## _cr13293 — Executive Summary and Key Findings ## Source details **Canonical URL:** [_cr13293 — Executive Summary and Key Findings](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13293.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13293.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13293.pdf.json) --- ### Extended Arrangement and Financing - On May 15, 2013 the Executive Board approved a three-year Extended Arrangement under the Extended Fund Facility (EFF) in the equivalent of SDR 891 million (563 percent of quota; €1 billion). - A purchase of SDR 74.25 million (about €86 million) was made in May 2013. - Another equal purchase (SDR 74.25 million, or about €86 million) will be released upon completion of the first review. - The European Stability Mechanism has released €3 billion (of €9 billion committed). ### Recent Economic Developments — Output, Demand, Labor, Prices - Output and demand: - Output contracted in the first half of the year, but by less than projected. - End-June flash estimates: output declined by 5.2 percent y-o-y in the second quarter. - Drivers: March bank crisis, introduction of deposit restrictions and capital controls, and drag from large fiscal adjustment implemented in 2012 and early 2013 (public consumption contracted by 26 percent in the first quarter). - Net external demand contribution positive due to a sharp contraction of imports of goods by about 20 percent y-o-y through June; goods exports remained stable (staff estimate excludes one-off sale of planes; including that sale, exports of goods increased 10 percent y-o-y through June). - High-frequency indicators (retail sales, manufacturing production, cement sales) suggest widespread downturn; tourism receipts have held up. - Confidence indicators rose for the last three months from the trough in April. - Labor market and prices: - Unemployment rate climbed to 17.3 percent in June compared with 11.7 percent a year before. - Wages declined by 0.6 percent in nominal terms through March. - Inflation fell to 0.7 percent at end-June from 1.3 percent in March. ### External and Fiscal Developments - External sector: - Trade deficit declined from about 8 to 6 percent of GDP in the first quarter of 2013 (y-o-y, non-seasonally adjusted). - Current account deficit increased by about 1.3 percent of GDP y-o-y due to deterioration in the net income balance from recognition of income losses by Cypriot bank branches in Greece. - On the capital account, financial institutions sold about €10 billion in external portfolio assets to finance loan repayments (€7.2 billion) and deposit outflows (€2.9 billion) in the first quarter. - Historical BOP revision: 2012 current account deficit lowered from 11.7 to 6.5 percent of GDP. - Fiscal developments (January–June 2013, Millions of Euros / Percent of GDP): - Revenues — Program: Revenue 3,009 / 18.3 percent ; Prelim.: Revenue 3,224 / 19.6 percent. - Expenditure — Program: Expenditure 3,486 / 21.2 percent ; Prelim.: Expenditure 3,444 / 21.0 percent. - General Government balance — Program -477 / -2.9 percent of GDP ; Prelim. -220 / -1.3 percent of GDP. - General Government primary balance — Program -222 / -1.4 percent ; Prelim. 67 / 0.4 percent. - General Government primary spending — Program 3,230 / 19.7 percent ; Prelim. 3,156 / 19.2 percent. - Government financing measures: - €1 billion domestic debt exchange replacing bonds maturing between 2013–16 with bonds averaging slightly below 5 percent coupon and extended maturities through 2019–23. - Rollover of the €1.9 billion Laiki recapitalization bond (now held by BoC) until 2014 with possibility to roll over annually until 2017. - End-June structural benchmark on government financing completed on July 1. ### Program Status and Implementation - The program is on track; ownership by the authorities has improved. - All end-June performance criteria (PCs) were met with a comfortable margin. - All structural benchmarks were observed, albeit some with brief delays. - Structural benchmark on restructuring strategy for cooperative credit institutions (CCI) sector met at end-June; exchange of €1 billion of domestic debt and rollover of the €1.9 Laiki recapitalization bond completed on July 1. - Authorities published a roadmap to gradually ease payment restrictions and finalized a restructuring strategy for the cooperative credit sector. - Key reforms underway: revenue administration and the social safety net. --- ### Financial Sector — Asset Quality, Liquidity, Restructuring ### Asset quality and credit contraction - Non-performing loans (NPLs) reached almost 30 percent of total loans at end-March. - Provisioning for loan losses stands at only 30 percent of total loans, compared with an average ratio of 50 percent for European banks. - Credit contraction: - Corporate credit contracted by 9 percent y-o-y in June. - Mortgage lending fell by about 3 percent. - Consumer credit fell by about 7 percent. ### Bank of Cyprus (BoC) recapitalization and bail‑in - KPMG fair value assessment (July 26) concluded total capital needs for the merged BoC amounted to €3.9 billion at end-March to reach an initial Core Tier 1 (CT1) ratio of around 12 percent to ensure CT1 remains above regulatory minimum of 9 percent throughout the program period under conservative assumptions. - On July 30, resolution authority converted a further 10 percent of BoC’s uninsured deposits (€0.8 billion) into equity, in addition to 37.5 percent (€3.1 billion) already bailed in, to cover additional fair valuation losses (€0.4 billion) and further needs from partial exemption of some uninsured deposits (€0.4 billion). - Restructuring of remaining frozen uninsured deposits (about €3.5 billion or 42.5 percent of initial uninsured deposits): - 5 percent released. - Remaining 37.5 percent equally split and converted into time deposits with 6, 9, and 12 month maturities, extendable by another 6, 9, 12 months, if needed. - Bail-in amounts (Billions of euros): - BoC uninsured deposits: 3.9 - Laiki uninsured deposits: 4.0 - Total uninsured deposits bailed in: 7.8 - BoC subordinated debt: 0.6 - Laiki subordinated debt: 0.8 - Total subordinated debt bailed in: 1.3 - BoC senior debt: 0.0 - Laiki senior debt: 0.1 - Total senior debt bailed in: 0.2 - Total bail-in (BoC + Laiki): 9.4 - Ownership of BoC (Percent of total): - BoC uninsured depositors: 81% - Laiki depositors: 18% - Others: 1% - BoC governance and restructuring: - Annual General Meeting called for September 10 to appoint a new Board. - CBC instructed BoC to prepare a strategic restructuring plan with technical support; plan and consistent capital and funding plans to be assessed by the CBC by end-October (modified structural benchmark). - Voluntary retirement scheme expected to reduce staffing by about 25 percent; expected wage cost reduction by about 35 percent. ### Liquidity support and transition from ELA to ECB refinancing - After exiting resolution, BoC regained access to ECB’s monetary policy operations. - About €1.3 billion of existing ELA has already been substituted with ECB refinancing. - Short-run liquidity options include pledging the Laiki recapitalization bond as collateral for ECB refinancing; if needed, pledging new own bonds guaranteed by the government. - Authorities proposed augmenting the ceiling on the accumulation of government guarantees by a maximum of €2.9 billion. ### Cooperative credit institutions (CCIs) restructuring - Assessment showed sector solvent overall but undercapitalized, with capital needs amounting to €1.5 billion. - Strategy to recapitalize and restructure sector completed; key elements include: - Recapitalization with state support, fully protecting all CCI depositors. - Use public funds to recapitalize the Cooperative Central Bank (CCB) in line with state aid rules, by end-October. - CCB to inject capital into individual CCIs to achieve a CT1 ratio of 9 percent at sectoral level and 4 percent at individual level. - Consolidation: existing 93 CCIs to be consolidated into at most 18 institutions (end-March 2014 structural benchmark). ### Roadmap for lifting administrative restrictions and capital controls (phased) - Phase 1 (published August 9, 2013): reduce cash circulation and administrative burden (e.g., open new accounts to create term deposits with minimum maturity of three months). - Phase 2: reinstate accessibility of funds and domestic transfers after BoC restructuring plan approval, Hellenic Bank recapitalized, and CCI restructuring plan finalized; expected to start by end-2013. - Phase 3: lift restrictions on cash and checks after merger completion of CCIs and tangible progress with BoC restructuring. - Phase 4: abolish restrictions on external capital flows based on progress and broad-based deposit stabilization. - Selected relaxations (27-Mar vs 2-Aug, Euros): e.g., cash withdrawals per day per person — Natural person 300 -> 300 ; Legal person 300 -> 500; Payments via debit or credit card (per month): 5,000 -> No limit; Exports of euro notes per person per journey: 1,000 -> 3,000. - As of August 21, net deposit outflows reached close to €8 billion or about 12.6 percent of the deposit base since end-March, excluding the conversion of Laiki and BoC deposits into equity in April and May. - Of these outflows, 60 percent correspond to non-residents, largely concentrated among uninsured deposits. - Outflows from domestic entities represent about 11 percent of their deposit base. - Foreign banks have lost about 15 percent of their deposits, but more recently experienced new inflows and stabilization following exemption from restrictions. - Outflows financed largely through own funds, including liquid asset disposals; about 20 percent of outflows used to pay loans within the same bank, with no impact on liquidity. - BoC remained heavily reliant on Emergency Liquidity Assistance (ELA) until substitution and ECB refinancing steps. ### Anti‑money‑laundering (AML) findings and reforms - Independent forensic audit by Deloitte and Moneyval assessment identified weaknesses in implementation of AML measures. - Deloitte sampled 390 customers across six credit institutions; Moneyval estimated 75 percent of international business involves third-party “introducers”. - Key findings: - 70 percent of deposit holders with complex ownership structures have nominee shareholders and an average of three layers between customer and beneficial owner(s). - Only in 9 percent of complex ownership structure cases had proper steps been taken to verify identity of beneficial owners. - Deloitte’s review: only three suspicious transaction reports sent to authorities during 2008–12; forensic analysis identified 29 potentially suspicious transactions during the past 12 months alone that were not identified by the banks. - Charted statistics (Deloitte/Moneyval): - Beneficial owner verification: 9% Appropriate steps taken ; 91% Inappropriate verification of beneficial owner's identity. - Suspicious cases aggregate: Suspicious cases: 23% (No issues reported: 77%; Suspicious transactions: 7%; Misclassified risk: 13%; Criminal background: 3%). - Action plan and structural benchmarks: - Revise AML legal framework by end-September 2013. - CBC to follow up on breaches and apply supervisory enforcement actions by end-September 2013. - Strengthen AML supervision structure and resources by end-December 2013. - Registrar of Companies third party assessment completed by end-December 2013; trust registries to be established Q3-2013. --- ### Macroeconomic Outlook, Risks, and Debt Sustainability ### Short-run and medium‑run GDP and labor projections - Short-run GDP projections: - Output projected to contract by about 9 and 4 percent in 2013 and 2014, respectively, led by domestic demand and sharp contraction of financial services and construction. - Staff macro projections (selected years, percent change): - Real GDP: 2013 -8.7; 2014 -3.9; 2015 1.1; 2016 1.9; 2017 2.3. - Unemployment rate (EU standard): 2013 17.0; 2014 19.5; 2015 18.7. - HICP (period average): 2013 1.0; 2014 1.2; 2015 1.6. - Sector dynamics: - Construction and financial services major contributors to 2013 contraction. - Tourism and professional services more resilient. ### Risks — direction and key channels - Risks described as substantial and tilted to the downside. - Domestic risks: - Confidence in banking sector not yet restored. - Impact of banking crisis on households, corporates, and vital service sectors could be larger, risking deeper and more prolonged recession and weaker long-run growth with consequences for debt sustainability. - External risks: - Continued EU weakness could dampen Cypriot exports. - Upside possibilities: - Tourism could benefit from turmoil in competing destinations and stronger non-EU demand (e.g. China and Russia). - Development of gas sector could provide upside to investment and growth over the longer term. ### Public debt and external debt projections - Public debt projections: - Debt expected to peak at 126 percent of GDP in 2015 and gradually decline toward 105 percent of GDP by 2020 as activity recovers and primary surplus improves. - 2013 debt revised up from 109 to 114 percent of GDP due to postponement of a €1 billion planned swap of debt held by the CBC for state-owned assets from third quarter of 2013 to mid-2014. - Baseline public sector debt in 2013 reported as 114.1 percent of GDP. - Public sector debt (percent of GDP, selected): 2013: 114.1; 2014: 123.0; 2015: 125.7; 2016: 121.7; 2017: 115.9; 2018: 111.7; 2019: 108.1; 2020: 105.0. - External debt and IIP: - Gross external debt declined by about 10 percent of GDP since end-2012 to around 440 percent of GDP at end-March 2013; expected to decline to 345 percent of GDP by 2020. - International investment position (IIP): 123 percent of GDP at end-March 2013. ### Debt sustainability and contingent liabilities - Debt sustainability highly vulnerable to shocks; lower nominal GDP growth would have profound implications for debt trajectory. - Contingent liabilities from banking sector pose risks. - BoC implicit liabilities and exposures: - BoC had about 70 percent of GDP in insured deposits at end-March. - BoC had about 70 percent of GDP in ELA granted by the CBC at end-June. - Additional government guarantees to support BoC liquidity would add to implicit liabilities. - Full materialization of risks may require additional financing measures to preserve debt sustainability. --- ### Program Financing, Buffers, and Sensitivity Analysis ### Program financing and buffers - Gross financing requirement including a buffer (millions of euros): 2013: 5,859.2; 2014: 4,180.2; 2015: 3,522.4; 2016: 2,120.1; 2017: 1,682.4. - Government gross financing requirement (millions of euros): 2013: 3,768.6; 2014: 3,233.8; 2015: 3,065.7; 2016: 2,045.3; 2017: 1,682.4. - Net financing requirement (millions of euros): 2013: 4,843.4; 2014: 3,194.5; 2015: 2,536.6; 2016: 802.9; 2017: 400.0. - Official financing sources and buffers (millions of euros): 2013: 4,843.4; 2014: 2,794.5; 2015: 2,036.6; 2016: 302.9; 2017: 0.0. - IMF (millions of euros): 2013: 258.4; 2014: 344.5; 2015: 344.5; 2016: 86.1; 2017: 0.0. - ESM (millions of euros): 2013: 4,585.0; 2014: 2,450.0; 2015: 1,692.2; 2016: 216.8; 2017: 0.0. - The program financing buffer remains sizeable and can cover additional fiscal needs even in case of a significant recession (Annex I). Use of the buffer is already accounted for in debt sustainability analysis. ### Sensitivity of program financing to tailored adverse growth shock (Annex 1) - Shock assumptions: - Additional decline in growth of about 9.2 percent in 2013–14 (with 2/3 in 2013 and the rest in 2014) on top of the baseline decline, for a total recession of 22 percentage points. - Regression estimate: a 1 percent fall in growth relative to baseline leads to a 0.26 percent decline in inflation and the deflator. - Fiscal transmission: - Revenues: 0.4 percent of GDP decline in revenues per each percentage point fall in growth in 2013–14; revenues recover in 2015–17 reducing peak loss in 2014 by 50 percent from 2017 onwards. - Safety net spending: 0.1 percent of GDP increase in safety net spending per each percentage point fall in growth for 2013–14; permanent effect in 2015–17 is 1/3 of peak effect at end 2014. - Combined impact implies financing needs increase by about €210 million during the program period per each additional percentage point decline in growth. - Results: - Tailored shock results in full exhaustion of program financing buffer in absence of additional fiscal measures. - Debt-to-GDP ratio rises to 153 percent by 2015 and increases thereafter, leading to unsustainable debt dynamics. - Conclusion: debt sustainability cannot be safeguarded without additional measures. ### Gross external financing needs (selected) - Gross external financing need (in billions of US dollars, selected): 2013: 51.5. - Gross external financing requirements (millions of euros): 2013: 56,411; 2014: 42,100; 2015: 40,575; 2016: 39,510; 2017: 39,343. --- ### Policy Priorities, Structural Reforms, and Conditionality ### Key near‑term policy priorities and conditionality - Restore financial sector stability via: - Completing BoC resolution and recapitalization, recapitalizing other banks where needed, and restructuring the CCI sector. - Strengthening supervision by consolidating supervision of CCIs under the CBC. - Implementing a roadmap to lift capital controls (milestone-based). - Strengthen AML framework: - Revise Trust and Company Services Provider law and Anti‑Money Laundering Law by 11 September 2013 (prior action for second tranche). - CBC to follow up on Deloitte findings and apply enforcement actions by end‑September 2013. - Fiscal structural reforms: - Adopt FRBSL by end‑December 2013 (modified structural benchmark). - Implement revenue administration reforms, integrate tax administration, and adopt measures to fight tax evasion by end‑December 2013. - Implement social welfare reform and guaranteed minimum income system with legal framework adopted by end‑May 2014 and implementation by end‑June 2014 (modified structural benchmark). - Financial sector regulatory reforms and reporting: - New CBC directive: classify loans in arrears for more than 90 days as NPLs (enter into force end‑September). - Adopt legal framework for a central credit register by end‑September 2013. - CBC to require banks to submit restructuring, capital and funding plans; CBC to review and approve BoC plan by end‑October 2013. ### Structural benchmarks and prior actions (selected) - Prior actions completed before Board meeting: - Establish legal framework for ownership and governance to manage government’s majority stake in CCI sector. - Amend cooperative and banking laws to establish CBC as single supervisor of CCI sector. - Revise AML, companies, and international trusts laws (end-September structural benchmark). - New structural benchmarks (selected): - CBC to instruct Hellenic Bank to launch an offer for private participation: End-September 2013. - Recapitalize Hellenic Bank per PIMCO-identified capital needs: End-December 2013. - Merge credit cooperative sector into a maximum of 18 institutions recapitalized to meet capital requirements: End-March 2014. ### Broader structural agenda - Fiscal-structural measures include: - Pension reform: actuarial study for GSIS by end-August 2013; adopt reforms by end-December 2013; enter into force by end-March 2014. - Health care reform: implement NHS by end-2015; restructure public hospitals by Q2-2015. - Privatisation: privatization proceeds target €1.4 billion by end-2018; appoint external consultant by end-November 2013; implement legal/institutional framework by end-December 2013. - Public administration reform and reduction in permanent posts: reduce public sector employees by at least 4,500 over 2012–16; implement an abolition of at least 1,880 permanent posts over 2013–2016. --- *Source: IMF Executive Summary, staff report excerpts, Technical Memorandum of Understanding, and annexes (August–September 2013).* ### EXECUTIVE SUMMARY ### _cr13293 - EXECUTIVE SUMMARY ### Extended Arrangement - On May 15, 2013 the Executive Board approved a three-year Extended Arrangement under the Extended Fund Facility (EFF) in the equivalent of SDR 891 million (563 percent of quota; €1 billion). - A purchase of SDR 74.25 million (about €86 million) was made in May 2013. - Another equal purchase (SDR 74.25 million, or about €86 million) will be released upon completion of the first review. - The European Stability Mechanism has released €3 billion (of €9 billion committed). ### Recent Economic Developments — Output and Demand - Output contracted in the first half of the year, but by less than projected. - End-June flash estimates: output declined by 5.2 percent y-o-y in the second quarter. - Drivers of decline: March bank crisis, introduction of deposit restrictions and capital controls, and drag from large fiscal adjustment implemented in 2012 and early 2013 (public consumption contracted by 26 percent in the first quarter). - Contribution of net external demand to growth was positive due to a sharp contraction of imports of goods by about 20 percent y-o-y through June; goods exports remained stable (staff estimate excludes one-off sale of planes; including that sale, exports of goods increased 10 percent y-o-y through June). - High-frequency indicators (retail sales, manufacturing production, cement sales) suggest widespread downturn; tourism receipts have held up. - Confidence indicators rose for the last three months from the trough in April. ### Labor Market and Prices - Unemployment rate climbed to 17.3 percent in June compared with 11.7 percent a year before. - Wages declined by 0.6 percent in nominal terms through March. - Inflation fell to 0.7 percent at end-June from 1.3 percent in March. ### External Sector Developments - Trade deficit declined from about 8 to 6 percent of GDP in the first quarter of 2013 (y-o-y, non-seasonally adjusted). - Current account deficit increased by about 1.3 percent of GDP y-o-y due to deterioration in the net income balance from recognition of income losses by Cypriot bank branches in Greece. - On the capital account, financial institutions sold about €10 billion in external portfolio assets to finance loan repayments (€7.2 billion) and deposit outflows (€2.9 billion) in the first quarter. - Historical BOP revision: 2012 current account deficit lowered from 11.7 to 6.5 percent of GDP. ### Fiscal Developments and Government Financing - Overall fiscal deficit reached 1.3 percent of GDP at end-June. - Primary balance and primary spending were better than targets by 1.8 and 0.5 percent of GDP, respectively. - Revenues (January–June 2013, Millions of Euros / Percent of GDP): - Program: Revenue 3,009 / 18.3 percent - Prelim.: Revenue 3,224 / 19.6 percent - Taxes on production and imports: Program 1,029 / 6.3 percent ; Prelim. 1,156 / 7.0 percent - Current taxes on income and wealth: Program 627 / 3.8 percent ; Prelim. 782 / 4.8 percent - Social contributions: Program 729 / 4.4 percent ; Prelim. 744 / 4.5 percent - Other revenue: Program 624 / 3.8 percent ; Prelim. 