 (2026), 3.0 (2027). - Fiscal balance (percent of GDP): 0.0 (2025), -0.3 (2026), -0.7 (2027). ### Policy Discussions — Fiscal Policy: Improving Tax and Spending Efficiency - Fiscal stance and space: - Fiscal stance projected to loosen in 2026: overall balance expected to decline to 2.3 percent of GDP, driven by discretionary measures to counter higher energy prices and a comprehensive tax reform. - Structural primary balance: fiscal impulse equals a 0.7 percentage point decline in the structural primary balance. - Recommendation: a neutral stance would be more appropriate given the positive output gap; easing should be gradual and high-quality. - Anchor: aim to anchor the medium-term primary balance around a debt-stabilizing level of -0.5 percent of GDP. - Preservation of fiscal space for long-term pressures: - Rising long-term pressures between 2030–50 are estimated at around 4 percent of GDP. - Recommendation: begin building financial assets in the Social Security Fund to frontload future pressures. - Composition and quality of fiscal easing — priorities and cautions: - Prioritize boosting capital expenditure and improving spending efficiency. - Avoid costly, distortionary measures (e.g., broad VAT reductions, cuts in fuel excise duties, broad subsidies). - Reconsider use of consumption taxes for redistribution and cost-of-living relief: recent VAT reductions and exemptions are costly, poorly targeted, and distortionary and should be rolled back. - Specific revenue recoupment: reversing the 0 percent VAT rate on specific food items and the reduced 5 percent rate on electricity would recoup 0.2 percent of GDP in revenues. - Redistribution efficiency: redirecting revenue to targeted social transfers would reduce inequality by 6 times more than the recent tax-based measures. - Indexation and wages: - Recommendation: do not revise the COLA-based indexation formula again; avoid across-the-board salary increases. - Context: authorities agreed in 2025 to gradually increase COLA indexation from two-thirds to full inflation indexation by July 2027. - Pay adjustment should be driven only by the COLA, with no additional discretionary increases. - National Solidarity Fund (NSF) and cost-of-living measures: - NSF compensation to date has been small; final compensation criteria lack clarity and total cost of the scheme is uncertain. - Recommendation: clarify NSF financing and compensation strategy; weigh any further financing against opportunity costs. - Selected measures (fiscal impact, € millions and % of GDP and duration) as presented: - VAT rate (9% → 5%) for electricity consumption: -53, -0.1, May 2026→Mar 2027. - Zero VAT rate on various food items: -28, -0.1, Apr→Sep 2026. - Reduced excise on motor fuels (-8.33 cents/litre): -60.0, Apr→Jun 2026. - Subsidisation of consumers' electricity bills: 20.0, Apr 2026→Mar 2027. - Grant to the Natural Gas Public Company: 700.2, One-off. - "Photovoltaics for all" scheme: -55, -0.1, 2025 one-off unwind. - Hotel industry wage subsidy (30%), airline support: 70.0, Apr 2026. - Farm input and foot-and-mouth disease subsidies: 290.1, Apr→May 2026. - Total fiscal impact reported: 1060.3 (€ millions). - Note: table mixes revenue and expenditure lines; use of these measures underscores trade-offs between targeted support and broad tax/subsidy measures. - Social protection and targeting: - Support vulnerable households via well-targeted and temporary transfers, avoid broad-based VAT reductions and fuel tax cuts. - Compensatory support should be delivered through existing social assistance programs, be temporary, well targeted, and phased out as inflationary pressures ease. - Avoid across-the-board wage adjustments that could fuel second-round inflation. - Macroeconomic and financial stability safeguards: - Maintain macroprudential measures to safeguard financial stability. - Advance structural reforms, particularly in energy, to enhance long-term resilience and competitiveness. ### Box 2 — The National Solidarity Fund and the 2025 Replenishment Scheme - Purpose and scope: - NSF established in 2013 to facilitate partial compensation of retail clients affected by 2013 bank resolutions. - Total losses from the two bank resolutions amounted to about €9 billion. - Financing and governance: - NSF accumulated about €260 million by 2025 through state budget transfers. - No automatic funding mechanism and no predefined target for accumulated resources. - Compensation implemented through ad hoc replenishment schemes financed by the annual budget. - 2025 replenishment scheme: - Applications received: 13,000 applications corresponding to roughly €2 billion in verified bail-in losses. - Scheme covered only natural persons. - Maximum payment: €100,000 per individual. - Replenishment rates: 10 percent for Laiki Bank losses; 3.6 percent for Bank of Cyprus losses. - The scheme was funded with €100 million from the NSF. - By September 2025, 4,500 beneficiaries had received €44.4 million. - Implications: - Future replenishments possible but require new government decisions and budget allocations. - Absence of legal mandate or automatic funding implies reliance on political and fiscal choices. ### Energy, Structural Reforms, and Market Developments - Authorities’ views and staff appraisal: - Energy security and high energy costs are key challenges for competitiveness. - Launch of a competitive electricity market with EU Target Model arrangements should improve efficiency, lower prices, and facilitate renewable energy integration. - Audit of the LNG terminal project completed; new tender expected shortly; completion not expected before 2029. - Strategic importance of the GSI noted, with concerns about financial viability and geopolitical uncertainties. - Recommendations: - Progress on GSI and LNG projects together with improvements to the competitive electricity market framework would help lower costs, diversify supply, and facilitate renewable energy integration. - Accelerate deployment of renewable energy, modernize the electricity grid, expand storage capacity, and strengthen incentives for energy efficiency. - Climate and water risks: - Climate change and increasing water stress pose medium-term risks, particularly for agriculture and tourism. - Continued investment in desalination, water management, and climate adaptation remains essential. ### Financial Sector, Banking, and NPLs - Banking sector indicators and developments: - Total capital ratio: 28.2 (2024), 29.5 (2025). - Non-performing loans (NPLs) to total gross loans: 6.2 (2024), 3.2 (2025). - Provisions to NPLs: 64.2 (2024), 77.5 (2025). - Return on assets: 2.0 (2024), 1.8 (2025). - Common Equity Tier 1 ratios exceeding 25 percent in 2025. - Countercyclical capital buffer increased to 1.5 percent, effective January 2026. - Non-performing loan (NPL) ratio declined to 1.6 percent by end-2025 (alternate reporting within the document). - Foreclosure framework changes raising legal uncertainty could slow resolution of legacy NPLs. - Credit intermediation and dynamism: - Credit intermediation remains subdued; loan-to-deposit ratio among the lowest in the EU. - High profitability contrasts with limited banking sector dynamism. - Digitalization and regulatory priorities: - Banks reducing branch networks and accelerating migration to online channels. - AML/CFT: enhance implementation of safeguards and entity-level risk assessments across supervised entities. ### Annex I — Sovereign Risk and Debt Sustainability Framework (selected) - Overall risk of sovereign stress: "Low". - Medium term risk: Low. - Long term risk: Moderate. - Long-term spending pressures (above baseline): - About 2.7 percent of GDP by 2030. - 4.6 percent of GDP by 2040. - 6.7 percent of GDP by 2050. - Population aging accounts for 5.0 percent of GDP of the increase. - Baseline public debt projections (percent of GDP): - 2025: 55.0 - 2026: 50.5 - 2027: 46.2 - 2028: 42.2 - 2029: 38.4 - 2030: 35.5 - 2031: 32.4 - 2032: 31.2 - 2033: 30.3 - 2034: 29.7 - 2035: 29.8 - Change in public debt (percent of GDP): - 2026: -7.8 - 2027: -4.5 - 2028: -4.3 - 2029: -4.1 - 2030: -3.8 - 2031: -2.9 - 2032: -3.1 - 2033: -1.3 - 2034: -0.9 - 2035: -0.6 - 2036: 0.1 - Gross financing needs (GFN) (percent of GDP): - 2026: 1.5 - 2027: 3.0 - 2028: 3.2 - 2029: 3.6 - 2030: 0.2 - 2031: 1.9 - 2032: 2.1 - 2033: 4.7 - 2034: 4.8 - 2035: 4.6 - 2036: 5.2 - Debt service (percent of GDP): - 2026: 6.1 - 2027: 6.4 - 2028: 6.9 - 2029: 7.2 - 2030: 3.6 - 2031: 5.1 - 2032: 5.1 - 2033: 5.6 - 2034: 5.5 - 2035: 5.3 - 2036: 5.2 ### Annex II — External Sector Assessment (selected) - Overall assessment for 2025: external position assessed to be weaker than the level implied by fundamentals and desirable policies. - Current account and NIIP: - CA deficit in 2025: 6.4 percent of GDP. - NIIP 2025: -77 percent of GDP. - NIIP after 2013 crisis: -164 percent of GDP. - NIIP excluding SPEs in 2025: -24 percent of GDP, with debt liabilities at 162 percent of GDP. - Gross assets and gross liabilities (percent of GDP) in 2025: - Gross Assets: 1,660 - Debt Assets: 611 - Gross Liabilities: 1,738 - Debt Liabilities: 617 - Model estimates for 2025 (percent of GDP): - CA-Actual: -6.4 - Adjusted CA: -6.0 - CA Norm: -2.6 - Adjusted CA Norm: -2.6 - CA Gap: -3.3 7.8 - Relative policy gap: 3.2 - Elasticity: -0.6 - REER Gap (in percent): 5.5 -13.0 - REER assessment: - REER gap from CA-based approach: overvaluation of 5.5 percent in 2025. - REER model suggests a gap of -13 percent. - Staff assessment: REER is moderately overvalued (placing higher weight on the CA model). - Policy responses recommended: - Reduce reliance on fossil fuels through investment in green energy and infrastructure. - Improve the judiciary to strengthen debt enforcement and resolve legacy NPL issues to support credit intermediation. ### Annex III — Risk Assessment Matrix (selected highlights) - Global conjunctural risks with Likelihood: High and Expected Impact: High: - Geopolitical tensions and intensification of conflicts; recommended: allow automatic stabilizers to work, diversify trade and investment, accumulate buffers. - Commodity price volatility; recommended: allow commodity price passthrough but provide temporary targeted support and accelerate energy transition. - Disorderly AI correction; recommended: strengthen macroeconomic and financial stability frameworks and active labor market policies. - Domestic risks: - Delays in implementation of structural reforms (Likelihood: Medium, Impact: Medium); recommended: accelerate implementation. - Growing fiscal pressures (Likelihood: Medium, Impact: Medium); recommended: maintain gradual prudent fiscal easing focused on high-productivity investment and enhance tax and spending efficiency. ### Conclusions and Policy Considerations — AI, Labor, and Innovation - AI adoption and exposure: - AI adoption in Cyprus has been slow in firms despite high personal use. - Workforce exposure is high—particularly among women, highly educated workers, and in sectors such as business services, clerical work, and ICT. - Need for a coordinated national strategy: - National AI Task Force established in January 2025; ongoing preparation of a national AI action plan to align with EU AI regulation. - Recommendations include developing a national AI strategy, strengthening digital and AI skills across education, and supporting AI uptake by firms, especially SMEs. - Building a future-ready workforce: - Integrate digital and AI-related skills into education, update curricula in collaboration with industry, and foster lifelong learning. - Public sector productivity gains: - Strategic AI adoption in government operations can reduce administrative costs and streamline processes. - Government “AI in Government” funding program supports development and testing of AI prototypes. ### Data Issues (Annex VII — selected) - Data Adequacy Assessment Rating: A. - External Sector Statistics: published with a relatively long lag ("3 months after quarter end"), occasionally delayed and can include large revisions. - Cyprus subscribes to the Special Data Dissemination Standard (SDDS) since December 2009. - Table of Common Indicators Required for Surveillance (As of May 05, 2026) — timestamps include: - Exchange Rates: Date of Latest Observation 2026-05-05; Date Received 2026-05-05. - International Reserve Assets: Date of Latest Observation 2026-03; Date Received 2026-04. - Consumer Price Index: Date of Latest Observation 2026-03; Date Received 2026-04. - Revenue, Expenditure, Balance — General Government: Date of Latest Observation 2025-12; Date Received 2026-03. - External Current Account Balance: Date of Latest Observation 2025-12; Date Received 2026-04. - Staff assessment: "Staff assess the data provided to the Fund to be adequate for surveillance with no major data weaknesses affecting staff's analysis of macroeconomic and financial risks." *IMF staff summary of "Macroeconomic Forecasts and Policy Advice to Manage a Severe Scenario" (Cyprus).* ### 1. Macroeconomic Forecasts and Policy Advice to Manage a Severe Scenario ___________________ 11 ### 1. Macroeconomic Forecasts and Policy Advice to Manage a Severe Scenario ### Context and Background - Cyprus experienced an impressive recovery from the 2013 crisis, recording among the highest growth in the EU in recent years and fully recovering GDP per capita relative to the EU. - Strengths: strong labor market, restored financial sector profitability and buffers, resilient growth from tourism and ICT. - Remaining vulnerabilities: still-large legacy NPLs outside banks, a relatively dormant banking sector, an inefficient judiciary, and an oil-dependent energy sector. - Fiscal turnaround: fiscal balance improved from almost -9 percent of GDP in 2014 to 2 percent by 2017; public debt declined from over 110 percent of GDP in 2014 to below 60 percent in 2025. ### Recent Economic Developments (2025) - Growth and demand: - Real GDP growth: 3.8 percent in 2025, among the highest in the EU. - Growth drivers: robust private consumption, high employment, strong real wage growth, declining interest rates, export-oriented services (ICT), and resilient tourism. - Investment: signs of recovery in 2025 once ship imports are excluded, supported by monetary loosening. - Inflation: - Headline inflation: 0.8 percent in 2025 (lowest in Euro Area). - Goods inflation: -2 percent in 2025. - Services inflation: 4.3 percent in 2025. - VAT policy: temporary reduction of VAT on household electricity from 19 to 9 percent effective April 2025; VAT rate further reduced from 9 to 5 percent from March 2026 until March 2027. - Flash estimate of year-over-year inflation in April: 3 percent. - Labor market: - Unemployment: 4 percent in 2025Q4. - Real wage growth: 3.5 percent year-over-year. - Job vacancies: elevated, particularly in services. - Fiscal sector: - Fiscal balance: fiscal surplus narrowed to 3.4 percent of GDP in 2025 from 4.1 percent in 2024. - Drivers: strong revenue growth moderated by lower indirect taxes, normalization in construction and real estate, and continuation of VAT exemptions and reduced rates. - Spending increases: mainly due to acceleration in EU-funded investment (RRF) and higher wages and social transfers. - Public debt: fell to 55 percent of GDP in 2025. - RRF disbursements: around €0.6 billion to date, totaling 58 percent of the total grant envelope; final deadline for remaining investments and reforms is end-August 2026 to secure full disbursement by year-end. - External sector: - Current account deficit: narrowed to 6.4 percent of GDP in 2025. - Trade balance improvement: expansion in net service exports (ICT, use of intellectual property, tourism) and contained goods imports. - Primary income: outflows continue to weigh on the balance but much is being reinvested; liabilities are not debt-creating. - External position assessment: weaker than implied by desirable policies and fundamentals (Annex II). - Financial and real estate: - Financial conditions: easing in 2025 with declining lending rates and domestic credit growth turning positive. - Legacy NPLs outside banking sector: declined from €19.9 billion in 2023 to €18.2 billion in December 2025 (around 50 percent of GDP). - Housing market: stabilized; house price growth moderated since 2024 and property sales growth broadly stable since 2022. - Banking sector: well-capitalized, highly liquid, profits strong though declined with falling interest rates; NPL ratio continued to decline. ### Outlook and Risks (Staff Baseline and Authorities’ Views) - Baseline staff forecasts (2025–2028): - Real GDP: 3.8 (2025), 2.6 (2026), 3.0 (2027), 3.0 (2028). - HICP (period average, SA): 0.8 (2025), 3.5 (2026), 1.5 (2027), 2.0 (2028). - General government balance (percent of GDP): 3.4 (2025), 2.3 (2026), 2.6 (2027), 2.5 (2028). - General government debt (percent of GDP): 55.0 (2025), 50.5 (2026), 46.2 (2027), 42.2 (2028). - Current account balance (percent of GDP): -6.4 (2025), -8.2 (2026), -8.3 (2027), -8.6 (2028). - Nominal GDP (billions of euros): 36.5 (2025), 38.9 (2026), 40.8 (2027), 43.0 (2028). - Near-term outlook: - Expected moderation of growth to 2.6 percent in 2026 due to higher energy prices, temporary decline in tourism, and cyclical slowdown. - Inflation expected to average 3.5 percent in 2026 and decelerate below 2 percent in 2027 as oil prices normalize. - Medium-term growth: staff expects growth to remain at potential (~3 percent). - Authorities’ projections: - Growth: project slowdown to 2.7 percent in 2026 then stabilizing at 3 percent thereafter. - Inflation forecasts range from 2.5 to 4.5 percent depending on assumptions. - Authorities expect a weaker current account due to higher energy import costs and lower tourism receipts. - Risks: - Near-term risks tilted to the downside, notably a more prolonged war in the Middle East that would raise inflation and damage growth (impact on tourism and spillovers to shipping). - Other risks: slowdown in major partners, escalation of trade conflicts, cyber-risks, global geopolitical fragmentation, infrastructure constraints. - Medium–long-term risks balanced; expansion into digital-economy industries presents upside. ### Severe Scenario (April 2026 IMF WEO Severe Scenario) — Key Effects - Scenario description: Intensification and prolongation of the war in the Middle East leading to global supply disruptions, spike in oil and gas prices, amplified second-round inflationary pressures, and risk-off episodes in global financial markets. - Main channels for Cyprus: - Energy price shock and tourism downturn erode real household incomes and constrain growth; negative spillovers to shipping and other sectors. - Fiscal and external positions deteriorate versus baseline: higher inflation temporarily supports revenues, but weaker activity reduces tax base and higher indexed wages and prices increase expenditure; external balance worsens with higher energy import bills and weaker tourism. - Cyprus’s resilience: strong fundamentals (robust growth, low inflation pre-shock, high primary surplus, ample financial sector buffers) allow focus on sustaining growth and protecting vulnerable groups. - Severe Scenario: Selected indicators (2025–27) - Real GDP growth (percent, yoy): 3.8 (2025), 1.7 (2026), 1.9 (2027). - HICP inflation (period average): 0.8 (2025), 4.6 (2026), 4.5 (2027). - Fiscal balance (percent of GDP): 3.4 (2025), 2.0 (2026), 1.9 (2027). - Percentage point deviation from baseline: - Real GDP growth: 0.0 (2025), -0.8 (2026), -1.1 (2027). - HICP inflation (period average): 0.0 (2025), 1.1 (2026), 3.0 (2027). - Fiscal balance (percent of GDP): 0.0 (2025), -0.3 (2026), -0.7 (2027). ### Policy Discussions — Fiscal Policy: Improving Tax and Spending Efficiency - Fiscal stance and space: - Fiscal stance projected to loosen in 2026: overall balance expected to decline to 2.3 percent of GDP, driven by discretionary measures to counter higher energy prices and a comprehensive tax reform. - Structural primary balance: fiscal impulse equals a 0.7 percentage point decline in the structural primary balance. - Recommendation: a neutral stance would be more appropriate given the positive output gap; easing should be gradual and high-quality. - Anchor: authorities should aim to anchor the medium-term primary balance around a debt-stabilizing level of -0.5 percent of GDP, implying scope for loosening while preserving fiscal space. - Preservation of fiscal space for long-term pressures: - Rising long-term pressures between 2030–50 are estimated at around 4 percent of GDP. - Drivers: elevated public pensions, rising healthcare spending, worsening demographics, and built-in indexation mechanisms. - Recommendation: begin building financial assets in the Social Security Fund to frontload future pressures. - Composition and quality of fiscal easing — priorities and cautions: - Prioritize boosting capital expenditure and improving spending efficiency. - Avoid costly, distortionary measures (e.g., broad VAT reductions, cuts in fuel excise duties, broad subsidies). - Reconsider use of consumption taxes for redistribution and cost-of-living relief: recent VAT reductions and exemptions are costly, poorly targeted, and distortionary and should be rolled back. - Specific revenue recoupment: reversing the 0 percent VAT rate on specific food items and the reduced 5 percent rate on electricity would recoup 0.2 percent of GDP in revenues. - Redistribution efficiency: redirecting revenue to targeted social transfers would reduce inequality by 6 times more than the recent tax-based measures. - Enhance social spending redistributive efficiency by reducing fragmentation and better targeting (Annex IV). - Indexation and wages: - Recommendation: do not revise the COLA-based indexation formula again; avoid across-the-board salary increases. - Context: authorities agreed in 2025 to gradually increase COLA indexation from two-thirds to full inflation indexation by July 2027, potentially making wages less flexible and increasing public sector wage premia. - Pay adjustment should be driven only by the COLA, with no additional discretionary increases. - National Solidarity Fund (NSF): - NSF compensation to date has been small relative to total eligible losses; final compensation criteria lack clarity and total cost of the scheme is uncertain. - Recommendation: clarify NSF financing and compensation strategy; weigh any further financing against opportunity costs and other uses including promoting sustainable growth and protecting vulnerable households. - Cost-of-living measures (selected measures, 2026) — fiscal impact (as presented): - Measures (Revenue and Expenditure effects, € millions and % of GDP and duration): - Revenue: VAT rate (9% → 5%) for electricity consumption: -53, -0.1, May 2026→Mar 2027. - Revenue: Zero VAT rate on various food items: -28, -0.1, Apr→Sep 2026. - Revenue: Reduced excise on motor fuels (-8.33 cents/litre): -60.0, Apr→Jun 2026. - Revenue: [line labeled "-190.0" appears under measures table—interpreted as expenditure?] (table shows mixed formatting; total shown below). - Expenditure examples: Subsidisation of consumers' electricity bills: 20.0, Apr 2026→Mar 2027. - Expenditure: Grant to the Natural Gas Public Company: 700.2, One-off. - Expenditure: "Photovoltaics for all" scheme: -55, -0.1, 2025 one-off unwind. - Expenditure: Hotel industry wage subsidy (30%), airline support: 70.0, Apr 2026. - Expenditure: Farm input and foot-and-mouth disease subsidies: 290.1, Apr→May 2026. - Total fiscal impact reported: 1060.3 (€ millions). - Note: table as published mixes revenue and expenditure lines with durations; use of these measures underscores trade-offs between targeted support and broad tax/subsidy measures. - Social protection and targeting: - Support vulnerable households via well-targeted and temporary transfers, avoid broad-based VAT reductions and fuel tax cuts. - Compensatory support should be delivered through existing social assistance programs, be temporary, well targeted, and phased out as inflationary pressures ease. - Avoid across-the-board wage adjustments that could fuel second-round inflation; instead use targeted assistance. - Macroeconomic and financial stability safeguards: - Maintain macroprudential measures to safeguard financial stability. - Advance structural reforms, particularly in energy, to enhance long-term resilience and competitiveness. *IMF staff summary of "Macroeconomic Forecasts and Policy Advice to Manage a Severe Scenario" (Cyprus).* ### Box 2. Cyprus: The National Solidarity Fund and the 2025 Replenishment Scheme ### Box 2. Cyprus: The National Solidarity Fund and the 2025 Replenishment Scheme ### Background and purpose - The NSF was established in 2013 following the banking crisis and the resolution of Bank of Cyprus and Laiki Bank, which imposed losses on uninsured depositors and investors. - The fund was created to facilitate partial compensation of retail clients, primarily natural persons and some legal entities classified as retail clients (e.g., small businesses or family-owned companies). - Professional or institutional investors (e.g., pension funds, investment funds, financial institutions) are excluded. - Total losses from the two bank resolutions amounted to about €9 billion. ### Financing, governance, and legal status - The NSF is financed through transfers from the state budget and gradually accumulated about €260 million by 2025. - The NSF is primarily funded by transfers from the central government through annual budget allocations approved by parliament. - There is no automatic funding mechanism and no predefined target for accumulated resources. - The timing and scale of resource allocations and subsequent compensation through the NSF depend on political decisions and fiscal considerations, including available fiscal space and compliance with medium-term fiscal targets. - Compensation from the NSF has not been legally mandated; payments are implemented through ad hoc replenishment schemes approved by the government and financed through the annual budget. ### The 2025 replenishment scheme: process and parameters - The first replenishment was implemented in 2025. - Potential claimants submitted applications through an electronic platform during December 2023–May 2024. - Applications received: 13,000 applications corresponding to roughly €2 billion in verified bail-in losses. - The scheme covered only natural persons. - Compensation parameters: - Maximum payment of €100,000 per individual. - Replenishment rates: 10 percent of losses related to Laiki Bank deposits and securities; 3.6 percent for Bank of Cyprus losses. - Funding and disbursements: - The scheme was funded with €100 million from the NSF. - Payments were disbursed in batches as claims were verified. - By September 2025, 4,500 beneficiaries had received €44.4 million. ### Outcomes, implications, and future outlook - The 2025 scheme provided partial compensation to a subset of eligible natural persons affected by the 2013 bank resolutions. - Future replenishment schemes remain possible but would require new government decisions and budget allocations. - Key governance implications: - Absence of a legal mandate or automatic funding implies reliance on political and fiscal choices for future compensations. - No predefined resource target means accumulated NSF resources and compensation timing are uncertain. *Source: Box 2. Cyprus: The National Solidarity Fund and the 2025 Replenishment Scheme.