542 / 3.3 percent - Expenditure (January–June 2013, Millions of Euros / Percent of GDP): - Program: Expenditure 3,486 / 21.2 percent - Prelim.: Expenditure 3,444 / 21.0 percent - Current expenditure: Program 3,282 / 20.0 percent ; Prelim. 3,301 / 20.1 percent - Intermediate consumption: Program 376 / 2.3 percent ; Prelim. 359 / 2.2 percent - Compensation of employees: Program 1,201 / 7.3 percent ; Prelim. 1,190 / 7.2 percent - Social transfers: Program 1,218 / 7.4 percent ; Prelim. 1,206 / 7.3 percent - Interest: Program 255 / 1.6 percent ; Prelim. 287 / 1.7 percent - Subsidies: Program 47 / 0.3 percent ; Prelim. 50 / 0.3 percent - Other current expenditure: Program 186 / 1.1 percent ; Prelim. 208 / 1.3 percent - Capital Expenditure: Program 203 / 1.2 percent ; Prelim. 143 / 0.9 percent - General Government balance: Program -477 / -2.9 percent of GDP ; Prelim. -220 / -1.3 percent of GDP. - General Government primary balance: Program -222 / -1.4 percent ; Prelim. 67 / 0.4 percent. - General Government primary spending: Program 3,230 / 19.7 percent ; Prelim. 3,156 / 19.2 percent. - Government financing measures: - €1 billion domestic debt exchange replacing bonds maturing between 2013–16 with bonds averaging slightly below 5 percent coupon and extended maturities through 2019–23. - Rollover of the €1.9 billion Laiki recapitalization bond (now held by BoC) until 2014 with possibility to roll over annually until 2017. - End-June structural benchmark on government financing completed on July 1. ### Policy Implementation and Program Status - The program is on track; ownership by the authorities has improved. - All end-June performance criteria (PCs) were met with a comfortable margin. - All structural benchmarks were observed, albeit some with brief delays. - Structural benchmark on restructuring strategy for cooperative credit institutions (CCI) sector met at end-June; exchange of €1 billion of domestic debt and rollover of the €1.9 Laiki recapitalization bond completed on July 1. - Two other benchmarks on assessment of capital needs and viability for Bank of Cyprus (BoC) and the CCIs were partially met by end-June and fully completed by end-July. - Authorities published a roadmap to gradually ease payment restrictions and finalized a restructuring strategy for the cooperative credit sector. - Key reforms underway: revenue administration and the social safety net. ### Financial Sector — Liquidity, Deposits, and Controls - Deposit restrictions and capital controls were introduced end-March to protect financial stability. - Selected relaxations (27-Mar vs 2-Aug, Euros): - Cash withdrawals (per day per person): Natural person 300 -> 300 ; Legal person 300 -> 500. - Cashless payments/transfers w/o justification (per account) to other credit institutions in Cyprus: Natural person (per month) 0 -> 15,000 ; Legal person (per month) 0 -> 75,000. - For the purchase of goods and services w/o documentation: 0 -> 300,000 per transaction. - To institutions abroad: Transactions within normal business w/o Committee's approval 5,000 per day -> 500,000 per transaction. - Payments via debit or credit card (per month): 5,000 -> No limit. - Exports of euro notes or foreign currency per person per journey: 1,000 -> 3,000. - Opening of new accounts is prohibited except: to deposit funds from abroad, and since August, for term deposits created with cash for a minimum of three months, for loans related to new customer credit facilities (No -> Yes). - It is prohibited to add new beneficiaries in a current account (No -> Yes). - Transactions of international customers of foreign banks exempted from restrictions (No -> Yes for 16 banks). - Termination of fixed term deposits prior to maturity: Only to repay a loan within same institution (unchanged). - As of August 21, net deposit outflows reached close to €8 billion or about 12.6 percent of the deposit base since end-March, excluding the conversion of Laiki and BoC deposits into equity in April and May. - Of these outflows, 60 percent correspond to non-residents, largely concentrated among uninsured deposits. - Outflows from domestic entities represent about 11 percent of their deposit base, with commercial banks more affected than the coops. - Foreign banks have lost about 15 percent of their deposits, but more recently experienced new inflows and stabilization following exemption from restrictions. - Outflows have been financed largely through own funds, including liquid asset disposals; about 20 percent of outflows used to pay loans within the same bank, with no impact on liquidity. - Bank of Cyprus (BoC), which absorbed most of Laiki and remained under resolution until end-July, remained heavily reliant on Emergency Liquidity Assistance (ELA). - Non-performing loans and provisions: charted (no new numeric values beyond graphical representation in source). ### Risks and Outlook - The economic situation remains very difficult. - Internal adjustment has led to rapidly rising unemployment while inflation has remained subdued. - The trade balance adjustment has occurred mainly through a sharp contraction in imports. - With still high uncertainty going forward, the program’s macroeconomic framework was maintained broadly unchanged. - Risks to the program remain substantial given: - Uncertain impact of the crisis. - Still-recovering banking system. - Ongoing challenges to policy implementation. *Source: IMF Executive Summary (August 30, 2013).* ### 10. Banks’ asset quality has deteriorated with the downturn, and credit to the economy ### 10. Banks’ asset quality has deteriorated with the downturn, and credit to the economy continued to contract ### Asset quality and credit contraction - Non-performing loans (NPLs) reached almost 30 percent of total loans at end-March. - Provisioning for loan losses stands at only 30 percent of total loans, compared with an average ratio of 50 percent for European banks. - Bank profitability is expected to be significantly impaired going forward. - Credit supply contracted and demand weakened following the March crisis: - Corporate credit contracted by 9 percent y-o-y in June. - Mortgage lending fell by about 3 percent. - Consumer credit fell by about 7 percent. ### Strategy - Program strategy remains anchored in policies agreed in March to restore financial sector stability and public finance sustainability to support long-run growth. - Objective of the authorities’ banking sector recapitalization and restructuring strategy: restore financial intermediation and support economic activity. - Short-run focus: - Ensure Bank of Cyprus (BoC) exit from resolution and appropriate liquidity support. - Medium-run focus: - Refine and adapt strategy to ensure BoC can achieve stable long-run funding in line with new restructuring and business plans. - Fiscal strategy: - Ambitious yet well-paced consolidation efforts supported by significant structural fiscal reforms to ensure debt sustainability without excessive short-run burden. - Emphasis on protecting vulnerable groups given rapidly rising unemployment. ### Policy discussions - Need to establish a strong track record of policy implementation to boost confidence. - Discussions focused on: - (i) Assessing the macroeconomic outlook in light of recent developments and new data. - (ii) Refining financial sector reform strategy, including completion of the resolution of BoC; next steps in restructuring and recapitalization of remaining financial institutions; strengthening supervision and regulation; developing a roadmap to lift capital controls; and strengthening implementation of the anti-money laundering (AML) framework. - (iii) Reviewing fiscal developments through end-June and projections for the rest of the year. - (iv) Advancing agenda to modernize fiscal institutions, including revenue administration, public financial management, and social welfare. ### Macroeconomic outlook and risks - Short-run GDP projections: - Output projected to contract by about 9 and 4 percent in 2013 and 2014, respectively, led by domestic demand and sharp contraction of financial services and construction. - Sector dynamics (Box 1 sectoral model): - Construction and financial services will contribute significantly to 2013 contraction; monthly cement sales point to shrinking construction sector. - Bail-in of uninsured depositors, deposit outflows, and credit contraction have drastically reduced banks’ balance sheets, leading to negative value added in financial services. - Administrative and education activities declining due to public sector downsizing and tuition discounts. - Tourism and professional services show resilience: fewer visitors but spending per tourist broadly constant; flat company registrations indicate continued attractiveness of legal and tax regime. - Medium-run growth: - Growth expected to turn positive in 2015 as private consumption gradually recovers; fiscal adjustment will continue to dampen domestic demand. - Long-run support from highly educated labor force, high quality of institutions, and low corporate tax regime. - Labor market and inflation projections: - Unemployment rate projected to reach 17 and 19½ percent in 2013 and 2014, respectively, then gradually decline. - 2013 headline and core inflation forecast remain at 1 percent and 0.4 percent, respectively. - External sector: - Current account deficit expected to reach 2 and 0.6 percent of GDP in 2013 and 2014, respectively, stabilizing at around 2 percent of GDP in the long run. - Risks: - Substantial and tilted to the downside. - Domestic risks: confidence in banking sector not yet restored; impact of banking crisis on households, corporates, and vital service sectors could be larger than anticipated, risking deeper and more prolonged recession and weaker long-run growth with dramatic consequences for debt sustainability. - External risks: continued EU weakness could dampen Cypriot exports. - Upside possibilities: tourism could benefit from turmoil in competing destinations and stronger non-EU demand (e.g. China and Russia); development of gas sector could provide upside to investment and growth over the longer term. ### Debt sustainability - Public debt projections: - Debt expected to peak at 126 percent of GDP in 2015 and gradually decline toward 105 percent of GDP by 2020 as activity recovers and primary surplus improves. - 2013 debt revised up from 109 to 114 percent of GDP due to postponement of a €1 billion planned swap of debt held by the CBC for state-owned assets from third quarter of 2013 to mid-2014. - Authorities requested a modification of the public debt performance criterion for end-September. - Domestic debt exchange completed at end-June resulted in a decline in financing needs, offset by a reduction in projected official financing required later this year, with no impact on debt. - Vulnerabilities: - Debt sustainability highly vulnerable to shocks; lower nominal GDP growth would have profound implications for debt trajectory. - Contingent liabilities from banking sector pose risks. - BoC implicit liabilities and exposures: - BoC had about 70 percent of GDP in insured deposits at end-March. - BoC had about 70 percent of GDP in ELA granted by the CBC at end-June. - Any additional government guarantees to support BoC liquidity would add to implicit liabilities. - Full materialization of risks may require additional financing measures to preserve debt sustainability. ### External debt and IIP - Gross external debt: - Declined by about 10 percent of GDP since end-2012 to around 440 percent of GDP at end-March 2013. - Expected to decline to 345 percent of GDP by 2020. - International investment position (IIP): - At 123 percent of GDP at end-March 2013, Cyprus’s IIP is roughly comparable to Ireland, Greece, Portugal, and Spain. - External debt sustainability depends on continued external adjustment and prospective economic rebound; vulnerable to interest rate shocks. ### Financial sector policy and BoC recapitalization - Immediate measures to take BoC out of resolution were central (MEFP ¶4). - Fair value independent assessment of BoC’s end-March balance sheet: - Concluded by KPMG on July 26, meeting the structural benchmark with a one-month delay. - KPMG concluded total capital needs for the merged BoC amounted to €3.9 billion at end-March to reach an initial Core Tier 1 (CT1) ratio of around 12 percent to ensure CT1 remains above regulatory minimum of 9 percent throughout the program period under conservative assumptions. - Conservative assumptions on NPLs and pre-provisioning profits provide an upside. - Actions based on the fair value assessment: - On July 30, resolution authority converted a further 10 percent of BoC’s uninsured deposits (€0.8 billion) into equity, in addition to 37.5 percent (€3.1 billion) already bailed in, to cover additional fair valuation losses (€0.4 billion) and further needs from partial exemption of some uninsured deposits (€0.4 billion). - Other bailed-in resources (former equity, junior, and senior debt) converted from non-voting into common shares with a €0.01 nominal value to comply with EU Capital Requirements Directive (CRD IV). - Restructuring of remaining frozen uninsured deposits (about €3.5 billion or 42.5 percent of initial uninsured deposits): - 5 percent released. - Remaining 37.5 percent equally split and converted into time deposits with 6, 9, and 12 month maturities, extendable by another 6, 9, 12 months, if needed. - Completion of BoC recapitalization and orderly unfreezing of uninsured deposits were key to allowing bank’s exit from resolution on July 30. - Bail-in amounts (Billions of euros): - BoC uninsured deposits: 3.9 - Laiki uninsured deposits: 4.0 - Total uninsured deposits bailed in: 7.8 - BoC subordinated debt: 0.6 - Laiki subordinated debt: 0.8 - Total subordinated debt bailed in: 1.3 - BoC senior debt: 0.0 - Laiki senior debt: 0.1 - Total senior debt bailed in: 0.2 - Total bail-in (BoC + Laiki): 9.4 - Ownership of BoC (Percent of total): - BoC uninsured depositors: 81% - Laiki depositors: 18% - Others: 1% ### Assessment of capital needs (Box 2) - Two independent assessments: - PIMCO due diligence (February 2013) based on June 2012 data (including Greek operations) and bottom-up stress test to determine capital needs to reach 9 and 6 percent CT1 through June 2015 under baseline and adverse scenarios. - KPMG fair value assessment (July 2013) based on end-March 2013 balance sheets (after sale of Greek operations), estimating net present value of assets and liabilities using discount rate reflecting funding costs of a potential market participant; used updated program growth projections implying a deeper recession than PIMCO adverse scenario. - Key methodological differences and results: - KPMG assigned larger initial losses on Cypriot government debt and crystallized Laiki losses upfront by valuing transferred Laiki assets at fair value; “old” BoC assets treated as ongoing concern. - PIMCO assumed ongoing concern treatment allowing losses to be booked over time. - Preliminary staff estimates suggest overall losses on end-March portfolios were similar between exercises, though KPMG projected somewhat lower peak NPLs but larger upfront needs. - Comparison of selected indicators: KPMG vs PIMCO Adverse (percent) - Real GDP growth: - KPMG: 2013 -8.7; 2014 -3.9; 2015 1.1 - PIMCO Adverse: 2013 -5.2; 2014 -2.3; 2015 0 - Unemployment rate: - KPMG: 2013 15.5; 2014 17.2; 2015 14.5 - PIMCO Adverse: 2013 13.8; 2014 14.6; 2015 14.5 - 3m Euribor: - KPMG: 2013 0.2; 2014 0.3; 2015 0.5 - PIMCO Adverse: 2013 2.3; 2014 2.5; 2015 2.5 - HICP inflation: - KPMG: 2013 0.9; 2014 0.9; 2015 1.4 - PIMCO Adverse: 2013 1.2; 2014 1.3; 2015 1.1 - House price change: - Both: 2013 -14; 2014 -10; 2015 -1.5 - Peak NPLs (SMEs / Retail) staff estimates: - BoC: KPMG 45/40/57; PIMCO Adverse 50/? - Laiki: KPMG 48/35/50; PIMCO Adverse 45/? - Note: Peak NPLs for KPMG are staff estimates and ratios are expressed as past due loans relative to total gross loans at the beginning of the exercise (June 2012 for PIMCO and March 2013 for KPMG). *Source: IMF Country Report text (section 10).* ### 19. Ensuring adequate liquidity for BoC was seen as paramount to restoring confidence ### 19. Ensuring adequate liquidity for BoC was seen as paramount to restoring confidence ### Liquidity support and transition from ELA to ECB refinancing - After exiting resolution, BoC regained access to ECB’s monetary policy operations. - Rapidly replacing ELA with ECB refinancing was agreed to provide more stable and less costly funding. - About €1.3 billion of existing ELA has already been substituted with ECB refinancing. - Short-run liquidity options: - Pledging the Laiki recapitalization bond as collateral for ECB refinancing. - If needed, pledging new own bonds guaranteed by the government. - Authorities proposed augmenting the ceiling on the accumulation of government guarantees by a maximum of €2.9 billion, to be utilized sparingly to preserve financial stability while mindful of risks to the public sector balance sheet. - Looking forward, BoC will need to develop a plan to ensure stable long-run funding. ### BoC governance adaptation and business plan - The Annual General Meeting of BoC shareholders was called for September 10 to appoint a new Board of Directors. - The CBC must ensure newly elected board members are fit and proper. - Given the short timeframe, legacy Laiki bank’s representation in BoC will remain with its special administrator appointed by the Resolution Authority; the prior staff recommendation to have representation by an independent private party was not implemented. - Until the general meeting, the current transitory board will remain in control. - BoC instructed to prepare a strategic restructuring plan with technical support from a well-known consultancy firm. - The plan, submitted together with consistent capital and funding plans, will be assessed by the CBC by end-October (modified structural benchmark). - The deadline allows time to reflect business goals of the incoming administration. - Restructuring measures underway: - A voluntary retirement scheme expected to reduce staffing by about 25 percent. - Expected wage cost reduction by about 35 percent. - Upon CBC approval, the restructuring plan will become BoC’s roadmap and be monitored through quarterly reviews of compliance with goals. ### Recapitalization of Hellenic Bank (HB) - After sale of its Greek operations, HB’s capital shortfall under PIMCO’s adverse scenario amounts to €294 million. - Staff supported allowing the bank more time to raise private capital. - CBC will instruct HB to launch an offer for participation in the bank’s capital, including voluntary conversion of junior debt into shares, by end-September (structural benchmark). - HB’s junior debt currently amounts to €308 million, of which only half can be automatically converted into shares under the terms of the debt instruments. - Authorities plan legislation requiring mandatory burden-sharing among junior bondholders as a precondition for potential injection of public funds, aligned with revised state aid rules effective since August 1. - Bank recapitalization agreed to occur no later than end-December (structural benchmark). ### Restructuring strategy for the credit cooperative sector (CCIs) - Assessment completed (meeting the end-June structural benchmark with slight delay) showed the sector solvent overall but undercapitalized, with capital needs amounting to €1.5 billion. - Authorities completed strategy to restructure and recapitalize the sector, fulfilling the end-July structural benchmark. - Key criteria of the strategy: - Recapitalization with state support, fully protecting all CCI depositors. - Distinction between solvent and insolvent institutions. - Use public funds to recapitalize the Cooperative Central Bank (CCB) in line with state aid rules, by end-October. - The CCB would inject capital into individual CCIs to achieve a CT1 ratio of 9 percent at the sectoral level and 4 percent at the individual level. - Insulation against political interference: - Legislation will establish a unit in the Ministry of Finance to manage the state’s majority stake in the CCI sector (MEFP ¶7) as a prior action for the review. - A relationship framework between the state and CCIs will be established to ensure commercial operation and minimize political interference in CCB business decisions. - Expansion of the CCB role to act as parent bank of all CCIs: - CCB to take responsibility for strategic and operational aspects, including risk policy and management, strategic management and monitoring of NPLs workouts and collection processes. - Deep restructuring and consolidation: - Existing 93 CCIs to be consolidated into at most 18 institutions (end-March 2014 structural benchmark). - Final number reflects assessment of efficiency, viability, and logistical aspects while seeking to preserve cooperatives’ role. - Need for regular review and merging of unviable CCIs with viable ones. - Possibility to exit state control: - After capital injection and maintenance of adequate capital ratios, CCIs and the CCB may buy back shares from the state and regain mutual status. - No specific timetable for returning ownership to members was defined at this stage. ### Roadmap for lifting administrative restrictions and capital controls - Authorities published a milestone-based roadmap linking relaxation steps to progress in the bank restructuring strategy (MEFP ¶10). - Purpose: reduce uncertainty, build confidence, and provide an orderly predictable process while retaining flexibility to respond to deposit flows and bank liquidity trends. - Staff welcomed the roadmap but stressed need to maintain flexibility and supervisory vigilance. - Roadmap phases (as published on August 9, 2013): - Phase 1—Reducing cash circulation and administrative burden: - CBC authorized opening of new accounts to create term deposits with a minimum maturity of three months to attract hoarded cash. - Banks allowed to open loan accounts related to new customer credit facilities. - Plans to lift restrictions on domestic payments above €300,000 and remove approval requirements on certain external payments contingent on positive developments. - Phase 2—Reinstating accessibility of funds and domestic transfers: - Restrictions on termination of term deposits before maturity and monthly ceilings on domestic transfers (not related to purchase of goods and services) to be lifted once BoC’s restructuring plan is approved, Hellenic Bank recapitalized, and CCI restructuring plan finalized. - This phase expected to start by end-2013 according to program strategy. - Phase 3—Lifting of restrictions on cash and checks: - Free movement of capital within Cyprus to be permitted after merger completion of CCIs and tangible progress with BoC restructuring plan—lifting restrictions on cash withdrawals, cashing of checks, and opening new bank accounts. - Phase 4—Abolishing restrictions on external capital flows: - Remaining restrictions on external flows to be lifted based on progress in policy implementation and restored confidence, including broad-based deposit stabilization. ### Financial sector regulation and supervision improvements - Integration of CCI supervision into the CBC: - Weak and separate supervision of CCIs contributed to vulnerabilities. - In April, CBC empowered to issue orders to current supervisor of cooperatives. - As a prior action, legislation will establish the CBC as sole supervisor of CCIs and the Cooperative Central Bank at individual and consolidated levels. - CBC expected to gradually take operational responsibility over next months, in line with CCI restructuring implementation. - Staff stressed need for CBC to acquire sufficient resources. - Classification and reporting of NPLs and asset impairment and provisioning: - New CBC directive to enter into force at end-September requiring reporting and classification of all loans in arrears for more than 90 days as NPLs, and all loans whose original terms were modified. - This is expected to lead to higher officially reported NPLs (program statistics already include these updated categories). - An independent accounting firm to deliver an assessment of current asset impairment and provisioning practices and recommendations. - Loan origination reforms: - Based on PIMCO due diligence and international best standards, authorities identified over-reliance on asset-based lending and disregard for borrowers’ ability to repay. - CBC to put in place a new regulatory framework on loan origination requiring banks to consider affordability, curtail related party lending and lending to bank directors. - Credit register enhancements: - Decision to merge and expand databases of two existing credit registers for commercial banks and CCIs. - Lenders required to submit data on performing and non-performing loans to the registers regularly. - CBC to oversee registers and develop tools for macro- and micro-prudential use. ### Private sector indebtedness and debt restructuring measures - Private sector debt-to-GDP ratio is close to 280 percent, the highest in Europe and about double the EU average. - Corporate credit concentrated in real estate and construction; for households, housing loans account for more than half of the total. - Non-financial corporate sector has been adjusting since rapid expansion in 2004–10; more deleveraging likely needed to reach the Euro area long term average of 1.2. - Households remain to start deleveraging; household borrowing rose rapidly in the last five years almost exclusively through mortgages. - Measures discussed: - Arrears management by banks: - Authorities developed an industry-wide approach and standardized code of conduct for credit institutions and borrowers, plus supervisory framework for arrears management. - Framework requires banks to offer troubled borrowers short- and long-term arrangements and restructuring options customized by asset class and arrears category. - Banks to prepare strategies and operational plans including restructuring options and key performance indicators. - Challenges include willingness of banks and borrowers to compromise and strength of legal/judicial processes once out-of-court solutions are exhausted. - Legal framework reforms: - Staff called for a review of corporate and household debt restructuring framework and a report identifying impediments and remedial measures. - Agreement to prepare legislation to expand the role of the Financial Ombudsman to facilitate negotiations of a debtor’s recovery, subject to adequate legal safeguards. - Additional measures to facilitate debt restructuring to be considered during the next review. ### Strengthening anti-money laundering (AML) framework - Independent audit by Deloitte and assessment by Moneyval revealed weaknesses in banks’ implementation of customer due diligence measures. - Authorities prepared an action plan to: - Follow up on possible breaches of compliance by banks with AML requirements identified by the audit. - Review the AML banking supervision’s structure and resources. - Monitor progress on AML supervision on a quarterly basis. - Authorities revising legal framework to improve transparency of companies and trusts, expected to be amended by end-September (existing structural benchmark). - Agreed to step up supervision of professionals involved in company formation and management, strengthen company registrar operations, and improve transparency by making information on companies available. *Source: _cr13293 - 19. Ensuring adequate liquidity for BoC was seen as paramount to restoring confidence* ### Box 5. Recent AML Findings ### Box 5. Recent AML Findings ### Audit and assessment scope - An independent forensic audit by Deloitte and an assessment by Moneyval were performed to assess the implementation of AML measures by banks in Cyprus. - Deloitte sampled 390 customers (the top 180 depositors and 90 borrowers, and a randomly selected additional sample) in six credit institutions with more than €2 billion in deposits. - The top borrowers accounted for more than 15 percent of the total loans, and the top depositors for more than 10 percent of the total banking system deposits. - Moneyval conducted an assessment of the implementation of customer due diligence (CDD) measures by banks using the FATF methodology. - Moneyval’s new report estimated that 75 percent of international business involves third-party “introducers”. ### Key findings on customer due diligence (CDD) and third‑party introducers - Both reports revealed weaknesses in the implementation of customer due diligence measures, particularly in the context of the frequent use of third party introducers (which sometimes involve chains of introducers). - The practice of using introducers removes banks from direct contact with the beneficial owners of legal entity customers and can be problematic when not properly managed. - Accurate customer information is foundational to AML preventive measures, enabling knowing the customer, understanding the business relationship, and establishing a proper risk profile. ### Beneficial ownership and ownership structures (Deloitte data) - Many deposit holders have complex ownership structures. - 70 percent of such deposit holders have nominee shareholders and an average of three layers between the customer and the beneficial owner(s). - Only in 9 percent of the complex ownership structure cases had proper steps been taken to verify the identity of beneficial owners, which are required by the law and the FATF. ### Suspicious transaction reporting and monitoring failures - Banks had not reported a significant number of suspicious cases to the authorities, including in compelling cases. - Moneyval found that only a few suspicious transaction reports appear to have been made as a result of ongoing monitoring or in relation to tax-related suspicions of money laundering. - Deloitte’s review of the sampled customer files indicated: - Only three suspicious transaction reports were sent to the authorities during 2008–12. - Forensic analysis identified 29 potentially suspicious transactions during the past 12 months alone that were not identified by the banks. - In 10 other cases, publicly available information pointing to a criminal background of customers and/or beneficial owners could have warranted reporting to the authorities. ### Charted statistics (as reported by Deloitte and Moneyval) - Beneficial owner verification of deposit holders with complex structures: - 9% Appropriate steps taken - 91% Inappropriate verification of beneficial owner's identity - Suspicious cases revealed (breakdown): - No issues reported: 77% - Suspicious transactions: 7% - Misclassified risk: 13% - Criminal background: 3% - Aggregate: Suspicious cases: 23% ### Implications and core concerns - Widespread use of introducers and multilayer nominee structures significantly impair banks’ ability to identify beneficial owners and to conduct effective CDD. - Weak CDD and monitoring practices materially reduce the quantity and quality of suspicious transaction reports submitted to authorities. - These deficiencies increase the risk of money laundering and terrorist financing remaining undetected by both banks and supervisors. *Source: Deloitte; Moneyval assessment (as reported in Box 5. Recent AML Findings).* ### 38. There are some factors mitigating these risks. In particular, the program financing buffer ### _cr13293 - 38. There are some factors mitigating these risks. In particular, the program financing buffer ### Mitigating factors and program financing buffer - The program financing buffer remains sizeable and can cover additional fiscal needs even in case of a significant recession (Annex I). - The use of the buffer will not increase public debt, as its full utilization is already accounted for in the debt sustainability analysis. - Maintenance and gradual relaxation of payment restrictions in an orderly fashion should help to safeguard financial stability. - Additional recapitalization of BoC to 12 percent CT1 without recourse to public funds and under conservative assumptions provides some margin against further asset deterioration. - Improved program ownership, exemplified by the recent policy actions and public commitments to the program, as well as by strong engagement with Fund technical assistance, helps to mitigate implementation risks. ### Safeguards assessment of the CBC - Staff completed a safeguards assessment of the CBC, finding: - A weak governance framework at the CBC. - A strained balance sheet given the large amount of ELA extended to commercial banks. - The absence of a functioning Board for part of 2013, lack of an Audit Committee, and staff resource constraints undermined the effectiveness of CBC’s audit mechanisms and key operational controls, placing all operations under the control and oversight of the Governor. - The CBC published its audited financial statements in a timely manner, but staff advised more detailed disclosures to improve transparency. - Underlying procedures and controls for ELA will need to be independently reviewed by the Internal Audit Department. - More recently, the CBC established a Board Audit Committee and signed a memorandum of understanding with the Ministry of Finance clarifying the roles and responsibilities for servicing Cyprus’s financial obligations to the IMF under the extended arrangement. ### Staff appraisal — macrofinancial outlook and program implementation - The program is meeting its short-run objectives, but much remains to be done to restore confidence and growth. - Authorities renewed commitment and fully implemented near-term stabilization policies, meeting the structural benchmarks and performance criteria set in May. - Maintaining a strong pace of policy implementation will become increasingly challenging given still lacking confidence, a deepening recession, and rapidly rising unemployment. - Full and timely implementation of the program remains critical to restore financial stability and public finance sustainability to support long-run growth. ### Banking resolution and liquidity - Important policy steps taken to complete the banking resolution process: - Full recapitalization and merger of the two largest and insolvent banks was finalized, including through additional bail in of uninsured deposits. - Restructuring of maturities of remaining uninsured deposits strengthened funding base, allowing the merged bank to exit resolution and recover counterparty status with the ECB by end-July. - Adequate liquidity support from the Eurosystem is critical in the near term. - Significant challenges remain to ensure the bank can adapt its business model and achieve long-run viability, including stable funding. ### Recapitalization and cooperative credit sector - Next steps: - Recapitalize and restructure other banks and the cooperative credit sector. - Recapitalization strategy for Hellenic Bank should preserve private ownership where possible, including participation of junior debt holders in the bank’s share capital. - In the case of the cooperative credit sector, public funds will need to be injected. - This requires establishing an adequate governance structure to manage the state’s majority stake. - Implementation of a comprehensive restructuring and consolidation of the sector is needed to ensure viability of remaining institutions. ### Payment restrictions and exchange restrictions - Authorities’ commitment to ease payment restrictions in line with their recently published roadmap is welcome. - Deposit restrictions and capital controls were necessary to safeguard financial stability. - Orderly and predictable relaxation is paramount to building depositor confidence and supporting economic activity. - The roadmap links easing of restrictions to specific milestones in the banking sector strategy, reducing uncertainty. - Authorities need to implement the roadmap steadfastly while maintaining flexibility to account for changes in deposit trends or banks’ liquidity conditions. - Staff supports the authorities’ request for an extension of the approval of existing exchange restrictions in line with Fund policy, on the basis that they: - Have been imposed for balance of payments reasons, - Are temporary, - Are non-discriminatory among Fund members. ### Financial sector oversight and private debt restructuring - Bank regulation and supervision and the framework for private debt restructuring need strengthening: - Financial sector’s asset quality is expected to deteriorate with the downturn. - Authorities need to: - Consolidate supervision of both cooperatives and commercial banks under the central bank. - Enhance reporting and monitoring of non-performing loans. - Strengthen provisioning and loan origination practices. - Implement an appropriate private debt-restructuring framework to facilitate orderly private sector deleveraging and maximize bank asset recoveries. - Improve implementation of the AML framework by banks, including strengthening supervision in this area. ### Fiscal performance and structural reforms - Cyprus is on track to meet its 2013 fiscal targets. - Ambitious consolidation and prudent execution of spending allowed meeting half-yearly fiscal targets with a comfortable margin. - Continued prudence is called for for the rest of the year given lingering macroeconomic uncertainties. - Staff supports modification of the 2013 targets to reflect one-off bank resolution-related compensation of pension funds. - For future years, fiscal policy must balance short-run cyclical concerns and long-run sustainability objectives. - Fiscal structural reforms recommended: - Integrate revenue administration into a single structure. - Protect revenues in the downturn, including fighting tax evasion by the self-employed. - Resolute implementation of the new welfare reform introducing a generalized minimum income scheme to mitigate recession impacts on vulnerable groups. - Accelerate steps to finalize the privatization strategy to prepare key assets for transfer from the state to the private sector. - Moving ahead with this ambitious structural agenda will require standing up to strong vested interests. ### Debt sustainability risks and contingencies - Risks to debt sustainability remain significant: - A deeper-than-projected recession and delays in restoring depositor confidence, with associated negative feedback loops with the fiscal and financial sectors, could add to financing needs and put debt sustainability at risk. - The program buffer continues to provide a cushion. - Authorities will need to ensure timely allocation of central bank profits and swap of the central bank debt with assets to facilitate financing needs and lower public debt. - Continued strong ownership, including full and timely implementation of the adjustment program, remains essential for the program’s success. - Should risks to debt sustainability fully materialize, additional financing measures may be necessary. *International Monetary Fund staff appraisal (excerpts).* ### 48. On the basis of progress to date and policy commitments going forward, staff ### _cr13293 - 48. On the basis of progress to date and policy commitments going forward, staff ### Staff recommendation - On the basis of progress to date and policy commitments going forward, staff supports the completion of the first review and the proposed modifications to performance criteria. ### Recent real-economy and labor market developments - Real GDP (selected years and projections, percent change): 2008: 3.6; 2009: -1.9; 2010: 1.3; 2011: 0.5; 2012: -2.4; 2013: -8.7; 2014: -3.9; 2015: 1.1; 2016: 1.9; 2017: 2.3; 2018: 2.2; 2019: 1.9; 2020: 1.8. - Output gap (percent of potential GDP): 2008: 2.8; 2009: -0.8; 2010: -1.2; 2011: -2.4; 2012: -3.3; 2013: -3.5; 2014: -3.7; 2015: -2.9; 2016: -1.8; 2017: -0.9; 2018: -0.3; 2019: -0.1; 2020: 0.0. - HICP (period average): 2008: 4.4; 2009: 0.2; 2010: 2.6; 2011: 3.5; 2012: 3.1; 2013: 1.0; 2014: 1.2; 2015: 1.6; 2016: 1.7; 2017: 1.7; 2018: 1.8; 2019: 1.9; 2020: 2.0. - Unemployment rate (EU standard, percent): 2008: 3.7; 2009: 5.4; 2010: 6.2; 2011: 7.8; 2012: 11.9; 2013: 17.0; 2014: 19.5; 2015: 18.7; 2016: 17.5; 2017: 15.9; 2018: 14.4; 2019: 13.1; 2020: 11.8. - Labor market notes from text/figures: - "The labor market is adjusting through quantities, reflected in sharply higher unemployment." - "Employment and unemployment: Employment growth declines in parallel with sharply increased unemployment." - "Compensation is only gradually adjusting." - "Employment has declined across the board, but some sectors have been more severely affected." - "Unit labor costs remain flat, and below the EA average." - "Over recent years, labor productivity has moved broadly in line with Euro Area developments." ### Short-term indicators and sector activity - Indicators noted: - "With weak activity, inflation has moderated further." - "With the exception of tourism, indicators reflect the weak economic environment." - "Company registration has declined, but no exits have been observed. Bankruptcies are on the rise." - "Housing prices have declined from their peak, but remain significantly above pre-boom prices." - "Confidence indicators are low but have rebounded in the last three months." ### External sector developments and outlook - Current account balance (percent of GDP, selected years): 2008: -15.6; 2009: -10.7; 2010: -9.8; 2011: -3.3; 2012: -6.5; 2013: -2.0; 2014: -0.6; 2015: -0.9; 2016: -1.0; 2017: -1.3; 2018: -1.5; 2019: -1.7; 2020: -2.0. - Trade balance (percent of GDP): 2008: -11.4; 2009: -5.5; 2010: -6.2; 2011: -4.2; 2012: -2.5; 2013: 2.4; 2014: 4.0; 2015: 3.8; 2016: 3.5; 2017: 3.1; 2018: 2.8; 2019: 2.4; 2020: 2.1. - Exports of goods and services (percent of GDP, selected years): 2008: 45.0; 2009: 40.2; 2010: 41.3; 2011: 42.7; 2012: 42.5; 2013: 44.4; 2014: 45.1; 2015: 45.4; 2016: 45.6; 2017: 46.0; 2018: 46.4; 2019: 47.1; 2020: 47.8. - Imports of goods and services (percent of GDP, selected years): 2008: 56.4; 2009: 45.7; 2010: 47.5; 2011: 46.9; 2012: 45.0; 2013: 42.0; 2014: 41.1; 2015: 41.6; 2016: 42.1; 2017: 42.9; 2018: 43.7; 2019: 44.7; 2020: 45.7. - International Investment Position: "The net international position has deteriorated significantly, due to the banking crisis." - Real Effective Exchange Rate: "Competitiveness measures based on unit labor costs has been improving through end-2012." ### Fiscal developments and projections - General government balance (percent of GDP, 2008–2020): 2008: 0.9; 2009: -6.1; 2010: -5.3; 2011: -6.3; 2012: -6.3; 2013: -6.7; 2014: -7.5; 2015: -5.3; 2016: -2.3; 2017: -0.7; 2018: 0.3; 2019: 0.2; 2020: -0.2. - Revenue (percent of GDP, selected years): 2008: 43.1; 2009: 40.1; 2010: 40.9; 2011: 39.7; 2012: 40.0; 2013: 40.6; 2014: 39.3; 2015: 40.1; 2016: 41.5; 2017: 42.0; 2018: 42.5; 2019: 42.6; 2020: 42.7. - Expenditure (percent of GDP, selected years): 2008: 42.1; 2009: 46.2; 2010: 46.2; 2011: 46.0; 2012: 46.3; 2013: 47.3; 2014: 46.8; 2015: 45.4; 2016: 43.9; 2017: 42.7; 2018: 42.2; 2019: 42.4; 2020: 42.9. - Primary balance (percent of GDP): 2008: 3.8; 2009: -3.6; 2010: -3.0; 2011: -3.9; 2012: -3.1; 2013: -3.3; 2014: -4.3; 2015: -2.1; 2016: 1.2; 2017: 3.0; 2018: 4.0; 2019: 4.0; 2020: 4.0. - Public sector debt (percent of GDP): 2008: 48.9; 2009: 58.5; 2010: 61.3; 2011: 71.1; 2012: 85.8; 2013: 114.1; 2014: 123.0; 2015: 125.7; 2016: 121.7; 2017: 115.9; 2018: 111.7; 2019: 108.1; 2020: 105.0. - Debt-to-revenue ratio (percent): 2008: 113.5; 2009: 145.8; 2010: 150.0; 2011: 179.0; 2012: 214.7; 2013: 280.9; 2014: 312.9; 2015: 313.4; 2016: 292.9; 2017: 275.7; 2018: 262.9; 2019: 253.9; 2020: 245.5. ### Public debt sustainability and stress tests - Baseline public sector debt in 2013: 114.1 percent of GDP (baseline value reported). - Change in public sector debt (2008–2020): 2008: -9.9; 2009: 9.6; 2010: 2.8; 2011: 9.7; 2012: 14.7; 2013: 28.3; 2014: 8.9; 2015: 2.7; 2016: -4.0; 2017: -5.8; 2018: -4.2; 2019: -3.6; 2020: -3.1 (all figures as presented in Table 9). - Identified debt-creating flows (percent of GDP): 2008: -5.5; 2009: 7.0; 2010: 3.4; 2011: 4.3; 2012: 6.7; 2013: 14.3; 2014: 10.9; 2015: 2.3; 2016: -2.1; 2017: -4.2; 2018: -4.9; 2019: -4.3; 2020: -3.8. - Automatic debt dynamics contribution (percent): 2008: -1.7; 2009: 3.4; 2010: 0.4; 2011: 0.4; 2012: 3.5; 2013: 11.0; 2014: 6.6; 2015: 0.2; 2016: -0.9; 2017: -1.2; 2018: -0.9; 2019: -0.3; 2020: 0.2. - Alternative scenarios (debt-stabilizing primary balance outcomes, percent of GDP): - A1. Key variables at historical averages (2012–2020): projected public sector debt declines to 93.1 then 93.5 etc.; example series includes 98.1, 96.3, 96.4, 94.7, 93.1, 93.5, 93.8, 94.2 (presented in Table 9). - A2. No policy change (constant primary balance) in 2012–2020: projected debt rises to 144.7 (series shows 113.9, 121.7, 128.5, 131.8, 134.3, 137.0, 140.6, 144.7). - B. Bound tests: see scenarios B1–B5 with outcomes (examples): B1 baseline plus real interest shock leads to debt series ending 111.7; B2 growth shock ends 131.5; B3 primary balance shock ends 118.9; B4 combination ends 137.5; B5 contingent liability 10 percent of GDP shock ends 115.3. ### External debt sustainability and financing needs - Baseline external debt (percent of GDP): 2008: 447.4; 2009: 544.1; 2010: 491.9; 2011: 465.6; 2012: 451.8; 2013: 410.9; 2014: 424.3; 2015: 418.2; 2016: 405.1; 2017: 389.5; 2018: 374.8; 2019: 360.6; 2020: 346.9. - Change in external debt (selected): 2008: 119.4; 2009: 96.7; 2010: -52.3; 2011: -26.3; 2012: -13.8; 2013: -41.0. - Identified external debt-creating flows (selected): 2008: 31.0; 2009: -4.6; 2010: 49.4; 2011: -18.0; 2012: -3.5; 2013: 28.6; 2014: 15.8. - External debt-to-exports ratio (percent): 2008: 993.1; 2009: 1352.6; 2010: 1191.3; 2011: 1091.0; 2012: 1062.4; 2013: 925.5; 2014: 940.3; 2015: 922.0; 2016: 889.0; 2017: 847.4; 2018: 807.2; 2019: 765.6; 2020: 725.6. - Gross external financing need (in billions of US dollars, selected): 2008: 51.8; 2009: 90.1; 2010: 109.4; 2011: 91.7; 2012: 96.3; 2013: 51.5. - Gross external financing need (percent of GDP, selected high values reported): 2008: 221.8; 2009: 366.3; 2010: 475.5; 2011: 386.8; 2012: 408.0. ### Gross financing requirements and program financing (2013–17) - Gross financing