* ### 2024. The recent launch of a competitive electricity market with EU Target Model arrangements ### 2024. The recent launch of a competitive electricity market with EU Target Model arrangements ### Authorities’ views - Structural reforms prioritized to raise potential growth by: - strengthening human capital, - reducing skills mismatches, - supporting innovation. - Labor market stance: - labor markets are tight and Cyprus is near full employment, - emphasis on easing labor shortages through a more flexible framework for employing non-EU nationals and measures to support integration. - Skills and technology: - acknowledged digital skills gaps; - highlighted training and reskilling efforts to support adaptation to technological change; - viewed AI adoption as a key opportunity to raise productivity led by the private sector and supported by policies that foster innovation. - Judicial system: - strengthening the judicial system is critical for investment, credit provision, and growth; - noted progress in reducing backlogs and advancing digitalization but continued capacity constraints; - operationalization of the Commercial Court deferred until at least the Admiralty Court becomes fully operational; - work underway on an implementation plan for enhancement of administrative capacity of the Court Service to improve court administration and efficiency. - Energy: - emphasized that energy security and high energy costs are key challenges for competitiveness; - pointed to progress with the competitive electricity market and efforts to expand renewables, supported by grid reforms and investments in battery storage; - an audit of the LNG terminal project completed and a new tender for project completion expected shortly, although completion is not expected before 2029; - recognized strategic importance of the GSI but reiterated concerns about financial viability, implementation risks, and geopolitical uncertainties, stressing need for an economically sustainable framework. ### Staff appraisal — macroeconomic performance and outlook - Resilience and growth: - Cyprus has shown impressive resilience, with growth remaining among the highest in the EU. - strong performance supported by export-oriented services, particularly ICT and tourism. - Fiscal performance: - sustained surpluses since 2014 have reduced public debt from above 110 percent of GDP to below 60 percent in 2025, strengthening investor confidence. - Remaining structural weaknesses: - high legacy NPLs outside banks, - limited credit depth in the banking sector, - judicial inefficiencies, - reliance on oil-based energy. - Near- and medium-term outlook: - growth is projected to weaken to 2.6 percent in 2026; - higher oil prices are expected to push inflation to 3.5 percent; - tourism has suffered but is expected to partly recover during the peak season; - external position assessed to be weaker than the level implied by medium-term fundamentals and desirable policies; - near-term risks are tilted to the downside, notably from escalation of the war in the Middle East. - Policy stance: - while a neutral stance would be preferable in 2026, there is scope for fiscal easing over the medium term; - given the positive output gap, the projected fiscal loosening in 2026 is sub-optimal but unlikely to significantly add to inflation pressures; - over the medium term a declining debt path and otherwise strong fiscal performance allows for a gradual, high-quality fiscal loosening that proceeds gradually to avoid overheating. ### Fiscal policy guidance and public finance projections - Preserve fiscal space: - some fiscal space should be preserved to anticipate rising long-term spending pressures driven mainly by population ageing and by defense, climate, and infrastructure needs; - the proposal to begin building financial assets in the social security fund is welcome. - Spending and tax priorities: - fiscal policies should focus on growth-enhancing investment and efficient spending and taxation; - public wage growth should not exceed the COLA index, and broader pay increases should be avoided to prevent widening of the public-private wage gap; - clarifying the financing strategy of the NSF and assessing its fiscal costs would help contain risks; - new spending or lower taxes should focus on high-quality public investment in energy, climate adaptation, digital infrastructure, and sustainable transport, supported by strong public investment management. - Targeting measures: - zero and reduced VAT rates, excise duty cuts, and other price-based measures to mitigate energy-related inflation are costly, poorly targeted, and distortionary, and should be rolled back; - targeted and temporary transfers coupled with measures to improve energy efficiency and infrastructure are recommended to protect vulnerable households. - Notable projections and fiscal indicators (selected): - Real GDP growth: 3.8 (2025), 2.6 (2026), 3.0 (2027) — table entries preserved in source tables. - HICP (period average): 0.8 (2025), 3.5 (2026) — as in Table 1. - General government balance (percent of GDP): 3.4 (2025), 2.3 (2026) — Table 1. - General government debt: 55.0 (2025), 50.5 (2026) (percent of GDP) — Table 1. ### Financial sector, banking, and NPLs - Banking sector strengths: - robust, supported by strong capital and liquidity buffers and improving asset quality; - NPLs within banks continue to decline; - recent increase in the counter-cyclical capital buffer reflects appropriately calibrated macroprudential policy. - Concerns and recommendations: - significant exposure of banks to real estate warrants ongoing vigilance; - further strengthening of risk monitoring frameworks recommended; - macroprudential policy should remain carefully calibrated to preserve financial stability while supporting the continued recovery in credit growth. - Credit intermediation and dynamism: - despite a recent recovery in credit, the banking sector shows limited dynamism; - credit intermediation remains subdued, with the loan-to-deposit ratio among the lowest in the EU; - high profitability—driven by wide interest rate spreads and low pass-through of policy rates to depositors—contrasts with limited banking sector dynamism. - Factors limiting credit deepening: - remaining frictions in resolving NPLs outside the banking sector; - structural constraints related to market size and concentration; - scarring from the 2014 crisis; - frictions within the EU banking union. - Foreclosure framework changes: - proposed changes widening the scope for challenging and delaying the foreclosure process create legal uncertainty and risk weakening payment discipline; - these would significantly slow resolution of legacy NPLs and weaken credit deepening, investment, and growth. - Financial soundness indicators (selected): - Total capital ratio: 28.2 (2024), 29.5 (2025) — Table 5. - Non-performing loans (NPLs) to total gross loans: 6.2 (2024), 3.2 (2025) — Table 5. - Provisions to NPLs: 64.2 (2024), 77.5 (2025) — Table 5. - Return on assets: 2.0 (2024), 1.8 (2025) — Table 5. ### Judicial efficiency and structural reforms - Continued priority to improve judicial efficiency to support: - investment, credit provision, and timely resolution of legacy NPLs. - Remaining challenges: - long case disposition times, staffing shortages, insufficient digitalization, and limited specialization continue to hinder court performance. - Recommended actions: - provide additional resources to expand number of judges and support staff; - improve digital and physical infrastructure; - strengthen specialization including by accelerating operationalization of the Commercial Court. ### Labor market, AI, and business policy - Labor market status: - Cyprus continues to outperform peers in labor force participation, although gender- and age-related gaps persist; - targeted migration of non-EU nationals could help ease labor shortages in ICT, construction, and hospitality. - AI exposure and policy implications: - AI exposure is high—particularly among women, highly educated workers, and in sectors such as business services, clerical work, and ICT; - need for strong upskilling, reskilling, and lifelong-learning frameworks for an inclusive transition. - Firm-level adoption: - despite widespread personal use of AI, firm-level adoption remains low, especially among SMEs, reflecting gaps in innovation financing, skills, and the regulatory environment. - Policy recommendations: - improve digital infrastructure; - support AI uptake by firms—especially SMEs; - strengthen active labor market policies to manage transition risks. ### Energy sector reform and market developments - Key issues: - electricity generation remains heavily oil-based, - the electricity system is not interconnected with the rest of the EU, - Cyprus has among Europe’s highest electricity prices due to a high share of costly oil-based production. - Market reform progress: - launch of a competitive electricity market with EU Target Model arrangements should improve efficiency, lower prices, and facilitate renewable energy integration, marking an important step toward integration in the EU energy market. - Infrastructure projects: - GSI and the LNG terminal continue to face delays; - audit of the LNG terminal project completed, a new tender expected shortly, but completion not expected before 2029. - Recommendations: - progress on GSI and LNG projects together with improvements to the competitive electricity market framework would help lower costs, diversify supply, and facilitate renewable energy integration. - Empirical note: - evidence shows that improving interconnection reduces price spreads. ### Final procedural note - It is proposed that the next Article IV consultation with Cyprus take place on the standard 12-month cycle. *Source: 2024. The recent launch of a competitive electricity market with EU Target Model arrangements (IMF staff report).