requirement including a buffer (millions of euros): 2013: 5,859.2; 2014: 4,180.2; 2015: 3,522.4; 2016: 2,120.1; 2017: 1,682.4. - Government gross financing requirement (millions of euros): 2013: 3,768.6; 2014: 3,233.8; 2015: 3,065.7; 2016: 2,045.3; 2017: 1,682.4. - Fiscal deficit ("+" = financing need) (millions of euros): 2013: 1,151.1; 2014: 1,226.4; 2015: 876.1; 2016: 392.6; 2017: 115.8. - Debt maturities (millions of euros): 2013: 2,617.5; 2014: 2,007.4; 2015: 2,189.6; 2016: 1,652.8; 2017: 1,566.6. - Banks recapitalization/support (millions of euros): 2013: 1,500.0; 2014–2017: 0.0. - Market financing (millions of euros): 2013: 1,015.7; 2014: 985.7; 2015: 985.7; 2016: 1,317.1; 2017: 1,282.4. - Net financing requirement (millions of euros): 2013: 4,843.4; 2014: 3,194.5; 2015: 2,536.6; 2016: 802.9; 2017: 400.0. - Official financing sources and buffers (millions of euros): 2013: 4,843.4; 2014: 2,794.5; 2015: 2,036.6; 2016: 302.9; 2017: 0.0. - IMF (millions of euros): 2013: 258.4; 2014: 344.5; 2015: 344.5; 2016: 86.1; 2017: 0.0. - ESM (millions of euros): 2013: 4,585.0; 2014: 2,450.0; 2015: 1,692.2; 2016: 216.8; 2017: 0.0. ### External financing requirements and sources (2012–20, millions of euros) - Gross financing requirements (selected years, millions of euros): 2012: 70,089; 2013: 56,411; 2014: 42,100; 2015: 40,575; 2016: 39,510; 2017: 39,343; 2018: 39,876; 2019: 40,007; 2020: 40,722. - Gross external financing need by component (2013): Current account deficit: 1,161; Medium- and long-term debt amortization: 15,854 (2012 figure shown in table); Short-term debt amortization: 53,074 (2012). - Sources of financing (2013 totals): New borrowing and debt rollover: 65,633 (2012); Capital account (net): 233 (2012); Foreign direct investment (net): 1,230 (2012). - Financing gap and program assistance: - Financing gap (millions of euros): 2013: 0; 2014: 4,843; 2015: 2,794; 2016: 2,037; 2017: 303; 2018–2020: 0. - ESM contributions (millions of euros) by year shown: 2013: 4,585; 2014: 2,450; 2015: 1,692; 2016: 217; 2017–2020: 0. - IMF contributions (millions of euros) by year shown: 2014: 258; 2015: 344; 2016: 434; 2017: 486; 2018–2020: 0 (per Table 5 presentation). ### Monetary and financial sector developments - Deposits (Billions of euros, Jan–Jul 2013): Total customer deposits series shows decline then stabilization; specific values shown in figure (unadjusted and adjusted deposits). - Non-performing loans (NPLs to total loans, percent): trend rising from Sep-10 through Mar-13; Provisions to NPLs (right axis) limited. - Credit growth (year-on-year percent change, private sector total, NFC, households): Declines observed since Mar-10 through Mar-13; "Credit has shrunk due to weak demand and supply." - Interest rates: "Deposit rates have declined more than lending since the events in March." - Notes: "Deposits have declined significantly this year but have recently stabilized. Asset quality has deteriorated and provision coverage is limited." ### IMF financing schedule and indicators of Fund credit - Schedule of review and purchases (SDR amounts and dates): - May 15, 2013: 74.25 (46.93% of quota) — Approval of arrangement. - September 15, 2013: 74.25 (46.93%) — First review based on end-June 2013 performance criteria. - December 15, 2013: 74.25 (46.93%) — Second review based on end-September 2013 performance criteria. - March 15, 2014: 74.25 (46.93%) — Third review based on end-December 2013 performance criteria. - June 15, 2014: 74.25 (46.93%) — Fourth review based on end-March 2014 performance criteria. - September 15, 2014: 74.25 (46.93%) — Fifth review based on end-June 2014 performance criteria. - December 15, 2014: 74.25 (46.93%) — Sixth review based on end-September 2014 performance criteria. - March 15, 2015: 74.25 (46.93%) — Seventh review based on end-December 2014 performance criteria. - June 15, 2015: 74.25 (46.93%) — Eighth review based on end-March 2015 performance criteria. - September 15, 2015: 74.25 (46.93%) — Ninth review based on end-June 2015 performance criteria. - December 15, 2015: 74.25 (46.93%) — Tenth review based on end-September 2015 performance criteria. - March 15, 2016: 74.25 (46.93%) — Eleventh review based on end-December 2015 performance criteria. - Total: 891.00 SDR (563.21% of quota) as presented in Table 8. - Indicators of Fund credit (stock and disbursement path in SDRs, Table 7 highlights): - Disbursement path (SDR, selected): 2013: 222.8; 2014: 297.0; 2015: 297.0; 2016: 74.3. - Stock of existing and prospective Fund credit (SDR, selected): 2013: 222.8; 2014: 519.8; 2015: 816.8; 2016: 891.0; 2017: 884.8; 2018: 835.3; 2019: 736.3; 2020: 594.0. - Obligations (SDR, selected): 2013: 1.6; 2014: 4.7; 2015: 10.4; 2016: 17.2; 2017: 24.2; 2018: 70.5; 2019: 117.9; 2020: 156.7. *Italic source attribution line.* ### Annex 1. Sensitivity of Program Financing ### Annex 1. Sensitivity of Program Financing and Debt to Growth Shocks ### Tailored adverse growth shock: assumptions and transmission - Shock magnitude: an additional decline in growth of about 9.2 percent in 2013–14 (with 2/3 in 2013 and the rest in 2014) on top of the baseline decline, for a total recession of 22 percentage points. - Inflation/deflator response: regression analysis estimates that a 1 percent fall in growth relative to the baseline leads to a 0.26 percent decline in inflation and the deflator. - Timing of deflator effect: the corresponding effect on the deflator is assumed for 2013–14, gradually diminishing as the economy recovers in 2015, with full convergence with the baseline inflation path achieved by 2017. ### Fiscal transmission mechanisms and quantitative assumptions - Revenues: - Assumed impact: a 0.4 percent of GDP decline in revenues per each percentage point fall in growth in 2013–14. - Recovery path: revenues are assumed to recover in 2015–17, reducing the peak loss in 2014 by 50 percent from 2017 onwards. - Safety net spending: - Assumed impact: a 0.1 percent of GDP increase in safety net spending per each percentage point fall in growth for 2013–14. - Permanent effect: in 2015–17, as the economy recovers, the permanent spending increase is assumed to be 1/3 of the peak effect at end 2014. - Nominal primary expenditure: - Assumption: nominal spending is assumed unchanged (and hence does not affect financing needs), but its share to GDP rises due to the lower nominal GDP. - Combined impact on financing: - The revenue and safety net nominal spending effects imply that financing needs increase by about €210 million during the program period per each additional percentage point decline in growth. ### Results and implications for program financing and debt sustainability - Program buffer: - The tailored shock results in a full exhaustion of the program financing buffer, in the absence of additional fiscal measures. - The program buffer can accommodate fiscal automatic stabilizers for relatively larger growth shocks, but exhaustion occurs under the analyzed shock. - Debt dynamics: - Debt-to-GDP ratio rises to 153 percent by 2015 and increases thereafter, leading to unsustainable debt dynamics. - Conclusion: debt sustainability cannot be safeguarded without additional measures. - Interaction with bank capital needs: - If growth shocks also generate additional bank capital needs, the program buffer would be able to accommodate commensurately smaller shocks. ### Summary of scenarios (as presented) - Growth in 2013-2014 (in percent): Baseline -12.6; Adverse -21.8 - Implied Q2 GDP growth (y-o-y, in percent): Baseline -9.1; Adverse -17.1 - Primary deficit 2020 (in percent of GDP): Baseline -4.0; Adverse 3.8 *Source: IMF Staff Estimates* ### 10. We have developed a milestone-based roadmap to ease administrative restrictions and ### _cr13293 - 10. We have developed a milestone-based roadmap to ease administrative restrictions and ### Roadmap to ease administrative restrictions and capital controls - Roadmap published on August 9, 2013. - Removal of measures will be milestone-based to preserve financial stability and retain flexibility for new developments. - Key guiding principles: - Domestic restrictions will be removed before lifting controls on cross border transfers. - Relaxation of restrictions contingent on key milestones, including: completing BoC’s recapitalization and resolution; approval of the restructuring strategy of BoC; recapitalization of HB; restructuring strategy and disbursement of funds for recapitalization of CCIs. - Relaxations will also consider prevailing confidence in the banking system and financial stability-related indicators, including the liquidity situation of credit institutions. - Request to the Fund: extension of approval on measures falling under Article VIII. ### Corporate and household debt-restructuring framework (milestones and actions) - Publish by end-August: Code of Conduct to guide negotiations between troubled borrowers and banks; Framework for Arrears Management. - Next steps and deadlines: - By end-September 2013: banks to submit to the CBC a strategy to implement the framework for arrears management, including diagnostic and implementation roadmap. - By end-October 2013: CBC to require banks to submit a detailed implementation plan and report on restructuring progress along performance indicators (e.g., number of loans restructured, cash collections). - By end-October 2013: legal review of relevant legislation and report on impediments in the framework (with technical assistance as needed). - By end-November 2013 (subject to review findings): pass legislation to expand the role of the financial Ombudsman to assist in restructuring disputes, ensuring adequate resources. ### Anti–Money Laundering (AML) implementation actions and timelines - Two independent AML audits of bank AML framework implementation completed at end-April. - Action plan and specific measures: - CBC to follow up on possible breaches identified by auditor and apply supervisory enforcement actions, including sanctions if applicable, by end-September 2013. - CBC to review its AML/CFT supervisory structure against Basel Core Principle and FATF standards and establish an effective and adequately resourced structure by end-December 2013. - Ministry of Finance (MOF) to commission a third party assessment of the Registrar of Companies, to be completed by end-December 2013; Registrar’s companies’ department to be appropriately resourced by then. - Registrar to revise pricing policy on access to basic information on all companies incorporated in Cyprus by end-June 2014 to make basic information free of charge while ensuring budget neutrality. - CBC (with technical assistance) and relevant AML supervisors to develop and implement risk-based tools: - for off- and onsite AML supervision of financial institutions by end-June 2014; - for lawyers and accountants by end-September 2014; - for trust and company service providers by end-December 2014. ### Fiscal policy performance and commitments - Fiscal performance H1 2013: - Primary balance for the first half of the year was €289 million (1.8 percent of GDP) better than programmed. - Primary spending was below target by €74 million (0.5 percent of GDP). - Commitment to prudent budget execution and tight control of discretionary spending for 2013 given high revenue uncertainty. ### Pension funds and compensation - Pension funds’ deposits in Laiki fully converted into equity; deposits of pension funds in BoC partially converted into equity. - Compensation terms: - Compensation for pension funds with deposits in Laiki will be based on total balance of deposits held in Laiki as of March 26 and the remaining balance of deposits in BoC after conversion into equity. - Compensation will not exceed €300 million. - Out of this amount, up to €154 million will be released by the time of the second review of the program. ### Structural fiscal reforms — Social welfare and pensions - Social welfare reform to introduce a guaranteed minimum income (GMI) and eliminate duplicate benefits: - Define basic needs by a minimum consumption basket to be reviewed by end-September 2013. - Estimate cost of GMI in line with the program’s macroeconomic framework by end-October 2013. - Refine means testing mechanism by end-December 2013. - Legal framework adopted by end-May 2014. - New system implemented by end-June 2014 (modified structural benchmark). - Pension reform: - Complete an actuarial study of GSIS by end-August. - Adopt reforms resulting from the study by end-December 2013. - Reforms to enter into force by end-March 2014. ### Revenue administration reforms and anti–tax evasion measures - Reform objectives: increase revenues via better compliance, improve efficiency and taxpayer services, reduce costs via economies of scale. - Steps and deadlines: - Establish steering committee and project team by end-September 2013 to develop reform plan. - Reform plan agreed with program partners and approved by the government by end-December 2013. - Technical assistance to be sought as appropriate. - Measures to fight tax evasion (end-December 2013 structural benchmark): - Use inter-agency databases to identify non-compliant taxpayers in high-risk professions and industries for audit. - Develop work program for targeted joint audits through end-December 2014. - Amend legislation to establish self-assessment for all income taxpayers. - Pass legislation to harmonize and increase enforcement powers of the revenue administration, including authority to seize assets or prohibit alienation/use of assets, and make the act of and assistance to tax evasion a criminal offense. ### Public financial management reforms - Fiscal Responsibility and Budget Systems Law (FRBSL) and Fiscal Council: - Draft FRBSL submitted to Parliament by end-October 2013. - FRBSL to be adopted by end-December 2013 (modified structural benchmark). - Commitment control and pre-invoicing controls: - Modify systems/procedures and publish circular announcing government orders subject to pre-commitment validation by end-March 2014. - Reporting and guarantees monitoring: - Treasury to provide monthly reports on key indicators (revenue, expenditure and borrowing) to MOF Budget Directorate starting with September data. - Change Public Debt Management Law by end-December 2013 to assign monitoring of stock of guarantees to the Public Debt Management Office and ensure adequate staffing. ### Hydrocarbon resource management and public investment framework - Develop legal basis for transparent management of natural resource revenues through the budgetary framework; include provisions in FRBSL to channel revenues and related spending through the budget. - Develop legal framework for a natural resource fund in consultation with program partners, to be established in line with international best practice. - Include public investment and PPP provisions in FRBSL to integrate projects in the budget process and formalize Minister of Finance role in reviewing/approving public investment projects, including PPPs. ### Privatization - Inventory prepared of assets with highest commercial value. - Privatization proceeds target: €1.4 billion by end-2018. - Appoint external consultant to develop a privatization plan and draft legal framework by end-November 2013. - Implement legal and institutional framework by end-December 2013. ### Program financing actions and targets - Completed exchange of €1 billion domestic debt falling due during the program period into new debt at 6–10 year maturities, interest rate unchanged. - Rolled over the €1.9 billion Laiki recapitalization bond at original terms. - Progressing on restructuring of the €2.5 billion Russian bond falling due in 2016; expect terms envisaged in March. - Plan for allocation of central bank profits of €0.4 billion to be distributed in 2014 (in line with CBC duties under the Treaties and the Statute). - CBC to decide an asset swap to contribute approximately €1 billion to reduction of public debt by end-June 2014. ### Program monitoring and conditionality - Policies monitored through quarterly reviews. - Program includes continuous performance criteria, indicative targets, and structural benchmarks defined in the Technical Memorandum of Understanding (TMU). - Continuous performance criteria include: - Non-accumulation of external payment arrears. - Non-intensification of restrictions of payments and transfers for current international transactions or introduction of multiple practices. - Authorization for IMF to publish the Letter of Intent, attachments, and staff report. ### Select quantitative conditionality figures (from Table 1) - Floor on the general government primary balance (Jun-13 target): -222 - Primary balance adjustments and targets: 67; -402; -549; -47; -367 - Ceiling on general government primary expenditure (Jun-13): 3,230; adjusted target 3,156; actual 5,065; subsequent targets 7,223; 1,581; 3,196 - Ceiling on the stock of general government debt (Jun-13): 17,153; Sep-13 adjusted target 17,083 5/; Dec-13 target 16,930; Mar-14 18,521; Jun-14 18,744; adjusted 18,728; actual 18,498 - Ceiling on the accumulation of new general government guarantees (Jun-13): 145.3; Sep-13 adjusted 9.9; Dec-13 145.3; Mar-14 145.3; Jun-14 0; adjusted 0 - Ceiling on the accumulation of external arrears: 0 across reported periods - Ceiling on the accumulation of domestic arrears: 0 across reported periods - Ceiling on accumulation of VAT refund arrears by the general government: 10 (Jun-13 target); Sep-13 actual -0.9; Dec-13 10; Mar-14 10; Jun-14 10; adjusted 10 ### Structural conditionality highlights (from Tables 2–3) - Prior actions completed before Board meeting: - Establish legal framework for ownership and governance to manage government’s majority stake in CCI sector. - Amend cooperative and banking laws to establish CBC as single supervisor of CCI sector. - Performance criterion met: no measures to intensify restrictions on making payments and transfers for current international transactions or to introduce multiple currency practices. - Structural benchmarks and statuses: - Due diligence valuation of CPB and BoC assets: End-June 2013 — Partially met (valuation study completed on July 26). - CBC and CCI supervisor to assess capital needs and viability for individual CCIs: End-June 2013 — Partially met (capital needs assessed on time; viability assessment completed on July 19). - Develop a strategy to recapitalize and restructure the CCI sector with public money as needed: End-July 2013 — Met. - Roll over and extend maturity of at least €1 billion of domestic debt and roll over €1.9 billion recapitalization bond of CPB: End-June 2013 — Completed on July 1. - Existing structural benchmarks (selected): - CBC to prepare assessment of BoC's restructuring, business, funding and capital plans: End-October 2013. - Adopt legal framework for a central credit register: End-September 2013. - Revise AML legal framework: End-September 2013. - Adopt FRBSL: End-December 2013. - Implement new social welfare system: End-June 2014. - New structural benchmarks (selected): - CBC to instruct Hellenic Bank to launch an offer for private participation: End-September 2013. - Recapitalize Hellenic Bank per PIMCO-identified capital needs: End-December 2013. - Adopt measures to fight tax evasion: End-December 2013. - Merge credit cooperative sector into a maximum of 18 institutions recapitalized to meet capital requirements: End-March 2014. *Source: IMF staff report content as provided in the supplied PDF content unit.* ### 1. This Technical Memorandum of Understanding (TMU) sets out the understandings ### This Technical Memorandum of Understanding (TMU) sets out the understandings ### Definitions, scope, and consultation - The TMU sets out understandings regarding definitions of indicators subject to quantitative targets (performance criteria and indicative targets) specified in the tables annexed to the Memorandum of Economic and Financial Policies (MEFP). - Describes methods for assessing program performance and information requirements for monitoring targets. - Authorities will consult with the Fund on a timely basis before modifying measures contained in this letter, or adopting new measures that would deviate from the goals of the program, and provide the Fund with the necessary information for program monitoring. ### Program exchange rates and valuation rules - All foreign currency-related assets, liabilities, and flows will be evaluated at “program exchange rates” for program purposes, except items affecting government fiscal balances, which will be measured at current exchange rates. - The program exchange rates are those that prevailed on April 15: - €1 = U.S. 1.308099 dollar - €1 = 129.0309 Japanese yen - €1.15222 = 1 SDR ### General government coverage - For program purposes, the general government includes institutions listed under ESA 95 for EDP reporting: - Central government: Constitutional Powers, Constitutional Services, Independent services, Independent offices, Ministries and departments, services and other bodies they supervise, 21 special purpose funds, and 14 semi-government organizations. - Local governments: 39 municipalities, 356 village authorities, and all agencies and institutions attached thereto classified as local governments under ESA 95. - Social security funds: medical treatment scheme, the regular employees’ provident fund, the social insurance fund, the holiday fund, the redundancy fund, and the protection of the rights of employees’ fund. - Any newly created institution defined as general government under ESA 95 (new budgetary institution, special fund, social security fund, semi-government organization, municipality, village authority, or any other entity created during the program period to carry out operations of a fiscal nature). The government will inform IMF staff of creation or pending reclassification immediately. - The general government, as measured for program monitoring for a given year, shall not include entities re-classified from outside general government into general government during that year. ### Quantitative performance criteria and indicative targets - Floor on the General Government Primary Cash Balance (GGPCB) — performance criterion: - GGPCB defined as general government cash balance (GGCB) minus general government interest receipts plus general government interest payments. - GGCB defined as total revenue (tax revenue, social security contributions, grants and other revenue) minus total expenditure. - Payment of called guarantees recorded as cash expenditures. - Privatization receipts and proceeds from sale of land and buildings will be excluded from revenue (privatization receipts defined as disposal to private owners by a government unit of controlling equity of a public corporation or quasi-corporation). - Floor on GGPCB measured cumulatively from start of calendar year. - Floor on GGPCB will be adjusted downwards by payments related to bank support when carried out under the program’s banking sector support and restructuring strategy. Transactions that may be excluded include: - loans to financial institutions and investments in equity of financial institutions (requited recapitalization); - unrequited recapitalization; and - purchases of troubled assets. - Any central government financial operation to support banks, including issuance of guarantees or provision of liquidity, will be immediately reported to IMF staff. - Specific adjustment: Floor on the GGPCB of end-December 2013 will be adjusted downwards by the payments to compensate pension funds for the losses related to the resolution of Laiki up to €146 million. - Ceiling on the General Government Primary Expenditure (GGPE) — performance criterion: - GGPE includes compensation of employees, goods and services, subsidies, social benefits, other recurrent expenditure, and capital expenditure. - Ceiling on GGPE will be adjusted upwards by payments related to bank support under the program’s banking sector support and restructuring strategy. Transactions that may be excluded include: - loans to financial institutions and investments in equity of financial institutions (requited recapitalization); - unrequited recapitalization; and - purchases of troubled assets. - Any central government financial operation to support banks, including issuance of guarantees or provision of liquidity, will be immediately reported to IMF staff. - Specific adjustment: Ceiling on the GGPE of end-December 2013 will be adjusted upwards by the payments to compensate pension funds for the losses related to the resolution of Laiki Bank up to €146 million. - Ceiling on the stock of General Government Debt — performance criterion: - General government debt constitutes total outstanding gross liabilities as defined by ESA95, includes debt of all institutions in general government and other ESA 95 adjustments; debt measured at nominal value. - Program exchange rate applies to all non-euro denominated debt. - Ceiling on general government debt will be adjusted: - Upward (downward) by the amount of any upward (downward) revision to the stock of end-March 2013 general government debt. - Upwards by debt arising from payments for bank restructuring carried out under the program’s banking sector support and restructuring strategy. These payments may include loans to financial institutions and investments in equity of financial institutions (requited recapitalization); unrequited recapitalization; and purchases of troubled assets. - Any financial operation by central government to support banks, including issuance of guarantees or provision of liquidity, will be immediately reported to IMF staff. - Ceiling on the Accumulation of new General Government Guarantees — performance criterion: - Ceiling includes domestic and external guarantees granted during test period, and guarantees whose maturity is extended beyond initial contractual provisions. - Excludes guarantees granted under a risk sharing instrument of the EU structural funds (COM (2011) 655 final) that do not create contingent liabilities for the Cypriot State. - Government entities outside of general government but within the non-financial public sector are not permitted to grant guarantees. - Stock of guarantees at end March 2013 was €3.1 billion. This excludes €3.8 billion of temporary government guarantees issued on March 25 to facilitate sale of Laiki’s Greek branch and cancelled on June 27. - Ceiling adjusted upwards for issuance of government guaranteed bonds to be used in monetary policy operations to boost BoC’s liquidity up to €2.9 billion. - Ceiling on the Accumulation of External Arrears — continuous performance criterion: - External payment arrears defined as payments on debt to non-residents contracted or guaranteed by general government not made within seven days after falling due. - Stock of external payment arrears as of end-March 2013 was €0. - Ceiling on the Accumulation of Domestic Arrears — performance criterion: - Domestic expenditure arrears defined as unpaid invoices past due date by 90 days; if no due date specified, considered in arrears 90 days after initiation of the invoice. - Stock of domestic expenditure arrears as of end March 2013 was €0. - Ceiling on the Accumulation of VAT Refund Arrears by the General Government — performance criterion: - VAT refund arrears consist of unpaid VAT refunds that have past the due date for payment established in tax legislation and/or corresponding regulations. - Stock of VAT refund arrears as of end March 2013 was €140 million. ### Monitoring of structural benchmarks - Revision of the anti-money laundering (AML) legal framework (end-September 2013). Specification includes: - Ensure financial intelligence unit can exchange adequate information with foreign counterparts on money laundering, associated predicate offenses and terrorist financing in the context of its analytical function without a court order. - Ensure all trustees of trusts under Cyprus law are regulated or registered; registers kept by relevant supervisory authorities to contain adequate, accurate and current information on trust name and trustee(s) name and address. - Ensure adequate, accurate and up-to-date information on beneficial ownership of legal entities can be obtained timely by competent authorities, with following lines: - Company secretary is holder of beneficial ownership information and accountable for providing adequate, accurate and current beneficial ownership information to competent authorities. - Company secretary is i) a regulated professional supervised by a Cypriot authority, or ii) if the company is excluded from scope of the TCSP Law, a natural person resident in Cyprus. - Ensure nominee directors or nominee shareholders do not obstruct timely access to adequate, accurate and up-to-date beneficial ownership and control information; require nominee directors and shareholders be authorized or regulated (lawyers, accountants or TCSPs) and maintain information on identity of their nominator, available to competent authorities upon request. A record of nominee status will be accessible through registers under the TCSP Law listing all regulated persons (lawyers, accountants and TCSPs). - AML supervision implementation: - On a quarterly basis, in context of program review starting in Q4 2013, supervisory competent authorities will, on a confidential and anonymized basis, share information with Fund staff by granting access to supervisory assessments and information about enforcement actions applied for non-compliance and/or violations of laws and regulations. - Adopt legal framework for a central credit register (end-September 2013). Specification includes: - Establish framework allowing credit institutions to keep centrally critical information on household and corporate borrowers (including consolidated debt exposure, past due and performing loans, collateral, etc.), while safeguarding sensitive and/or confidential information. - Ensure adequate access by credit institutions and exchange of consumers’ data among credit institutions to enhance credit underwriting policies. - Adopt a law on fiscal responsibility and budget systems (end-December 2013). Specification includes: - Provide comprehensive coverage of general government sector and government’s financial relationships with state enterprises and other public entities outside the general government boundary. - Incorporate provisions on fiscal transparency and accountability requiring government to articulate a comprehensive, legally based and independently monitored fiscal strategy consistent with EU requirements. - Provide for development over time of disciplined and policy-oriented budget decision-making: reduce number of appropriations, adopt a top-down approach to budget preparation closely linked to fiscal policy-making, and provide more flexibility to ministries and semi-governmental organizations. - Adopt measures to fight tax evasion (end-December 2013). Specification includes: - Develop a work program for conducting targeted joint audits through end-December 2014. - Amend relevant legislation to establish self-assessment for all income taxpayers. - Pass legislation to harmonize and increase collection enforcement powers of the revenue administration, including authority to seize assets, or prohibit the alienation or use of assets, including property and bank accounts, and turning the act and assistance of to tax evasion into a criminal offense. ### Reporting requirements and data provision - Performance monitored using data supplied to the IMF by the Ministry of Finance (MOF), Cystat, and the Central Bank of Cyprus (CBC). Authorities to transmit data revisions timely. - Table 1 (reporting requirements) specifies supporting data, frequency, responsible institution/department, and maximum time lag for submission after end of reporting period. Key entries include: - Detailed execution of revenues, expenditure and financing (EDP format): Monthly; MOF Budget Department/Cystat Government Financial Statistics; 25 days after end of month, except end-December data provided 30 days after end of month. - Debt issuance, amortization, interest cost details by instrument, maturity, currency, holder: Monthly; MOF Public Debt Management Unit; 25 days after end of month. - Central Government Debt stock by type, interest bill details through 2020: Monthly; MOF Public Debt Management Unit; 25 days after end of month. - Budgetary Central Government deposits in Consolidated Fund and Banking System: Monthly; MOF Public Debt Management Unit; 5 days after end of month. - Stock of expenditure and VAT refund arrears and monthly flows by type of expenditure: Monthly; MOF Customs & Excise Department, VAT Service; 15 days after end of month. - Stock of government guarantees and monthly flows by institution: Quarterly; MOF Treasury Department; 25 days after end of month. - Stock of external arrears: Monthly; MOF Treasury Department; 15 days after end of month. - Assets and liabilities of the central bank: Monthly; Central Bank of Cyprus; 30 days after end of month. - Assets and liabilities of domestic operations of banking system — aggregate monetary balance sheet by institutional category: Monthly; Central Bank of Cyprus; 30 days after end of month. - Assets and liabilities of consolidated banking system (including foreign operations): Quarterly; Central Bank of Cyprus; 45 days after end of reporting period. - Individual operational balance sheet of domestic operations of largest banks and coops with detailed information on deposits, central bank funding, interbank funding, debt securities, loans to public and private sector: Monthly; Central Bank of Cyprus; 30 days after end of month. (Reporting requirements for cooperative banks to be revisited after CBC becomes their supervisor.) - Details for largest banks and coops on liquid assets, liquidity position, other assets and liabilities: Daily; Central Bank of Cyprus; Next working day. - Deposits by institution, currency, and residency and end-of-day liquidity buffers: Daily; Central Bank of Cyprus; Next working day. - Financial soundness indicators—core set, deposits, NPLs, capital adequacy ratios: Quarterly; Central Bank of Cyprus; 60 days after end of month. ### Attachment 3 — Memorandum of Understanding on Specific Economic Policy Conditionality (European Commission): Key program objectives - Restore soundness of Cypriot banking sector and rebuild depositors' and market confidence by: - Thoroughly restructuring and downsizing financial institutions. - Strengthening supervision. - Addressing expected capital shortfalls. - Continue fiscal consolidation to correct excessive general government deficit by 2016, in particular through: - Measures to reduce current primary expenditure. - Maintain fiscal consolidation in the medium-term through measures to increase efficiency of public spending within a medium-term budgetary framework, enhance revenue collection and improve public sector functioning. - Implement structural reforms to support competitiveness and sustainable and balanced growth, allowing unwinding of macroeconomic imbalances, in particular by: - Reforming wage indexation system. - Removing obstacles to the smooth functioning of services markets. *Technical Memorandum of Understanding (TMU) for Cyprus — program definitions, measurement rules, targets, structural benchmarks, and reporting requirements.* ### 1. Financial sector reform ### 1. Financial sector reform ### Key objectives - The banking sector was severely affected by the broader European economic and sovereign crisis, in particular through its exposure to Greece. - Many sector problems are home‑grown and relate to overexpansion in the property market as a consequence of poor risk management practices of banks. - The financial sector was vulnerable because of its size relative to that of the domestic economy. - Collateral valuations are highly sensitive to property prices; gaps in the supervisory framework were used to delay recognition of loan losses, leading to significant under‑provisioning. - The sector would benefit from considerable restructuring to: - restore solvency and viability; - reinforce resilience; and - regain public confidence. ### Progress since April - Actions taken: - Bank of Cyprus has been taken out of resolution upon the finalisation of its asset valuation. - Authorities designed a strategy to restructure the cooperative credit institutions. - Hellenic Bank launched a capital raising plan. - Administrative restrictions and capital controls have gradually been relaxed. - Supervisory and regulatory progress: - New classification on non‑performing loans in effect since 1 July. - Unified data reporting system for commercial and cooperative banks implemented. - On 23 July the financial stability indicators in the new framework were made available on the Central Bank of Cyprus (CBC) website. - Integration of supervision of cooperative credit institutions is being finalised. - Monitoring of private sector indebtedness stepped up; first (internal) quarterly report presented on 12 July. - CBC circular issued end‑April to grant a grace period of 60 days for dealing with troubled borrowers; legislation/regulation in preparation to better manage arrears and set up a mediation service. - Amendments to anti‑money laundering legislation submitted to Parliament; changes to trust register for beneficial owner information under legal vetting. ### A. Regulation and supervision — Maintaining liquidity in the banking sector - Exceptional temporary restrictive measures introduced after the two largest domestic Cypriot banks were put under resolution to prevent large deposit outflows and preserve solvency and liquidity. Measures covered: - cash withdrawals and exports of cash; - card payments; - credit transfers; - cashing of cheques; and - account opening. - Measures designed to minimise payment system disruptions and ensure execution of essential transactions. - Restrictions implemented in line with Treaty on the Functioning of the European Union rules on free movement of capital. - Monitoring and governance: - Daily monitoring by Cypriot authorities with information sharing with EC, ECB, ESM and IMF. - Monitoring Board established by the EC and Cypriot authorities; ECB, IMF, ESM and EBA participating as observers. - Gradual relaxation of a number of restrictions after consultation with the Monitoring Board. - Remaining restrictions to remain no longer than strictly necessary to mitigate serious risks to domestic financial stability. - Roadmap: - Roadmap for gradual relaxation of remaining measures published on 8 August 2013. - Roadmap foresees two major stages of relaxation: measures within the Republic, then cross‑border movements of capital. - Ongoing liquidity oversight: - CBC, in consultation with the ECB, will closely monitor banking sector liquidity and stand ready to take appropriate measures in line with Eurosystem rules. - Cypriot authorities stand ready to consider issuance of additional government guarantees, if needed. - Funding and planning requirements: - Domestic banks relying on central bank funding or to receive State aid must submit quarterly medium‑term funding and capital plans at end of each quarter to the CBC; CBC will transmit to ECB, EC, ESM and IMF. - Cooperative Central Bank and Bank of Cyprus to submit their first plans by end‑September 2013 and mid‑October 2013 respectively. - Plans should reflect anticipated deleveraging, reduce dependency on central bank borrowing, and avoid asset fire sales and a credit crunch. - Reporting template and macroeconomic scenario to be provided by CBC in coordination with the ECB. - Liquidity regulation reform: - CBC will update liquidity regulations by December 2014, after consultation with ECB, EC and IMF and informing the ESM, to avoid concentrated exposures such as to Greek sovereign debt. ### A. Regulation and supervision — Regulation and supervision of banks and cooperative credit institutions - Asset recovery and collateral enforcement: - Maximise bank recovery rates for non‑performing loans while minimising incentives for strategic defaults. - Administrative hurdles and legislative framework constraining seizure and sale of loan collateral will be amended so property pledged as collateral can be seized within a maximum time‑span of 1.5 years from initiation of legal or administrative proceedings; for primary residences this time‑span could be extended to 2.5 years. - Necessary legislative changes to be submitted to the House of Representatives by mid‑2014 and implemented by end‑2014, macroeconomic conditions permitting. - Non‑performing loans (NPLs): - New definition of non‑performing loans entered into force on 1 July 2013. - Time series for NPLs to be published including historical observations reaching as far back as possible. - Central credit register: - CBC to create a central credit register listing all borrowers and beneficial owners from both commercial banks and cooperative credit institutions. - The register will identify borrowers who are or were in arrears and help monitor credit risk and large exposures. - Legal framework for the credit register to be set up by end‑September 2013. - Central credit register to be operational by end‑September 2014. - Regulatory framework review: - CBC will review, by end‑October 2013, its regulatory framework with respect to loan origination processes, asset impairment and provisioning, and treatment of collateral in provisioning, following due diligence and IFRS best practices. - Regulatory amendments will be introduced, drawing on technical assistance, to mitigate the impact of changes in collateral values on impaired asset values. - New prudential regulations to enter into force by end‑March 2014. - Governance and disclosure: - Legislation by end‑September 2013 to strengthen bank governance by: - prohibiting commercial banks and cooperative credit institutions from lending to independent board members, including their connected parties; - removing board members whose existing debts to their banks are non‑performing under the new CBC definition; - prohibiting lending to other board members above a threshold to be calibrated by the CBC; - requiring disclosure to the public of loans and other credit facilities to each board member; - ensuring a majority of directors on banks' boards are independent. - CBC to submit draft legislation to Parliament by end‑December 2013 to introduce mandatory supervisory action based on capitalisation levels, becoming effective by end‑March 2014. - CBC to issue by end‑October 2013 mandatory disclosure requirements so banks regularly communicate restructuring progress to markets. - Starting end‑December 2013, banks under restructuring plans required to publish quarterly reports describing main developments. - Reports to be accompanied by independent assessments by external auditors based on agreed procedures with the CBC. - Stress‑testing: - Stress‑testing will be integrated into regular off‑site supervision and serve as input into Pillar 2 assessments. - Supervisory stress‑tests to be carried out annually, with first exercise completed per timeline in the Single Supervisory Mechanism framework. - Cooperative credit institutions supervision: - Integration of supervision of cooperative credit institutions into the CBC to complete alignment with commercial bank regulation; legislation to be passed as a prior action. - CBC to finalise by end‑September 2013 a detailed action plan to exercise supervision of the cooperative sector; action plan to include recruitment of experienced staff and application of CBC supervisory and regulatory model. - Full operational supervision of cooperative sector to be achieved by end‑March 2014. - Accounts of cooperative credit institutions above a size to be decided by the CBC (after consultation with EC, ECB, IMF and informing ESM) will be subject to an independent annual audit by an external, recognised and independent auditing firm. - CBC will have the right to overturn selection of an auditor by any cooperative credit institution. - Pro forma consolidated accounts of cooperative credit institutions to be published beginning from 2013 annual accounts. - Capacity and standards: - Legal obstacles to CBC's ability to employ and retain necessary and qualified staff should be removed without delay. - Authorities will request a standalone assessment against the “Basel Core Principles for Effective Banking Supervision”, to be completed by end‑2015. ### A. Regulation and supervision — Monitoring of corporate and household indebtedness - Monitoring enhancement: - Cypriot authorities will step up monitoring of corporate and household indebtedness and prepare quarterly reports including: - information on distribution of assets and liabilities across households; - an assessment of debt‑servicing capacity and refinancing activities. - Survey data to be used until credit register fully operational. - Financial Stability Report, to be published yearly as of December 2013, will include extended analysis on corporate and household indebtedness. - First quarterly monitoring report received beginning of July 2013; scope and content to be further enhanced. - Measures for troubled borrowers and private‑sector debt restructuring: - Framework for targeted private‑sector‑debt restructuring to be established to facilitate new lending and diminish credit constraints; ways to improve SME funding constraints to be explored. - Specific near‑term deliverables and timelines: - Finalise banks' Code of Conduct for dealing with troubled borrowers and framework for management of arrears by end‑August 2013; implement framework for seizure and sale of loan collateral. - By end‑September 2013, banks to submit to CBC a strategy to implement management of arrears framework, including diagnostics and action plans. - By end‑October 2013, banks to submit to CBC their plan to implement restructuring framework within their organizations and report on restructuring progress using performance indicators (e.g. number of loans restructured, cash collections). - By end‑October 2013, authorities to perform a legal review of relevant legislation with technical assistance as needed. - Legislation to expand role of mediation service between banks and clients to achieve fair debt restructuring to be passed by end‑November 2013, ensuring adequate resources for expected case load. ### A. Regulation and supervision — Increasing financial transparency (AML and beneficial ownership) - AML strengthening and transparency commitments: - Cyprus' AML regime had an overall positive evaluation in 2011 MONEYVAL report; April 2013 audit by MONEYVAL and an independent auditor identified specific shortcomings. - Authorities committed to enhance AML framework under the agreed AML Action Plan (see Annex 2) and to implement measures including: - Strengthen preventive measures of obliged entities regarding customer due diligence, use of introduced business and reporting of suspicious transactions (Action Plan – sections 1, 2 and 3). - Ensure transparency and timely access to information on beneficial ownership of trusts (Action Plan – section 4). Commitment to establish trust registers with supervisory authorities (Action Plan – section 4.3.1). - Supervisory competent authorities to review off‑site and on‑site supervisory procedures and implement a risk‑based AML supervision approach for financial and non‑financial institutions (lawyers, accountants and TCSPs) (Action Plan – sections 5 and 6). - On a quarterly basis, starting Q4 2013, supervisory competent authorities will, on a confidential basis, share anonymised information with programme partners, granting access to supervisory assessments and information about enforcement actions for non‑compliance. - Legal and supervisory changes prior to second tranche of assistance: - By 11 September 2013 and prior to release of the second tranche of financial assistance: - Adopt revisions to the Trust and Company Services Provider law. - Amend the Anti‑Money Laundering Law to enable provision of the widest possible range of cooperation to foreign counterparts (including laundering of proceeds of tax crimes involving fraudulent activity) and give precision to the scope of cooperation by the financial intelligence unit. - By Q3 2013, ensure directives and circulars issued by supervisory authorities (CBC, CySEC, Cyprus Bar Association, and Institute of Certified Public Accountants of Cyprus) are revised to lay down clear implementing procedures in line with legislation and international standards. ### B. Recapitalisation, resolution and restructuring — Restoring adequate capital buffers - CBC to increase the minimum Core Tier 1 capital ratio from the present level of 8% to 9% by end‑December 2013. ### B. Recapitalisation, resolution and restructuring — Restructuring and resolution of Bank of Cyprus - A transitory Board of Directors of Bank of Cyprus, appointed on 26 April 2013, mandated to ensure bank stability once it exits resolution. - Transitory Board called a General Meeting of shareholders no later than 12 September 2013 to appoint a new Board. - CBC will require the Board to prepare a restructuring plan defining business objectives and credit policies, including measures to enhance viability and profitability, by mid‑October 2013. - Plan to be reviewed and approved by CBC and specify quarterly goals. ### B. Recapitalisation, resolution and restructuring — Restructuring and recapitalisation of other commercial banks - Commercial banks with capital shortfalls deemed viable can request State recapitalisation aid if other measures do not suffice. - Capital should be raised from private sources to the largest extent possible, including asset disposals and liability management. - By end‑September 2013, necessary steps to launch private participation will have been initiated. - If private sector participation is not successful by end‑October 2013, State aid can be granted, in line with State aid rules. - Banks need to be fully capitalised by end‑December 2013 without burdening depositors. ### B. Recapitalisation, resolution and restructuring — Restructuring and recapitalisation of cooperative credit institutions - CBC assessed capital needs indicating total capital shortfall of EUR 1.5 billion. - CBC finalised by July 2013 a strategy for restructuring and recapitalising the sector, including a plan to merge individual cooperative credit institutions into a maximum of 18 entities by March 2014 to achieve viability, efficiency and profitability. - Minimum capital requirement: - CBC will introduce a minimum capital requirement for the core tier 1 ratio of 4% for individual affiliated cooperative credit institutions. - That requirement enters into force by end‑December 2013; capital will be injected by the Central Cooperative Bank into individual cooperative credit institutions as mergers are completed. - At the consolidated level, the sector remains subject to the general minimum core tier 1 capital requirement of 9%. - Restructuring process and state aid: - Restructuring plan for the cooperative sector to be submitted to the EC by September 2013. - Cooperative credit institutions needing State aid will not be recapitalised before restructuring plan is formally approved under state‑aid rules. - Terms and remuneration of public support to comply with EU State‑aid rules, with due consideration for financial stability. - Beneficiaries of capital injections will be subject to specific management rules and restrictions and a restructuring process scrutinised by an external monitoring trustee. - Unviable cooperative credit institutions will be required to merge with viable ones. - Governance and recapitalisation funding: - Legal framework for a new governance structure to manage the State's stake in the cooperative credit sector will be established as a prior action for the review; framework to allocate clear levels of accountability and define the State's role as main Central Cooperative Bank shareholder. - Relationship framework between the State and Central Cooperative Bank to be established and fully operationalized by end‑October 2013 to ensure Central Cooperative Bank adopts sound policies and restructuring measures without interfering in commercial business decisions. - Sufficient funds for recapitalisation will be made available from the programme following fulfillment of the prior action and deposited in a securities account with the CBC. - EUR 1.5 billion of state funds will be injected in the Central Cooperative Bank in exchange for common shares on the basis of capital needs identified in the PIMCO exercise and in line with state aid rules, by end‑October 2013. *Source: _cr13293 - 1. Financial sector reform* ### 2. Fiscal policy ### 2. Fiscal policy ### Key objectives - Overriding importance: put public finances on a sustainable path to stabilise the economy and restore confidence of companies, citizens and foreign investors. - Primary fiscal targets: - achieve a 3% of GDP primary surplus in 2017, - achieve a 4% of GDP primary surplus in 2018, - maintain at least such a level thereafter. - Annual budgetary targets: achieve the targets set out in this Memorandum of Understanding (MoU) through high-quality permanent measures, and additional measures in the outer years, in particular to reduce growth in expenditure on the public sector wage bill, social benefits and discretionary spending, while minimising the impact of consolidation on vulnerable groups. - Immediate implementation: fully implement the fiscal consolidation measures for 2013, listed in Annex 1 and below. - Correct excessive deficit: correct the excessive general government deficit by 2016. - Medium-term objective: maintain fiscal consolidation over the medium term, converging towards Cyprus' medium-term budgetary objective of a balanced budget in structural terms, by containing expenditure growth, improving the structure of taxation and undertaking fiscal-structural measures, including the implementation of a Medium-Term Budgetary Framework designed in accordance with EU specifications. - Commitments by authorities: - fully implement fiscal measures adopted for 2012–14 and initial fiscal-structural reforms (see Annex 1); - monitor the budgetary effect of measures on a monthly basis; any deviation from projected budgetary effect will be evaluated and addressed in quarterly programme reviews, taking into account macroeconomic developments; - be ready to take additional measures in case of revenue underperformance or higher social spending needs, including by reducing discretionary spending, taking into account adverse macroeconomic effects. - Treatment of outturns: - cash revenues above programme projections, including any windfall gains, will be saved or used to reduce debt; - if over-performance materialises and is deemed permanent, it can reduce the need for additional measures in the outer years. - EU funds and implementation capacity: - sound fiscal policy and expenditure prioritisation should contribute to preserving the good implementation of Structural and other EU funds consistent with the programme's budgetary targets; - EU funds will be targeted to areas delivering the most important economic and social impact, in accordance with relevant EU regulatory framework priorities; - ensure necessary national funds remain available to cover national contributions, including non-eligible expenditure, under the European Structural and Investment Funds (ERDF, ESF, Cohesion Fund, EAFRD and EFF/EMFF) in the framework of the 2007-2013 and 2014-20 programming periods, while taking into account available EIB funding; - improve institutional capacity to implement current and future programmes and ensure appropriate human resources of Managing Authorities and implementing bodies are available. - Reporting and consultation: - in accordance with Regulation 472/2013, Cyprus shall provide all information necessary for monitoring the implementation of the economic adjustment programme; - Cypriot authorities will consult ex-ante with the European Commission, the ECB and the IMF on adoption of policies not included in this Memorandum but that could have a material impact on achievement of programme objectives. Note on windfall gains: - Windfall gains associated with hydrocarbons shall mean only the blocks’ licencing fees or related signature bonuses for exploration thereof. Any streams of revenues associated with hydrocarbon exploitation are dealt with under section 5.6, second bullet-point, indent 3. The Cypriot authorities have submitted Law N. 205(I)/2012 (enacted on 28 December 2012), transposing the Directive, to the European Commission. ### Fiscal policy in 2013 - Target: - achieve a general government primary deficit of no more than EUR 395 million (2.4% of GDP) in 2013. - The 2013 deficit target may be revised to incorporate compensation for provident and retirement funds in Cyprus Popular Bank (see item on compensation below). - Budget implementation: - rigorously implement the 2013 Budget Law (as amended), including additional permanent measures adopted prior to the granting of the first disbursement of financial assistance, which should amount to at least EUR 351 million (2.1% of GDP). - Measures to be adopted after review and consultation with programme partners (prior to the granting of the second disbursement): - 2.2: Reform of the tax system for motor vehicles with effect from budget year 2014, based on environmentally-friendly principles, to raise additional revenues in the medium-term through the annual road tax, the registration fee and excise duties, including motor fuel duties. The reform will take into account the related study of the University of Cyprus. - 2.3: Compensation scheme for provident and retirement funds in Cyprus Popular Bank. Scheme criteria: - (i) ensure comparable treatment with such funds in Bank of Cyprus; - (ii) take into account the cash-flow and actuarial position of each fund in determining timing by which the compensation will take place; - (iii) minimise the impact on the general government deficit and ensuring its one-off nature. - The Cypriot authorities will earmark an amount of up to EUR 299 million out of the state budget for such compensation, of which up to a maximum of EUR 154 million can be released before the second review of the adjustment programme. ### Fiscal policy in 2014 - Target: - achieve a deficit of the general government primary balance of no more than EUR 678 million (4¼% of GDP) in 2014. - Measures: - fully implement permanent measures for 2014, amounting to at least EUR 270 million in 2014 (Annex 1). - the total amount of fiscal policy measures to underpin the 2014 budgetary targets will be agreed in the context of the 2014 Budget Law consultation. - Budget law timing and expenditure ceilings: - after review by and consultation with the programme partners by mid-September 2013, the 2014 Budget Law will be adopted by December 2013. - the 2013-2015 expenditure ceilings will be updated for the period 2014-2016 and will accompany the 2014 Budget Law document. - presentation of these ceilings will evolve into a full-fledged Fiscal Strategy Statement in line with the MTBF requirements contained in Directive 2011/85/EU. - any deviation from the budgetary objectives contained in the 2013-2015 framework will be properly documented and reasons provided to the programme partners. - Additional expenditure savings: - ensure additional expenditure savings, including by revising the formula for calculating overtime compensation on weekdays and in weekends for state officers and apply the revision pro rata in the case of hourly paid employees. ### Fiscal policy in 2015–16 - Targets: - 2015 general government primary balance: deficit of no more than EUR 344 million (2.1% of GDP). - 2016 general government primary balance: surplus of at least EUR 204 million (1.2% of GDP). - Budget law timing and ceilings: - after review by and consultation with the programme partners the 2015 and 2016 Budget Laws will be adopted, respectively, by December 2014 and December 2015. - the 2014-2016 expenditure ceilings will be updated for the period 2015-2017 and will accompany the 2015 Budget Law document. - any deviation from the budgetary objectives contained in the 2014-2016 framework will be properly documented and reasons provided to the programme partners. - Forward planning for 2017–18: - in Q2-2016, the Cypriot authorities will present the programme partners with a provisional list of measures to attain a primary surplus of 3% of GDP in 2017 and 4% of GDP in 2018. - the measures required will be included in the draft 2017 Budget Law. *Source: _cr13293 - 2. Fiscal policy* ### 3. Fiscal-structural measures ### 3. Fiscal-structural measures ### Key objectives - Improve the efficiency of public spending and the budgetary process via an effective Medium-Term Budgetary Framework (MTBF) fully compliant with the Directive on requirements for budgetary frameworks and the Treaty on Stability, Coordination and Governance (TSCG). - Implement further reforms of the pension system to address the high projected increase in pension spending. - Take further steps to control the growth of health expenditure. - Enhance tax revenues by improving tax compliance and collection. - Reform the public administration to improve functioning and cost-effectiveness, notably by reviewing the size, employment conditions and functional organisation of public services. - Reform the overall benefit structure to produce efficient use of resources and ensure balance between welfare assistance and incentives to take up work. - Elaborate a programme for improving the efficiency of state-owned and semi-public enterprises and initiate a privatisation programme. ### Pension reform - Objectives of pension reforms: - reduce the increase in pension spending; - ensure the long-term financial viability of the pension system through 2060; - limit the fiscal subsidy to the General Social Insurance Scheme for credited contributions for current and future pensioners and for the non-contributory pension. - Measures implemented/agreed: - separate in accounting terms the non-contributory pension benefit from the insurance-based (contributory) pension scheme (in place since July 2013). The non-contributory part will be tax financed; - measures adopted to ensure that total annual public pension benefits do not exceed 50% of the annual pensionable salary earned at the time of retirement from the post with the highest pensionable salary of the official's career in the public sector and broader public sector (except for pension benefits for Members of the House of Representatives, for whom the measures will be adopted by mid-October 2013 and enter into force by 1 January 2014); - ensure that all of the measures aimed at the GEPS will apply also to pension schemes in the broader public sector and to pension schemes for hourly-paid public employees. - Actuarial study and follow-up: - An actuarial study for the GSIS will be submitted by end-August 2013, for peer review in the Ageing Working Group of the Economic Policy Committee. - The study should project the scheme’s finances on a cash basis and, for revenues, should not take into account any government subsidy (i.e. contribution that is currently at 4.3% of the payroll and the return on the accumulated notional reserves as at the start of the projection period), with the exception of credited contributions and the contributions made by the government as an employer on behalf of its employees. - On expenditures, the study should only take into account benefits related to contributions paid and credited contributions, excluding costs related to the top-up for the minimum pension (which is considered tax financed). - The study should analyse impact of additional reform options such as benefit reductions (while considering adequacy), an increase in the statutory retirement age and increases in contribution rates or combinations thereof, taking into account the impact on labour costs. - After review and consultation with programme partners, if needed, a comprehensive reform aiming to establish long-run viability will be carried out; this reform will be adopted by end-December 2013 and enter into force in Q1-2014. ### Health care expenditure - Measures to strengthen sustainability and efficiency of public healthcare provision: - preserve and implement all fiscal measures relating to compulsory health-care contribution for public servants and public servant pensioners to be reviewed by Q2-2014 with the programme partners and all co-payments for using public health care services; - restructure public hospitals according to the action plan as approved by the Council of Ministers at end-June 2013 and aim at full implementation by Q2-2015; - taking into account results of the updated actuarial study and after consultation with programme partners, implement without further delay a National Health System (NHS), to be in place by end-2015, ensuring its financial sustainability while providing universal coverage and considering the possibility of implementation in stages by end-2015; - secure adoption by the Council of Ministers of a binding set of contingency measures (e.g. revision of the basket of publicly reimbursable medical services and products, cuts in tariffs for medical products and providers of medical services, limits to the volume of reimbursable products and services) by Q4-2014, to ensure agreed budget limits of public health expenditure are not exceeded; - complete the IT-infrastructure necessary for implementing the NHS, explore all options for improving the IT-infrastructure via the most cost-effective web-based applications as an alternative to the currently-defined IT tender by Q4-2013; - review income thresholds for free public health care in comparison to the eligibility criteria for social assistance, while ensuring that co-payments to public health care are set so as to protect individuals/households effectively from catastrophic health expenditures by Q4-2013; - continue to publish clinical and prescription guidelines and to audit their implementation; continue to establish the system for health-technology assessment; periodic reviews of the basket of publicly-reimbursable medical services will be conducted based on objective, verifiable criteria, including cost-effectiveness criteria (health technology assessment will contribute when feasible); prepare quarterly reports on the results of the respective workstreams; - introduce a coherent regulatory framework for pricing and reimbursement of goods and services based on the actual level of costs incurred in accordance with Article 7 of Directive 2011/24/EU of the European Parliament and of the Council of 9 March 2011. An interim report will be ready by Q3-2013; - continue to code inpatient cases by the system of diagnosis-related groups (DRGs) with the aim of replacing the current hospital payment system by payments based on DRGs by Q3-2013; - in a first step, establish working time in the Health Service, in conjunction with moving the starting time by half an hour (from 7.30 to 8.00) and extending the flexibility period from a half to one hour. With this modification, the weekly working hours of public officers remain unchanged, but are distributed throughout the year as follows: 37 ½ hours per week, 7 ½ hours per day, daily (Monday to Friday): 8.00/9.00 to 15.30/16.30. The same applies for the transitional period of 1.1.2013-31.8.2013 but the starting time remains the same (7:30) and thus the ending time is moved back by half an hour (15:00/16:00). Following a review, in a second step, revise the regular working hours and stand-by shifts of healthcare staff, including rules to increase the mobility of staff; revise current regulations on overtime pay and fully implement existing laws on recording/monitoring overtime payments (see 3.10) by Q1-2014. - Consider establishing a system of family doctors acting as gate-keepers for access to further levels of care. ### Budgetary framework and public financial management - Fiscal Council and FRBSL: - provide for establishment of a Fiscal Council with a statutory regime, functions, nomination procedures for its governing body and funding arrangements grounded in the high-level Fiscal Responsibility and Budget System Law (FRBSL), which will be adopted by Q4-2013 (including an implementing text pertaining to Fiscal Council staff and a draft MoU on exchange of information between the Fiscal Council and the Ministry of Finance); - enact a FRBSL applicable to the entire general government sector. The umbrella law will encompass macro-fiscal policy-making, and budget formulation, approval and execution. It will take on-board and deepen existing provisions transposing Council Directive 2011/85/EU on requirements for budgetary frameworks, and implementing the Two-Pack EU Regulation 473/2013 and the Fiscal Compact of the Treaty on Stability, Coordination and Governance (TSCG) on the basis of the Common Principles for national fiscal correction mechanisms laid down in Commission Communication COM(2012)342, with implementing texts (on budget documentation and statistics) ensuring adopted measures are fully effective by Q4-2013. - Expenditure controls (to avert overspending and arrears), by Q4-2013: - Remove the risk of overspending by making sure all spending