* ### Annex I. Sovereign Risk and Debt Sustainability Framework ### Annex I. Sovereign Risk and Debt Sustainability Framework ### Overall sovereign risk assessment - Overall risk of sovereign stress: "Low". - Near term assessment: Not published for surveillance-only cases (note on procedure). - Medium term risk: Low. - Long term risk: Moderate. - Rationale: - Rapidly falling public debt. - Large primary fiscal surplus. - Robust growth. - High cash buffers (exceeding 10 percent of GDP). - Diminishing risks as NPLs have gradually moved out of the banking sector and economic volatility has reduced. - Long-term spending pressures (above baseline): - About 2.7 percent of GDP by 2030. - 4.6 percent of GDP by 2040. - 6.7 percent of GDP by 2050. - Population aging accounts for 5.0 percent of GDP of the increase. - Mitigants: strong starting fiscal position, authorities’ track record of fiscal discipline, commitment to continue reducing public debt ratio. ### Debt sustainability assessment (DSA) summary - Cyprus's debt-to-GDP ratio fell below the 60 percent of GDP threshold in 2025 (declining by about 59 percentage points from its 2020 peak). - Debt stock management features: - Average maturity: about 7 years. - No foreign currency debt. - Limited share of floating interest rate debt on concessional basis. - Cash buffers: exceeding 10 percent of GDP. - Authorities plan to sustain primary surpluses over the medium term; debt expected to decline further. - Risks declined as NPLs have gradually moved out of the banking sector and economic volatility has reduced. - Banking crisis stress test: debt remains manageable under a banking crisis shock scenario; benign debt stock composition, low GFN and sizable preexisting cash buffers support resilience. ### Debt coverage and disclosures - Debt coverage in the DSA: consolidated at the general government level (GG). - Intra-governmental debt is significant: social security funds hold 35 percent of GDP in central government debt. - Public entities beyond the GG perimeter are not deemed a material fiscal risk. - Government guarantees are not included in public debt. - Subsectors included in baseline: - Budgetary central government: Yes - Extra budgetary funds (EBFs): Yes - Social security funds (SSFs): Yes - Local governments: Yes - State governments: No - Public nonfinancial corporations: No - Central bank: No - Other public financial corporations: No ### Baseline scenario: key projections and contributions to change in public debt (Percent of GDP) - Public debt (actual 2025 and projections): - 2025: 55.0 - 2026: 50.5 - 2027: 46.2 - 2028: 42.2 - 2029: 38.4 - 2030: 35.5 - 2031: 32.4 - 2032: 31.2 - 2033: 30.3 - 2034: 29.7 - 2035: 29.8 - Change in public debt: - 2026: -7.8 (actual change from 2025 to 2026) - 2027: -4.5 - 2028: -4.3 - 2029: -4.1 - 2030: -3.8 - 2031: -2.9 - 2032: -3.1 - 2033: -1.3 - 2034: -0.9 - 2035: -0.6 - 2036: 0.1 - Contribution of identified flows: - 2026: -6.7 - 2027: -5.0 - 2028: -4.8 - 2029: -4.6 - 2030: -4.3 - 2031: -3.3 - 2032: -3.5 - 2033: -1.3 - 2034: -0.9 - 2035: -0.6 - 2036: 0.1 - Primary deficit (percent of GDP): - 2025: -4.5 - 2026: -3.4 - 2027: -3.6 - 2028: -3.5 - 2029: -3.4 - 2030: -3.2 - 2031: -3.0 - 2032: -0.9 - 2033: -0.7 - 2034: -0.6 - 2035: 0.0 - Noninterest revenues (percent of GDP): - 2025: 43.6 - 2026: 42.3 - 2027: 41.8 - 2028: 41.3 - 2029: 40.8 - 2030: 40.6 - 2031: 40.5 - 2032: 40.5 - 2033: 40.5 - 2034: 40.5 - 2035: 40.5 - Noninterest expenditures (percent of GDP): - 2025: 39.1 - 2026: 38.9 - 2027: 38.1 - 2028: 37.7 - 2029: 37.4 - 2030: 37.4 - 2031: 37.4 - 2032: 39.5 - 2033: 39.8 - 2034: 39.9 - 2035: 40.5 - Automatic debt dynamics: - 2026: -1.8 - 2027: -2.6 - 2028: -1.5 - 2029: -1.5 - 2030: -1.4 - 2031: -1.0 - 2032: -1.0 - 2033: -0.8 - 2034: -0.6 - 2035: -0.5 - 2036: -0.4 - Real interest rate and relative inflation (contribution): - 2026: 0.5 - 2027: -1.2 - 2028: -0.1 - 2029: -0.2 - 2030: -0.2 - 2031: 0.1 - 2032: 0.0 - 2033: 0.2 - 2034: 0.3 - 2035: 0.4 - 2036: 0.5 - Real growth rate (contribution to automatic dynamics): - 2026: -2.3 - 2027: -1.4 - 2028: -1.5 - 2029: -1.3 - 2030: -1.2 - 2031: -1.1 - 2032: -1.0 - 2033: n.a. - 2034: -0.9 - 2035: -0.9 - 2036: -0.9 - Other identified flows: - 2026: -0.4 - 2027: 1.0 - 2028: 0.4 - 2029: 0.4 - 2030: 0.4 - 2031: 0.9 - 2032: 0.4 - 2033: 0.4 - 2034: 0.4 - 2035: 0.4 - Contribution of residual: - 2026: -1.1 - 2027: 0.5 - 2028: 0.5 - 2029: 0.6 - 2030: 0.5 - 2031: 0.5 - 2032: 0.5 - 2033: 0.0 - 2034: 0.0 - 2035: 0.0 - 2036: 0.0 - Gross financing needs (GFN) (percent of GDP): - 2026: 1.5 - 2027: 3.0 - 2028: 3.2 - 2029: 3.6 - 2030: 0.2 - 2031: 1.9 - 2032: 2.1 - 2033: 4.7 - 2034: 4.8 - 2035: 4.6 - 2036: 5.2 - Of which: debt service (percent of GDP): - 2026: 6.1 - 2027: 6.4 - 2028: 6.9 - 2029: 7.2 - 2030: 3.6 - 2031: 5.1 - 2032: 5.1 - 2033: 5.6 - 2034: 5.5 - 2035: 5.3 - 2036: 5.2 - Memo projections: - Real GDP growth (percent): 2025: 3.8; 2026: 2.6; 2027–2036: 3.0 each year where shown. - Inflation (GDP deflator; percent): 2025: 1.1; 2026: 4.0; 2027: 1.9; 2028: 2.2; 2029: 2.3; 2030–2036: 2.2. - Nominal GDP growth (percent): 2025: 4.9; 2026: 6.6; 2027: 4.9; 2028: 5.3; 2029: 5.4; 2030: 5.2; 2031: 5.2; 2032: 5.2; 2033: 5.2; 2034: 5.2; 2035: 5.2. - Effective interest rate (percent): 2025: 1.9; 2026: 1.7; 2027: 1.7; 2028: 1.8; 2029: 1.9; 2030: 2.3; 2031: 2.3; 2032: 2.7; 2033: 3.1; 2034: 3.5; 2035: 3.9. ### Public debt structure and indicators - Public debt characteristics: - Largely owed to non-residents. - Wholly denominated in local currency. - Long maturities; residual maturity: 7. years (as shown). - About a third is held by multilaterals, including the ESM, EIB, EC and ECB. - Debt by currency: foreign currency share: 0.00 (no foreign currency debt across projected years). - Public debt by holder (Percent of GDP) and instruments: data illustrated in figures (general government perimeter). ### Medium-term risk assessment and stress tests - Debt fanchart results: - Fanchart width: 53.9 (percent of GDP) with contribution 0.8. - Probability of debt non-stabilization: 1.6 (percent). - Terminal debt-to-GDP: x18.6 contribution 0.4. - Debt fanchart index (DFI): 1.2. - Risk signal from DFI: Moderate. - Gross Financing Needs (GFN) module: - Average baseline GFN: 2.3 (percent of GDP) with contribution 0.8. - Initial Banks' claims on the general government (pct bank assets): 3.5 contribution 1.1. - Change in banks' claims in stress (pct banks' assets): 0.3 contribution 0.1. - GFN financeability index (GFI): 2.0. - Risk signal from GFI: Low. - Medium-term index: - Combined medium-term index value: 0.30.5 0.1 (as shown in figure context). - Final assessment: Low risk (mechanical signal and staff assessment align). - Prob. of missed crisis, 2026-2031, if stress not predicted: 0.0 pct. - Prob. of false alarms, 2026-2031, if stress predicted: 68.2 pct. - Banking stress test: - Assumed direct first-round effect: 6.8 percent of GDP (standard calibration for advanced economies). - Under stress, GFNs remain below 15 percent of GDP and debt remains on a declining path. - Risks from banking stress are mitigated by the EU Single Resolution Mechanism. *Source: IMF staff.