commitments are timely and properly recorded and reported in the accounting system. - Improve monitoring of government guarantees through a risk assessment analysis. To this end, amend the Public Debt Management Law, by end-December 2013, to ensure a proper risk assessment of the outstanding stock of government guarantees and ensure appropriate human resources to that end. ### Public private partnerships (PPPs) - Actions required: - create an inventory of PPPs including objectives of current and planned PPPs and detailed information on signed contracts, including nature, private partner, capital value, future service payments, size and nature of contingent liabilities, amount and terms of financing. In addition, compile an inventory of contingent liabilities with detailed information (nature, intended purpose, beneficiaries, expected duration, payments made, reimbursements, recoveries, financial claims established against beneficiaries, waivers of such claims, guarantee fees or other revenues received, indication of amount and form of allowance made in the budget for expected calls, and forecast and explanation of new contingent liabilities entered into in the budget year). The inventories will be shared by Q3-2013 with the programme partners. As of 2014, the inventories will be updated annually and included as “Statement of PPPs” and “Statement of Contingent Liabilities” in appendices to the annual budget law and to the annual financial report; - put in place an adequate legal and institutional framework for public investment projects, including PPPs, to assess fiscal risks and to monitor execution through: (i) establishing an effective gateway process that verifies the fiscal affordability of projects; (ii) adapting fiscal management laws to formalize the role of the Minister of Finance and his services (i.e. the Ministry, Planning Bureau and Treasury) in reviewing and approving public investment projects and in particular PPPs at critical points in the gateway process; and (iii) developing financial reporting and accounting rules that ensure timely and transparent communication of public investment project and PPP related obligations. The legal basis for managing public investment and specifically PPPs will be included in the FRBSL, which will be drafted by Q3-2013 and implemented by Q4-2013; - commit not to enter into any new tendering process and not to sign any new PPP contract before implementation of the legal and institutional PPP framework, excluding any project having reached commercial close by end-October 2012. ### State-owned enterprises and privatisation - Inventories and governance: - establish an inventory of assets owned by central government and local authorities, including real estate and land. The inventory shall include all SOEs, reflecting up-to-date valuations of those with the highest commercial value by Q3-2013. The inventory will indicate which SOEs could be subject to divestment or restructuring or liquidation. The inventory of the largest and most valuable real estate and land assets (those of market value exceeding EUR 1 million) will be ready by Q3-2013. The full inventory of all assets (SOEs, real estate and land) will be completed by Q4-2013. The inventory will be gradually submitted to the programme partners; - prepare a plan to strengthen the governance of SOEs in accordance with international best practices and draft a report reviewing the operations and finances of SOEs (see 3.10) by Q3-2013. The report will assess these companies' business prospects, the potential exposure of the government to the SOEs and the scope for orderly privatisation. The Cypriot authorities will adopt the necessary legal changes to fulfill this requirement by Q4-2013. No additional SOEs will be created throughout the duration of the Programme; - submit to the House of Representatives a draft law to regulate the creation and the functioning of SOEs at the central and local levels and enhance the monitoring powers of the central administration, including reporting on SOEs in the context of the annual budgetary procedure by Q4-2013. - Privatisation plan: - Consider privatisation prospects of SOEs and semi-governmental organisations (SGOs), including, inter alia, CyTA (telecom), EAC (electricity), CPA (commercial activities of ports), as well as real estate/land assets. For privatisation of natural monopolies, an appropriate regulatory framework is a prerequisite. Provision of basic public goods and services by privatised industries will be fully safeguarded, in line with national policy goals and in compliance with the EU Treaty and appropriate secondary legislation rules; - Privatisation plan will be based on the report reviewing and assessing operations and finances of SOEs (3.5), as well as the inventory of assets. The privatisation plan will be finalised after consultation with programme partners, including asset-specific timelines and intermediate steps by November-2013; - Implement specific legal and institutional framework for the privatisation process by Q4-2013, after consultation with programme partners; - The privatisation plan identified by the Government after consultation with the programme partners will raise at least EUR 1 billion by the end of the programme period and an additional EUR 400 million by 2018 at the latest. ### Revenue administration, tax compliance, and international tax cooperation - Reform objectives: - reinforce efficiency and effectiveness of revenue collection capacity and the fight against tax fraud and evasion, with a view to increasing fiscal revenue. - Reform comprises a short-term programme of measures to enhance compliance, efficiency and effectiveness, and a comprehensive long-term reform covering risk management and establishment of a new integrated function-based tax administration structure, integrating existing IRD and VAT services. - Short-term programme (to be implemented by Q4-2013) — legislative changes to enhance tax collection and voluntary compliance: - attribute personal responsibility for payment of company taxes to those who — in the case of non-listed companies — truly and effectively control a company and to the responsible manager for fraudulent filing of company taxes; - harmonise legislation among tax types so that not paying taxes is a criminal offense regardless of the type of tax and ensure tax fraud is prosecuted as a criminal offense; - strengthen powers by the tax authorities to ensure payment of outstanding tax obligations, e.g. by having authority to seize corporate assets, prohibiting alienation or use of assets, including property and bank accounts, by the taxpayer. - Short-term programme — improve efficiency and effectiveness of the administration: - ensure staff mobility between different tax administration entities to ensure appropriate staffing of entities with high revenue collection capacities; - optimise use of IT systems in the tax administration based on: (i) facilitating information exchange between tax administration entities and with other relevant authorities, taking into account legal provisions for data protection; and (ii) enhancing the use of e-filling of tax returns and e-payment (e.g. by allowing payment through bank transfers); - enact necessary legislation to establish self-assessment for all income taxpayers by changing from a pre-assessment verification of income tax returns to post assessment audits selected on the basis of risk; - decide on a joint audit programme for large taxpayers, to be conducted in 2014; - develop a joint work programme for conducting targeted audits and enhancing voluntary compliance of known high-risk groups; - conduct an independent formal review to recommend changes to legislation to determine the appropriate level of discretion available to the tax administration management and how it is exercised. - Long-term reform: - A comprehensive compliance strategy will be put in place by Q2-2015. The strategy will be firmly based on analytical work on risk identification and analysis and on an evaluation of different risk treatment strategies. Work for the risk identification and analysis will begin in Q4-2013. - The full integration of the two tax departments will be completed in several phases and will be accompanied by a set of flanking reform measures, such as the development of a common tax procedure code. As a first step, the authorities will, *Source: IMF staff report chapter "3. Fiscal-structural measures" (Cyprus).* ### 1. establish the project management, including a high-level governmental steering ### establish the project management, including a high-level governmental steering committee chaired by the Minister of Finance and an executive technical committee, which manages the development and implementation of the reform plan and which will be chaired by the Permanent Secretary of the Ministry of Finance by Q3-2013 ### Project management and reform planning - Establish a high-level governmental steering committee chaired by the Minister of Finance and an executive technical committee chaired by the Permanent Secretary of the Ministry of Finance by Q3-2013. - Develop a reform plan that reflects the recommendations of the TA received in February 2013; the reform plan will be agreed with program partners and approved by the government by Q4-2013. - Reinforce the tax unit in the Ministry of Finance responsible for tax policy formulation and for monitoring implementation of tax policy and revenue performance (including by measuring the tax gap) by Q2-2014. ### Exchange of tax information and compliance with EU/OECD standards - Safeguard timely and effective exchange of information in regard to tax matters; fully ensure applicability of laws and standards governing international exchange of tax information. - Enhance timely delivery of relevant and accessible tax information to other EU Member States. - Commitments: - fully transpose and implement Council Directive 2011/16/EU on administrative cooperation in the field of taxation and abide by Art 7 of the Directive and Art 10, 19 and 21 of Council Regulation 904/2010 on administrative cooperation and combating fraud in the field of value-added tax, which prescribe specific timeframes within which Member States shall provide information to each other; - ensure the systematic follow-up and use of information received from other countries about savings income payments received by Cyprus resident individuals and savings income payments received by entities and legal arrangements such as trusts under Cyprus law, notably entities and legal arrangements the beneficial owners of which are resident in other EU Member States; - improve capacity of the Inland Revenue Department to follow-up on tax information received from other countries, e.g. by permitting the department to access databases of other public entities in order to facilitate and expedite the identification of the taxpayer; - implement the recommendations put forward in the in-depth review of Cyprus' legal and regulatory framework under the OECD Global Forum on Transparency and Exchange of Information for Tax Purposes and commit to address any shortcomings to be identified in the forthcoming evaluation of implementation issues. - In the context of Council Directive 2003/48/EC (EUSD): - continue to provide to the EC all necessary and available information/statistics extracted from the data exchanged under the FISC153; - on an annual basis and starting from the tax year ending on 31 December 2013, provide to the EC a breakdown of the information provided under the EUSD by sector of activity of the paying agents, including possible sanctions actually claimed of paying agents for their application of the EUSD; - in 2015, provide to the European Commission a report on the results of audits conducted in 2014. - The Cypriot authorities (CBC) will provide on an annual basis detailed sectoral deposit statistics with a breakdown of non-resident deposits by country. ### Immovable property tax reform — objectives and measures - Objectives: - increase revenue and improve fairness of the tax burden by levying the recurrent property tax on current market values; - reduce overhead cost in tax base administration. - Agreed measures: - implement a property price index that establishes the average market valuation in 2013 by square meter of habitable surface and land plot; index shall be operational to provide imputed market valuations for each cadastral plot by Q2-2014, in time for the immovable property tax collection in 2014; - index shall vary according to location and zoning as well as other tangible building- and plot-related characteristics; - implement a methodology for annual updates of such imputed market valuations; - implement the recurrent immovable property tax based on such imputed market valuations by Q3-2014; - tax rates shall reflect the progressivity and revenue of the preceding property tax; - for co-owned land plots, individual owners shall be taxed according to ownership proportions as provided in the cadastre; - establish the legal basis for a mandatory annual adjustment of the property unit tax base by a competent authority by Q3-2014. - Studies to be initiated by Q3-2013 and implemented by 1 January 2015: - a study on refining parameters of the imputed property market value index within bounds of administrative and legal simplicity, including: - assess feasibility of a unit tax base for individual dwellings; - report on a mechanism to dampen cyclical variations in the index; - a study on scope of consolidating the collection and administration of the municipal recurrent property tax and sewage tax, including: - review existing exemptions and derogations from property taxation; - report on scope of shifting revenues from transaction fees and taxes to recurrent taxation. ### Public administration reform — working time, reviews, and restructuring - Working time changes (first step): - starting on 1 September 2013, establish working time in the Public Service by moving the starting time by half an hour (from 7:30 to 8:00) and extending the flexibility period from a half to one hour; - weekly working hours remain unchanged and are distributed as follows: 37 ½ hours per week, 7 ½ hours per day, daily (Monday to Friday): 8.00/9.00 to 15.30/16.30; - for the transitional period of 1.1.2013-31.8.2013 the starting time remains 7:30 and ending time is moved back by half an hour (15:00/16:00). - Working time changes (second step): - further reductions of overtime and related costs to the public sector wage bill by making working time more flexible to cover, as a minimum, service hours from 7:00 until 17:00 in the entire public sector and service hours from 7:00 to 19:00 for public sector services with extended operating hours (including, but not limited to, healthcare and security) under regular working time; - working hours outside regular working time shall be limited by enforcing strict controls, including requiring pre-approval of any non-emergency work outside regular working time by Q1-2014. - Independent external review of public administration reforms: - horizontal element (undertaken by the World Bank and the UK public administration): - review appropriate system of remuneration and working conditions/conditions of employment in the public sector (e.g. annual vacation leave, sick leave, maternity leave, working time) in relation to the private sector and other EU countries and based on best practices; - introduce a new performance based appraisal system in the public sector linking performance with the remuneration system/increments; - results of the horizontal review will be presented by Q3-2014; - based on findings, agree on a reform after consultation with programme partners, submit to the House of Representatives for approval and implement by Q4-2014. - sectoral element will cover: - examination of the role, competences, organisational structure and size/staffing of relevant ministries, services and independent authorities; - examination of possibility of abolishing or merging/consolidating non-profit organisations/companies and state-owned enterprises; - re-organisation/re-structuring of local government; - sectoral element comprises two batches: - first batch (World Bank and UK public administration) covering Ministries of Agriculture, Education and Health, local government and the Department of Registrar of Companies and Official Receiver; results presented by Q1-2014; based on findings, agree on reform, submit to House of Representatives and implement by Q2-2014; - second batch covering remaining Ministries (Labour and Social Insurance, Communications and Works, Energy, Commerce, Industry and Tourism, Interior, Defense, Justice and Public Order, Foreign Affairs) and the Ministry of Finance (including the Treasury and the Planning Bureau under the PFM), all SOEs (subject to decisions under provision 3.5 regarding privatisation, restructuring or liquidation), President’s Office, Council of Ministers, and Constitutional and Independent Services; results presented by Q4-2015; based on findings, agree on reform, submit to House of Representatives and implement by Q1-2016. ### Welfare system reform — objectives, timetable, and measures - Objective: - ensure efficient use of public funds within the welfare system while balancing welfare benefits and incentives to take up work, and enhancing protection of vulnerable households. - Implementation date: - implement the reform plan of the welfare system as of 1 July 2014. - Reform approach: - consolidate existing social benefits by streamlining, merging some benefits and phasing out others, and integrating them under the Ministry of Labour and Social Insurance; - improve targeting of benefits; - provide work incentives to avoid welfare dependency. - Steps and deadlines: - define the minimum consumption basket in terms of composition and weights (Q3-2013); - refine the costing and coverage of the new guaranteed minimum income scheme (GMI) which will replace the existing public assistance scheme (end-October 2013); - refine means testing by introducing a common definition of income sources, financial assets and movable and immovable property to ensure consistency of eligibility criteria across different benefit schemes (Q4-2013); - ensure a comprehensive database and necessary IT requirements are in place to support administration of the reformed welfare system (by May 2014); - transfer all relevant competences and responsibilities related to administration and provision of all social benefits to the Ministry of Labour and Social Insurance, appropriately equipped in financial and human resources, with staff reassigned from other departments by April-2014, except benefits provided by the Ministry of Education and Culture (education benefits) and the Ministry of Interior (benefits to displaced people); - draft legislation will be submitted for review to the programme partners before submission to the House of Representatives; the law will be adopted by end-May 2014. - Fiscal consistency: - the reformed welfare system must be consistent with the fiscal targets defined in this MoU. ### Labour market — objectives and specific reforms - Key objectives: - implement a reform of the system of wage indexation to ensure sustainable improvement in competitiveness and allow wage formation to better reflect productivity developments; - prepare and implement comprehensive reform of public assistance to balance support and incentives to work, target income support to the most vulnerable, strengthen activation policies and contain fiscal impact of rising unemployment; - link any change in the minimum wage to economic conditions to attenuate adverse competitiveness and employment effects. - Cost of living adjustment (COLA) of wages and salaries — reform elements: - lower frequency of adjustment: base period for calculating indexation (COLA) lengthened from current period of six months to twelve months; indexation would take place on 1st January each year; - automatic suspension mechanism: if in the second and third quarters of a given year negative rates of growth of seasonally adjusted real GDP are registered, no indexation would be effected for the following year; - move from full to partial indexation: rate of wage indexation set at 50% of the rate of increase of the underlying price index over the previous year. - suspension of wage indexation in the wider public sector will remain in place until the end of the programme. - a tripartite agreement will be pursued with social partners for application of the reformed system in the private sector by end-2013. - based on current economic outlook, wage and salary indexation is foreseen not to be applied in the private sector until 2014. - Minimum wage: - over the programme period, any change in the minimum wage covering specific professions and categories of workers should be in line with economic and labour market developments and will take place only after consultation with the programme partners. - Activating the unemployed and combating youth unemployment: - conduct an overall assessment of activation policies and instruments for income support after expiration of unemployment insurance benefits; reform of public assistance should ensure social assistance serves as a safety net while safeguarding incentives to take up work and ensuring consistency with welfare reform (section 3.11). - Identified challenges in activation policies include: - difficulties faced by the Public Employment Services in serving an increased number of unemployed people; - lack of a coherent and homogeneous framework for continuous monitoring and evaluation of different schemes; - need for increased coordination across different ministries and departments and need to reduce fragmentation; - absence of a data warehouse impeding automatic and immediate processing and exchange of information. - Policy proposals to be submitted to programme partners by end-2013, including: - development of a coherent methodology for continuous monitoring and evaluation of activation programmes to be applied consistently across schemes; - development of appropriate IT infrastructure to automatize better and more comprehensive collection, processing and exchange of data across schemes and with social welfare administration; - centralise administration of all activation programmes and enhance coordination across departments responsible for various programmes; - enhance staff mobility to support administrative capacity of the public employment services to better respond to increased demand; - review and enhance cooperation between the public employment service and benefit-paying institutions in activation of the unemployed. *CYPRUS — excerpt from IMF document* ### 4.5 With one of the steepest increases in the youth unemployment rate in the EU and with ### _cr13293 - 4.5 With one of the steepest increases in the youth unemployment rate in the EU and with ### Youth unemployment and NEETs - Cyprus faces one of the steepest increases in the youth unemployment rate in the EU and a rapid rise of young people not in employment, education or