* ### Annex II. External Sector Assessment — Overall assessment and vulnerabilities - Overall assessment for 2025: external position assessed to be weaker than the level implied by fundamentals and desirable policies. - Key underpinning facts: - Current account (CA) deficit in 2025: 6.4 percent of GDP (driven by large negative primary income balance). - Positive contribution of policies to the CA assessment. - Looking ahead, CA expected to deteriorate due to higher goods imports (linked to higher domestic demand) and stabilization of services exports. - Large negative net international investment position (NIIP) and associated sizable primary income outflows are vulnerabilities for an economy reliant on external financing. ### Potential policy responses (external sector) - Reduce reliance on fossil fuels through continued investment in green energy and infrastructure to lessen dependence on energy imports and exposure to energy price shocks; strengthen medium-term CA balance. - Improve the judiciary to strengthen debt enforcement, resolve legacy NPL issues, and support credit intermediation in the banking sector. - Outcome: more dynamic banking sector and credit deepening, unlocking domestically-financed growth and reducing negative NIIP. ### Foreign assets and liabilities: position and trajectory (selected figures) - NIIP trajectory: - After 2013 crisis: -164 percent of GDP. - 2025 NIIP: -77 percent of GDP. - Medium-term projection: approximately -100 percent of GDP as CA deficits continue. - Gross assets and gross liabilities: - Peaked in 2019 at over 3,000 percent of GDP. - 2025: - Gross Assets: 1,660 (percent of GDP). - Debt Assets: 611 (percent of GDP). - Gross Liabilities: 1,738 (percent of GDP). - Debt Liabilities: 617 (percent of GDP). - NIIP excluding Special Purpose Entities (SPEs) in 2025: -24 percent of GDP, with debt liabilities at 162 percent of GDP. - Assessment notes: - Narrowing of negative NIIP continued in 2025. - NIIP remains highly negative and expected to decline slightly in the medium term as Cyprus continues to attract FDI. - NIIP of SPEs is sizable but not considered a risk due to limited linkages to the domestic economy. - Non-SPE NIIP is significant and affected by legacy NPLs portfolio which is largely foreign owned; resolution of legacy NPLs will improve NIIP. ### Current account (CA): background, assessment, and model estimates for 2025 - Background: - CA deficit has been widening since 2015, driven by a deteriorating net primary income balance (from -1 percent of GDP in 2015 to -11 percent of GDP in 2025). - Cyprus structural trade deficit due in part to reliance on oil imports for transport and electricity. - Services balance recovered strongly: from 17.4 percent of GDP in 2020 to 25.1 percent in 2025 (tourism recovery and ICT expansion after headquartering scheme). - Improvement in CA in 2025 supported by services balance improvements and lower goods imports; goods exports slightly deteriorated due to normalization of merchanting activity. - Going forward, services balance growth expected to stabilize as ICT sector matures; high net international investment inflows expected to partially reverse recent CA improvement. - Model estimates for 2025 (Percent of GDP): - CA-Actual: -6.4 - Cyclical contributions (from model): (-) -0.2 - Additional temporary/statistical factors (including natural disasters and conflicts): (-) -0.3 - Adjusted CA: -6.0 - CA Norm (from model): -2.6 - Adjusted CA Norm: -2.6 - CA Gap: -3.3 7.8 (table shows "CA Gap-3.37.8" — preserving exact source formatting) - Relative policy gap (part of CA gap): 3.2 - Elasticity: -0.6 - REER Gap (in percent): 5.5 -13.0 (preserving exact source formatting) - Assessment: - EBA model CA norm: -2.6 percent of GDP. - Adjusted CA estimate: -6 percent of GDP. - Policy gaps contribute 3.2 percent (driven by more prudent fiscal policy and slow private credit growth relative to the rest of the world). ### Real exchange rate (REER) - Background: - REER movements: depreciated by 1.3 percent in 2022; appreciated by 1.9 percent in 2023; depreciated 1.3 percent in 2024; euro appreciated to 1.12 EUR/USD in 2025 (after depreciation to 1.04 in 2024). - Correlation of REER movements with EUR/USD: 0.95 since 2010. - Assessment: - REER gap from CA-based approach (elasticity -0.6): overvaluation of 5.5 percent in 2025. - REER model suggests a gap of -13 percent (large contribution from lower dependency ratio in Cyprus relative to trading partners). - Staff assessment: REER is moderately overvalued (placing higher weight on the CA model). ### Capital and financial accounts; reserves and FX intervention - Capital and financial account flows: - Net capital inflows decreased to 6.4 percent of GDP in 2025 from 7.8 percent in 2024. - During 2025: FDI net inflows increased; portfolio outflows decreased; other investment declined. - Historically, CA deficits were more than offset by reinvestment of earnings into Cyprus; the drop in reinvested earnings during the pandemic highlights potential volatility. - Assessment: - With sizeable international financial ties (high external debt and negative FDI stock), Cyprus remains exposed to international financial market risks. - FX intervention and reserves: - Background: the euro has the status of a global reserve currency. - Assessment: reserves held by the euro area are typically low relative to standard metrics, but the currency is free floating. *Source: IMF staff.* ### Annex III. Risk Assessment Matrix ### Annex III. Risk Assessment Matrix ### Global conjunctural risks - Geopolitical Tensions and Intensification of Conflicts - Likelihood: High - Expected Impact: High - Expected outcomes: - Slowdown in economic activity. - Decrease in FDI inflows. - Increase in incoming refugees. - Policy Responses: - Allow automatic stabilizers to work. - Diversify trade and investment relations. - Continue to accumulate buffers to enhance resilience and confidence. - Protectionism and Trade Disruptions - Likelihood: High - Expected Impact: Medium - Expected outcomes: - Worsening trade balance and import-driven inflationary pressures. - Given the services-oriented export economy, the situation would become more severe if trade protectionism extends to services. - Policy Responses: - Allow automatic stabilizers to work. - Provide targeted support to the most vulnerable. - Advance structural reforms and promote economic diversification, including at the EU level. - Promote the strengthening of the EU single market. - Commodity Price Volatility - Likelihood: High - Expected Impact: High - Expected outcomes: - Given high dependence on imported oil, higher prices would worsen external position, raise supply-side inflation, lower disposable income and discourage investments. - Policy Responses: - Allow commodity prices passthrough but provide resources for temporary and targeted measures to shield the most vulnerable. - Diversify energy sources and accelerate transition by completing energy infrastructure projects. - Disorderly AI Correction - Likelihood: High - Expected Impact: High - Expected outcomes: - Indirect economic shocks through reduced global demand, tighter financial conditions, and lower foreign investment, which could slow growth and increase labor market vulnerabilities. - Policy Responses: - Strengthen macroeconomic and financial stability frameworks. - Maintain fiscal buffers to support counter-cyclical spending. - Promote economic diversification to reduce external shocks. - Maintain active labor market policies to support unemployment shocks. - Foster resilient financial institutions through robust regulation. Increase oversight and risk assessment of NBFIs to prevent systemic vulnerabilities. ### Global structural risks - Cyberthreats - Likelihood: High - Expected Impact: Medium - Expected outcomes: - Risks to critical infrastructure, institutions, and financial systems that lead to disruptions to socio-economic activity and the financial sector. - Policy Responses: - Continue to enhance infrastructure and upgrade ageing IT systems to reduce cyber risks and strengthen preparedness. - Pace AI adoption in line with capacity to manage risks and ensure adequate regulatory frameworks. - Climate Change - Likelihood: Medium - Expected Impact: Medium - Expected outcomes: - Slower potential growth. - Reduced fiscal space due to adaptation and transition costs. - Policy Responses: - Monitor climate risks and develop contingency plans. - Invest in adaptation and enable a framework for private sector participation. - Adopt climate neutral policies and accelerate the energy transition. - Maintain fiscal buffers to preserve capacity for absorbing climate change-related costs. - AI Acceleration - Likelihood: Medium - Expected Impact: Medium - Expected outcomes: - Rapid AI adoption could boost growth but may deepen workforce vulnerabilities without strong reskilling and transition support. - Policy Responses: - Develop and implement a national AI strategy aligned with EU frameworks. - Strengthen digital and AI skills across all education levels. Expand reskilling and upskilling programs for affected workers. - Support AI adoption in SMEs by removing barriers and fostering innovation. - Promote active labor market policies to facilitate job transitions. ### Domestic risks - Delays in implementation of structural reforms - Likelihood: Medium - Expected Impact: Medium - Expected outcomes: - Slower potential growth. - Loss of RRP funding. - Reduced confidence and higher risk premia. - Policy Responses: - Accelerate the implementation of structural reforms. - Growing fiscal pressures - Likelihood: Medium - Expected Impact: Medium - Expected outcomes: - Fiscal expansion leading to overheating in the near-term. - Slowdown or reversal in public debt reduction, reducing fiscal space to respond to future shocks. - Higher borrowing costs, lower investor confidence, and constrained funding for critical investments, ultimately weakening long-term economic growth. - Policy Responses: - Maintain a gradual and prudent fiscal easing path focused on high-productivity public investments. - Enhance tax and spending efficiency to safeguard fiscal sustainability. - Prioritize reforms that improve investment efficiency and public financial management. - Contain wage growth aligned with productivity gains. *Source: Annex III. Risk Assessment Matrix (excerpt).* ### Conclusions and Policy Considerations ### Conclusions and Policy Considerations ### AI adoption, exposure, and implications - AI adoption in Cyprus has been slow, indicating challenges but also opportunities from harnessing the new technology. - Use of AI is high among the Cypriot population, but its use in economic activities remains limited, suggesting gaps in AI preparedness. - Workforce exposure to AI is broadly similar to that observed in other European countries, although risks associated with job displacement appear somewhat higher. - Vulnerable groups and notable trends: - Elevated risks especially among female workers. - Elevated risks especially among highly educated workers. - Occupations with notable exposure to automation risks include: - Clerical and business administration professions. - ICT roles. ### Need for a coordinated national strategy and regulatory alignment - A holistic national strategy is essential to harness AI’s transformative potential while managing associated structural changes. - The establishment of a National AI Task Force in January 2025 is a significant step toward coordinated policy action. - Ongoing preparation of a national AI action plan should: - Lay the foundation for a comprehensive AI regulatory framework aligned with forthcoming EU AI regulation. - Prioritize targeted policies that facilitate productive AI adoption across sectors. - Implement measures to mitigate potential job disruptions, especially among vulnerable groups. - Clear, transparent, and efficient regulation compliant with the EU AI regulation can reduce uncertainty and foster responsible innovation. ### Building a future-ready workforce - Cyprus should strengthen focus on building a future-ready workforce through: - Systematic integration of digital and AI-related skills into all levels of the education system. - Ensuring students acquire competencies essential for the evolving labor market. - Making tertiary education institutions more agile and responsive to rapidly changing skill demands driven by AI adoption. - Updating curricula in close collaboration with industry to maximize complementarity between human and AI capabilities. - Fostering a culture of continuous learning and adaptability to position the workforce to thrive alongside technological advancements. ### Labor market monitoring, reskilling, and upskilling - Policymakers must closely monitor the evolving impact of AI on the labor market through continuous assessment to identify emerging trends in job displacement. - Priority actions include: - Expanding reskilling and upskilling initiatives to enable affected workers to transition toward professions with greater complementarity to AI or lower exposure to automation risks. - Targeting support to occupations most exposed to automation (e.g., clerical, business administration, ICT). - A proactive approach will help mitigate adverse employment effects, foster labor market resilience, and support inclusive economic adaptation. ### Supporting firm-level adoption, with emphasis on SMEs - Supporting AI adoption by companies, especially SMEs, is necessary to fully harness AI benefits. - Key measures to accelerate productive AI use: - Implement a transparent and efficient regulatory framework compliant with the EU AI regulation. - Provide clear guidelines to reduce uncertainty and encourage responsible innovation. - Develop a workforce equipped with AI-related skills so companies have access to talent that can maximize digital transformation benefits. - Special attention for SMEs: - SMEs often face greater barriers to implementing AI due to resource constraints. - The Cyprus DIGital INNovation Hub can serve as a strategic platform offering targeted training, opportunities for AI adoption testing, and guidance on investment strategies. ### Public sector productivity gains from AI - The public sector exhibits both higher exposure to and complementarity with AI technologies compared with the private sector, positioning it to benefit substantially from digital transformation. - Strategic AI adoption in government operations can: - Reduce administrative costs. - Streamline processes. - Enable expansion of modern, efficient public services. - The government’s “AI in Government” funding program supports development and real-world testing of AI prototypes addressing specific public-sector challenges and is a welcome initiative to accelerate public administration modernization and enhance service delivery. *Source: Conclusions and Policy Considerations* ### Annex VII. Data Issues ### Annex VII. Data Issues ### Data Standards and Dissemination - Cyprus subscribes to the Special Data Dissemination Standard (SDDS) since December 2009 and publishes the data on its National Summary Data Page. - The latest SDDS Annual Observance Report is available on the Dissemination Standards Bulletin Board. - External Sector Statistics are published with a relatively long lag ("3 months after quarter end"), and are occasionally delayed and can include large revisions. - External Sector Statistics excluding SPEs (which better reflect real economic activity) are shared with the Fund with an additional lag of several months. ### Data Adequacy Assessment (overall and questionnaire) - Data Adequacy Assessment Rating: A - Questionnaire Results and Assessment (heatmap-style summary as presented): - Median Rating: AAABAAA - Sectoral assessments (as shown in the source): - National Accounts: A - Prices: A - Government Finance Statistics: A - External Sector Statistics: B - Monetary and Financial Statistics: A - Intersectoral Consistency: A - Detailed Questionnaire Results — Data Quality Characteristics (sector-level characterizations shown): - Coverage: AAAAA - Granularity: top cell AABA; bottom cell AA (see note on interpretation below) - Consistency: ABA - Frequency and Timeliness: AAABA - Notes on interpretation: - The top/bottom cell for "Granularity" of Government Finance Statistics distinguishes granularity of reported government operations data (top cell) and public debt statistics (bottom cell). - The top/bottom cell for "Granularity" of Monetary and Financial Statistics distinguishes granularity of reported Monetary and Financial Statistics (top cell) and Financial Soundness indicators (bottom cell). - Rating legend as provided: - A: The data provided to the Fund are adequate for surveillance. - B: The data provided to the Fund have some shortcomings but are broadly adequate for surveillance. - C: The data provided to the Fund have some shortcomings that somewhat hamper surveillance. - D: The data provided to the Fund have serious shortcomings that significantly hamper surveillance. ### Rationale for staff assessment and data issues - Staff assessment summary: "Staff assess the data provided to the Fund to be adequate for surveillance with no major data weaknesses affecting staff's analysis of macroeconomic and financial risks." - Specific issues and complications: - External Sector Statistics: - Published with a relatively long lag ("3 months after quarter end"). - Occasionally delayed and can include large revisions. - Trade in services data is relatively granular; trade in goods data is highly aggregated. - Complicated by the large and complicated volume of data associated with the substantial Special Purpose Entities (SPEs) sector and FDI-associated transfers. - External Sector Statistics excluding SPEs are shared with the Fund with an additional lag of several months. - Authorities' engagement: "Authorities have shown a willingness to readily address data requests from the Fund demonstrating their commitment to engage on these issues." ### Changes, corrective actions, and data use in consultations - Changes since the last Article IV consultation: None - Corrective actions and capacity development priorities: None - Use of data and/or estimates in Article IV consultations in lieu of official statistics available to staff: "No data or estimates different from official statistics were used." - Other data gaps: None ### Table of Common Indicators Required for Surveillance (selected metadata as of May 05, 2026) - Table header: "(As of May 05, 2026)" - Examples of indicator timestamps and frequency/timeliness entries (as displayed): - Exchange Rates: Date of Latest Observation 2026-05-05; Date Received 2026-05-05; Frequency of Data: DDD - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of Latest Observation 2026-03; Date Received 2026-04; Frequency of Data: MMMM; Frequency of Reporting: 1W; Expected Frequency: 3W - Reserve/Base Money: Date of Latest Observation 2026-03; Date Received 2026-04; Frequency: MMMM; Frequency of Reporting: 2W; Expected Frequency: 2W - Broad Money: Date of Latest Observation 2026-03; Date Received 2026-04; Frequency: MMMM; Frequency of Reporting: 1M; Expected Frequency: 1M - Central Bank Balance Sheet: Date of Latest Observation 2026-03; Date Received 2026-04; Frequency: MMMM; Frequency of Reporting: 2W; Expected Frequency: 2W - Consolidated Balance Sheet of the Banking System: Date of Latest Observation 2026-03; Date Received 2026-04; Frequency: MMMM; Frequency of Reporting: 1M; Expected Frequency: 1M - Total assets of other depository corporations: Date of Latest Observation 2026-03; Date Received 2026-04; Frequency: MMMM; Frequency of Reporting: 1M; Expected Frequency: 1M - Total credit from other depository corporations: Date of Latest Observation 2026-03; Date Received 2026-04; Frequency: MMMM; Frequency of Reporting: 1M; Expected Frequency: 1M - Interest Rates: Date of Latest Observation 2026-05-05; Date Received 2026-05-05; Frequency: DDD - Consumer Price Index: Date of Latest Observation 2026-03; Date Received 2026-04; Frequency: MMMM; Frequency of Reporting: 1M; Expected Timeliness: 1W - Revenue, Expenditure, Balance and Composition of Financing — General Government: Date of Latest Observation 2025-12; Date Received 2026-03; Frequency: QQAQ; Frequency of Reporting: 2Q; Expected Frequency: 3M - Revenue, Expenditure, Balance and Composition of Financing — Central Government: Date of Latest Observation 2025-12; Date Received 2026-03; Frequency: MMMM; Frequency of Reporting: 1M; Expected Frequency: 1M - Stocks of Central Government and Central Government-Guaranteed Debt: Date of Latest Observation 2025-12; Date Received 2025-12; Frequency: QQQQ; Frequency of Reporting: 1Q; Expected Frequency: 1M - Total stock of General Government Debt: Date of Latest Observation 2025-12; Date Received 2025-12; Frequency: QQQ...4M... - External Current Account Balance: Date of Latest Observation 2025-12; Date Received 2026-04; Frequency: QQQQ; Frequency of Reporting: 1Q; Expected Frequency: 1Q - Exports and Imports of Goods and Services: Date of Latest Observation 2025-12; Date Received 2026-04; Frequency: QQMM; Frequency of Reporting: 8W; Expected Timeliness: 42D - GDP/GNP: Date of Latest Observation 2025-12; Date Received 2026-04; Frequency: QQQQ; Frequency of Reporting: 1Q; Expected Timeliness: 70D - Gross External Debt: Date of Latest Observation 2025-12; Date Received 2026-04; Frequency: QQQQ; Frequency of Reporting: 1Q; Expected Frequency: 1Q - International Investment Position: Date of Latest Observation 2025-12; Date Received 2026-04; Frequency: QQQQ; Frequency of Reporting: 1Q; Expected Frequency: 1Q - Explanatory notes (as provided in the table): - Definitions and expectations for reserve assets, other depository corporations, interest rates, government coverage, and frequency/timeliness codes ("D", "W", "M", "Q", "A", "SA", "I", "NA", "NLT") are reproduced in the source. - Entries shown as "..." indicate indicators not in the IMF Data Standards Initiatives or not applicable in the source's presentation. *Annex VII. Data Issues (Content unit: 1cypea2026001).* ### 2.3 percent of GDP in 2026. Supported by strong nominal GDP growth and sizable cash buffers, ### 1cypea2026001 - 2.3 percent of GDP in 2026. Supported by strong nominal GDP growth and sizable cash buffers, ### Fiscal outlook and policy guidance - Public debt declined to 55 percent of GDP at end-2025, from 63 percent in 2024 and 77 percent in 2023. - Public debt is projected to fall further to around 50 percent by end-2026. - Available fiscal space should be used prudently to support targeted, high-return capital investment, while preserving buffers to address long-term pressures arising from population aging, defense needs, and climate change. ### Comprehensive tax reform (start of 2026) - The reform is the most extensive overhaul of the tax system in more than twenty years. - Objectives: enhance fairness, strengthen compliance, preserve Cyprus’s attractiveness as a competitive business and investment destination, and align the tax framework with OECD and EU standards while safeguarding fiscal sustainability. - Key measures: - Higher tax-free threshold. - Expanded family and housing deductions. - Abolition of deemed dividend distribution. - Lower taxation of actual dividends. - Removal of most stamp duties. - Increase in the corporate tax rate to 15 percent. ### Financial sector resilience and developments - Banking system solvency and liquidity indicators rank among the strongest in the European Union. - Common Equity Tier 1 ratios exceeding 25 percent in 2025. - Countercyclical capital buffer increased to 1.5 percent, effective January 2026. - Overall buffer availability remains well above regulatory requirements. - Non-performing loan (NPL) ratio declined to 1.6 percent by end-2025. - Credit growth remained robust into 2026 despite still relatively tight financial conditions. - Banking sector profitability remains high but has begun to stabilize as net interest income moderates with the gradual pass-through of lower lending rates. - Cypriot banks continue to manage their MREL targets effectively through prudent capital planning. - The state-backed mortgage-to-rent scheme continues to support vulnerable homeowners. - The Financial Ombudsman has assumed a more prominent role as an out-of-court dispute resolution mechanism. - The National Solidarity Fund replenishment scheme: partial compensation disbursed in 2025 to individuals affected by the 2013 banking crisis, including haircut depositors and securities holders, supported by a dedicated budget and an electronic verification platform. - The foreclosure framework remains a key pillar for addressing legacy NPLs and ensuring payment discipline. - Parliament adopted in April 2026 a broad package of legislative amendments aimed primarily at strengthening borrower protection. - Digitalization trends: - Banks reducing branch networks and physical staffing while accelerating migration of retail clients to online and mobile platforms. - Fintech companies gaining traction and modernizing payment systems, lending processes, and financial planning. - AML/CFT priorities: - More effective implementation of safeguards, broader use of entity-level risk assessments across all entities supervised by the Central Bank of Cyprus, and continued adaptation to the evolving EU framework. - Additional resources provided to the securities markets supervisor expected to enhance the resilience of non-bank financial institutions. ### Structural reforms and investments - Structural reforms advancing in digital transformation, green investment, and financial innovation to support sustainable and inclusive growth. - National Recovery and Resilience Plan: investments of around €1.2 billion, with a strong focus on sustainable development, digitalization, and human capital. - Energy vulnerabilities and actions: - Island characteristic, limited diversification of energy sources, and relatively high electricity costs identified as critical structural vulnerability. - Strategic importance of strengthening connectivity with Europe through interconnection projects with Greece and Israel. - Accelerated deployment of renewable energy and ongoing investments in solar and wind energy. - Regional cooperation in gas exploration expected to enhance energy security and reduce import dependence. - Authorities committed to modernizing the electricity grid, expanding storage capacity, and strengthening incentives for energy efficiency. - Climate and water risks: - Climate change and increasing water stress pose medium-term risks, particularly for agriculture and tourism. - Continued investment in desalination, water management, and climate adaptation remains essential. - Green Cyprus Initiative expected to support adoption of green technologies and strengthen environmental sustainability. - Judicial reform: - Implementation phase following institutional restructuring. - Early progress visible in reducing judicial workload, though further efforts needed to address remaining backlogs. - Continued judicial training and modernization of digital systems are key to improving efficiency. ### Social inclusion, labor market, and innovation - Youth unemployment stood at 13.5 percent in 2025. - Key socioeconomic challenges: still-elevated youth unemployment, skills mismatches, and regional disparities in income, job opportunities, and access to quality public services. - Priorities: - Labor market reforms. - Expanded upskilling and vocational training, particularly in IT and green sectors. - Increased female labor force participation and improved mobility. - Strengthening AI readiness and fostering an enabling environment for innovation-driven growth. - Further progress in digital infrastructure and e-government to reduce administrative burdens and enhance transparency. ### Institutional stance on transparency - The Cypriot authorities agree with the publication of the staff report and the accompanying documents. *https://www.imf.org/-/media/files/publications/cr/2026/english/1cypea2026001.pdf* --- _Source: https://www.imf.org/-/media/files/publications/cr/2026/english/1cypea2026001.pdf_