training (NEETs). - Policy action: - The Cypriot authorities will present by Q4-2013 a draft action plan for the implementation of measures envisaged for support under the Youth Employment Initiative, in line with the conclusions of the European Council of June 2013. - Measures targeted to youth shall be well integrated within the broader system of activation policies (section 4.3) and be coherent with the reform of the social welfare system (section 3.11) and the agreed budgetary targets. ### Goods and services markets — Key objectives - Address structural issues to rebalance the Cypriot economy, restore growth potential and improve competitiveness. - Remove unjustified obstacles in services markets to boost growth in a services-intensive economy. - Improve quality and reduce cost of regulated professional services to enhance the business environment and competitiveness. - Reinvigorate tourism competitiveness as a major sector and potential growth driver. - Improve regulation of administration related to the real estate sector to foster housing market functioning and foreign demand. - Exploit domestic offshore natural gas potential to reduce energy import dependency and improve energy security and sustainability, while recognizing financing, planning, market design, and regulatory challenges. ### Services directive: Sector-specific legislation - The Cypriot authorities will adopt any remaining necessary amendments to the sector-specific legislation (e.g. construction, tourism, car rental services, employment agencies) to fully implement the Services Directive, easing requirements related to provision of services and establishment. - Amendments will be adopted by Q3-2013. - Rules referring to the calculation of fees for professional services (including those adopted by professional bodies) need assessment for compliance with internal market and competition principles, except as otherwise agreed with programme partners; the opinion of the Cypriot Commission for the Protection of the Competition (CPC) and of programme partners is required. ### Reform of regulated professions - The Cypriot authorities will: - eliminate any existing total bans on the use of a form of commercial communication (advertising) in specific regulated professions, such as veterinarians, as required by the Services Directive by Q3-2013; and - further improve the functioning of the regulated professions sector (such as lawyers, engineers, architects) by carrying out a comprehensive review of requirements affecting the access and exercise of activity: - review completed by Q3-2013 for a list of priority professions, to be agreed with programme partners before mid-August 2013; - review completed by Q4-2013 for the rest of regulated professions; - following completion, requirements that are not justified or proportional will be eliminated by Q1-2014. ### Competition and sectoral regulatory authorities - Strengthen independence and effectiveness of the Commission for the Protection of Competition (CPC) by: - guaranteeing sufficient and stable financial means and qualified personnel to ensure its effective and sustained operation by Q4-2013; - enhancing the effectiveness of competition law enforcement by adopting the necessary amendments to the legislation on mergers and antitrust, including the power to conduct sector enquiries by Q4-2013; - promoting a more active role of the CPC in the area of advocacy, with the objective of safeguarding and promoting competition by Q4-2013. - Increase competition by ensuring that powers and independence of the National Regulatory Authorities (NRAs) remain effective, and enable them to have necessary resources in line with their duties and in accordance with the EU Regulatory Framework. - Any legislative amendments necessary to reach these objectives will be adopted by Q4-2013. ### Housing market and immovable property regulation - Key risks: legal disputes from incomplete documentation of ownership and property rights and the slow pace of judicial procedures. - The Cypriot authorities will: - enact legislation for mandatory registration of sales contracts for immovable property by Q3-2013 and implement guaranteed timeframes for the issuance of building certificates and title deeds by Q1-2014; - ensure that the title deed issuance backlog drops to less than 2,000 cases of immovable property units with title deed issuance pending for more than one year by Q4-2014 (backlog refers to (i) applications, (ii) units that are eligible for the "ex officio" issuance of title deeds, required certificates and permits); - take action to accelerate the swift clearing of encumbrances on title deeds to be transferred to purchasers of immovable property by Q4-2014; - every three months, publish quarterly progress reviews, including executive commentaries on developments related to the issuance of building and planning permits, certificates, title deeds, title deed transfers and related mortgage operations, starting end-July 2013; - implement electronic access to the registries of title deeds, mortgages, sales contracts and cadastre for the monetary financial institutions and for all government services by Q4-2014; any requirements on the proof of legal interest for access to these data by these bodies shall be abolished by October 2013; - amend the procedure on the forced sale of mortgaged property to allow for private auctions by amending relevant legislation and rules in relation to the forced sales of mortgaged property either by adopting similar principles of the rules for immovable property recovery in bankruptcy regulations or by enacting new legislation by Q4-2013; - improve the pace of court case handling, in order to eliminate court backlogs by Q1-2016 and provide for specialized judges by Q4-2013, with instructions for the expeditious processing of cases under commercial and immovable property laws. ### Tourism - Rationale: tourism is one of Cyprus' largest economic sectors and a potential driver of future growth and employment. - The Cypriot authorities will: - provide a concrete action plan leading to the implementation of the quantified targets identified, inter alia in the recently revised Tourism Strategy 2011-2015 by Q3-2013; - present a progress report on the implementation of the action plan twice per year, starting in Q4-2013, including an assessment of its implementation based on performance indicators; - amend the current hotel and other relevant legislation (e.g. the immovable property law and town planning policies), in order to facilitate mixed-use developments, by Q4-2013; - provide a report on the analysis and assessment of concrete needs based on the existing and the future air services agreements by Q4-2013; this report will form the basis for an aeropolitical strategy leading to the adaptation of Cyprus' external aviation policy, while ensuring sufficient air connectivity; - launch the aeropolitical strategy accompanied with a concrete action plan by Q1-2014; implementation of the action plan will be reviewed annually by the Cypriot authorities, starting in Q1-2015. ### Energy - The Cypriot authorities will: - ensure, without delay, that the Third Energy Package is fully and correctly implemented particularly during and after the transformation of the sector; and provide clarity on the intended use of the available 'isolated market' and 'emergent market' derogations and indicate their intended duration of the latter derogations; - formulate a comprehensive strategy for the rearrangement of the Cypriot energy sector, to be developed under the full authority of the Cypriot Government, including at least three key elements to be presented to the programme partners according to the timeline specified: 1. a roll-out plan for the infrastructure required for the exploitation of natural gas, taking into account possible technical and commercial uncertainties and risks, covering required investments, associated costs, financing sources and methods, related ownership structure; related major planning risks and bottlenecks; and a projection of the revenue streams over time; first version by Q3-2013; 2. a comprehensive outline of the regulatory regime (CERA) and market organisation for the restructured energy sector and gas exports, with a view to introducing open, transparent, competitive energy markets and taking into account the size of the Cypriot economy, regional market integration, independent regulatory oversight, and EU targets for energy efficiency, renewable energy and carbon emissions; the outline should include institutional framework description, type and scope of regulatory instruments, forms of government ownership and involvement, sequence and timing of major actions, potential for wholesale markets for gas and electricity (with electricity open to non-producing traders), freedom for customers to choose supplier, full unbundling of gas suppliers and customers, in particular electricity companies, and an appropriate sales framework for the off-shore gas supply aimed at maximising revenues; by Q4 2013, with a view to a final outline by Q2 2014; 3. a plan to establish the institutional framework for the management of hydrocarbon resources, including a resource fund to receive and manage public revenues from offshore gas exploitation and sales (direct revenues, fees, dividends etc). Preparatory phase to include required legal steps and their adoption; the resource fund should have a solid legal base and governance structure drawing on internationally-recognized best practices; clear rules governing inflows and outflows should be established as part of Cyprus' budgetary framework, coupled with clear accounting rules regarding dividend and fees from government entities and stakes in the energy sector; these will be anchored in the FRBSL (see 3.3) which will be adopted by Q4-2013. - The three key elements are strongly interdependent and need to be developed in parallel. - The strategy should take into account uncertainty over the actual size of domestic, offshore, commercially-viable natural gas fields and possible changes in international gas prices and demand; data should be based on alternative world energy scenarios from an internationally-reputed organisation. - The plan will be based on an appropriate level of technical assistance on technical aspects. ### Technical assistance - Given the nature of the structural challenges, including lack of specific skills in some areas and scarcity of resources, the Cypriot authorities will provide a request for technical assistance needs during the programme period, including the on-going technical assistance projects by end-September 2013. - The request will identify and specify areas of technical assistance or advisory services considered essential for the implementation of the MoU and where the Cypriot authorities intend to seek such services, in coordination with programme partners. - All technical assistance provided by the European Commission, other than technical assistance provided directly under the Structural and other EU funds, will be coordinated by the Support Group for Cyprus. *International Monetary Fund — Cyprus memorandum of understanding (excerpts)* ### Annex 1 ### Annex 1 ### Fiscal measures with effect in 2012 - Expenditure measures - I.1 Implement a scaled reduction in emoluments of public and broader public sector pensioners and employees as follows: EUR 0-1000: 0%; EUR 1001-1500: 6.5%; EUR 1501-2000: 8.5%; EUR 2001-3000: 9.5%; EUR 3001-4000: 11.5%; above EUR 4001: 12.5%. - I.2 Extend the suspension of the practice of COLA for the public and broader public sector until the end of the programme (Q1-2016) (see 4.1). - I.3 Extend the freeze of increments and general wage increases in the public and broader public sector and temporary contribution in the public, broader public and private sectors on gross earnings and pensions by three additional years until 31 December 2016. - I.4 Reduce the number of public sector employees by at least four thousand five hundred over the period of 2012-16 by: i) freezing the hiring of new personnel on first entry posts in the broader public sector for three additional years until 31 December 2016; ii) implementing a policy of recruiting one person for every four retirees (horizontal); iii) introducing measures to increase the mobility of civil servants within and across line ministries (see 3.10); and iv) implementing a four-year plan aimed at the abolition of at least 1880 permanent posts (see I.16). - I.5 Freeze the hiring of new hourly paid employees and enforce immediate application of mobility within and across ministries and other government entities. In the case of health and security posts, recruitment of one person for every five retirees will be possible to meet urgent needs. - Revenue measures - I.6 Appropriate a one-off additional dividend income collected from semi-governmental organisations. - I.7 Increase the bank levy on deposits raised by banks and credit institutions in Cyprus from 0.095% to 0.11% with 25/60 of the revenue earmarked for a special account for a Financial Stability Fund. - I.8 Introduce a mechanism for a regular review of excise taxes to secure the real value of excise tax revenue. Such a mechanism should be non-recurring and should, by no means lead to an automatic indexation mechanism of excise taxes to price developments. ### Fiscal measures with effect in 2013 - Expenditure measures - I.9 Ensure a reduction in total outlays for social transfers by at least EUR 113 million through: (a) the abolition of a number of redundant and overlapping schemes such as the mothers allowance, other family allowances and educational allowances; and (b) the abolition of supplementary allowances under public assistance, the abolition of the special grant and the streamlining of the Easter allowance for pensioners. - I.10 Ensure a reduction of at least EUR 29 million in the total outlays of allowances for employees in the public and broader public sector by: - i. taxing pensionable allowances provided to senior government officials and employees (secretarial services, representation, and hospitality allowances) in the public and broader public sector; - ii. reducing the allowances provided to broader public sector employees and reducing all other allowances of broader public sector employees, government officials and hourly paid employees by 15%; and - iii. reducing the daily overseas subsistence allowance for business trips by 15%. Ensure a further reduction the subsistence allowance of the current allowance when lunch/dinner is offered by 50% (20% - 45% of overseas subsistence allowance instead of 40% - 90% currently paid). - I.11 Reduce certain benefits and privileges for state officials and senior government officials, in particular by: - i. suspending the right to travel first/business class by state officials, senior government officials and employees with the exception of transatlantic travel. The right to business class travel shall be maintained for the President of the Republic of Cyprus and the President of the House of Representatives; - ii. abolishing the right to duty free vehicles for employed and retired senior public sector officials; and - iii. extending the wage freeze and temporary contribution on gross earnings to cover all state officials and permanent secretaries (129 individuals) for 2013-2016, including members of the House of Representatives. Include pensionable and tax-free allowances of these individuals in the calculation of their taxable income. Introduce a contribution of 6.8% on the pensionable earnings of these individuals. - I.12 Implement the following measures regarding the Government Pension Scheme (GEPS): - i. freeze public sector pensions; - ii. increase the statutory retirement age by 2 years for the various categories of employees; increase the minimum age for entitlement to an unreduced pension (by 6 months per year) to be in line with the statutory retirement age; while preserving acquired rights, introduce an early retirement penalty of 0.5% per month of early retirement so as to make early retirement actuarially neutral; - iii. reduce preferential treatment of specific groups of employees, like members of the army and police force, in the occupational pension plans, in particular concerning the contribution to the lump-sum benefits; - iv. introduce a permanent contribution of 3% on pensionable earnings to Widows and Orphans Fund by state officials who are entitled to a pension and gratuity. Introduce a contribution of 6.8% on pensionable earnings by officials, who are entitled to a pension and gratuity but are not covered by the government's pension scheme or any other similar plan; - v. amend Article 37 of the Pensions Law to abolish the provision according to which, in the case of death of an employee, if the deceased had a wife/husband at the time of his/her retirement and thereafter he/she remarried, his/her last wife/husband is considered a widow/widower. With the abolition of this provision, the second wife/husband will not be considered a widow/widower and thus she/he will not be entitled to pension; - vi. increase the contribution rate on the pensionable earnings of the members of the Tax Tribunal Council and the Tender Review Authority from 3.4% to 6.8%; and - vii. the contributions to the Widows and Orphans Fund will no longer be reimbursable. - viii. introduce an automatic adjustment of the statutory retirement age every 5 years in line with changes in life expectancy at the statutory retirement age, to be applied for the first time in 2018; - ix. introduce a change of indexation of all benefits from wages to prices; and - x. pension benefits will be calculated on a pro-rata basis taking into account life-time service as of January 2013 (in place since January 2013). - I.13 Implement further reform steps under the General Social Insurance Scheme by: - i. actuarially reducing pension entitlements from the General Social Insurance Scheme by 0.5% per month for retirements earlier than the statutory retirement age at the latest from January 2013, in line with the planned increase in the minimum age for entitlement to an unreduced pension to reach 65 (by 6 months per year), between 2013 and 2016; - ii. freezing pensions under the Social Security Fund for the period 2013-2016; - iii. abolishing the increase of pensions for a working dependent spouse under the General Social Insurance Scheme at the latest from January 2013 onwards. - iv. increase the minimum age for entitlement to an unreduced pension by 6 months per year to be brought in line with the statutory retirement age; - v. introduce an early retirement penalty of 0.5% per month of early retirement so as to make early retirement actuarially neutral; - vi. introduce an automatic adjustment of the statutory retirement age every 5 years in line with changes in life expectancy at the statutory retirement age, to be applied for the first time in 2018; - vii. gradually (1 year per year) extend the minimum contributory period in the system from the current 10 years to at least 15 years over the period 2013-17 (in place since December 2012); and - viii. ensure that pension entitlements that will accrue after 1 January 2013 are considered as personal income, thus becoming fully taxable also in the case in which they are received as a lump-sum payment. At the same time, employees will be granted the option of converting all or part of the lump-sum into an actuarially neutral annuity (in place since January 2013). - I.14 Reduce transfers by EUR 25 million from central government to state-owned enterprises and semi-public institutions. - I.15 Ensure a targeted reduction of budgetary appropriations for a series of semi-governmental organisations in the 2013 Budget Law, supported by well-defined activity-reducing measures. - I.16 Implement a four-year plan as prepared by the Public Administration and Personnel Department aimed at the abolition of at least 1880 permanent posts over the period 2013-2016. - Additional permanent expenditure measures for 2013 adopted prior to the first disbursement: - I.17 Introduce the following measures to control healthcare expenditure: - a. abolish the category of beneficiaries class "B" and all exemptions for access to free public health care based on all non-income related categories except for persons suffering from certain chronic diseases depending on illness severity. Introduce as a first step towards a system of universal coverage a compulsory health care contribution for public servants and public servant pensioners of 1.5% of gross salaries and pensions. The measure will be reviewed by Q2-2014 with the programme partners. For families with three or more dependent children, the participation in this health care scheme will be voluntary; - b. increase fees for medical services for non-beneficiaries by 30% to reflect the associated costs of medical services and create a co-payment formula with zero or low admission fees for visiting general practitioners, and increase fees for using higher levels of care for all patients irrespective of age; - c. introduce effective financial disincentives for using emergency care services in non-urgent situations; - d. introduce financial disincentives (co-payment) to minimise the provision of medically unnecessary laboratory test and pharmaceuticals; and - e. adopt a new decision by the Council of Ministers concerning a restructuring plan for public hospitals, improving quality and optimising costs and redesigning the organisational structure of the hospital management, by putting into practice recommendations from the 2009 "Public Hospital Roadmap". - I.18 Reduce the expenditure on various housing schemes by at least EUR 36 million by consolidating and streamlining the schemes for the displaced and the Comprehensive Housing Scheme, discontinuing the special grant for acquiring a first residence and ceasing the provision of loans and loan guarantees related to house construction and acquisition under all government-administered housing schemes. - I.19 Further streamline the Easter allowance to pensioners by limiting the benefit to pensioners with a monthly per household income of at most EUR 500. - I.20 Implement a scaled reduction in emoluments of public and broader public sector pensioners and employees as follows: EUR 0-2.000: 0.8%; EUR 2.001-3.000: 1%; EUR 3.001-4.000: 1.5%; above EUR 4001: 2.0 %. - Revenue measures - I.21 Increase excise duties on tobacco products, in particular on fine-cut smoking tobacco, from EUR 60/kg to EUR 150/kg. Increase excise duties on cigarettes by EUR 0.20/per packet of 20 cigarettes. - I.22 Increase excise duties on beer by 25% from EUR 4.78 per hl to EUR 6.00 per hl per degree of pure alcohol of final product. Increase excise duties on ethyl alcohol from EUR 598.01 to EUR 956.82 per hl of pure alcohol. - I.23 Increase excise duties on energy, i.e., on oil products, by increasing tax rate on motor fuels (petrol and gasoil) by EUR 0.07. - I.24 Increase the standard VAT rate from 17% to 18%. - I.25 Introduce a tax of 20% on gains distributed to winners of betting by the Greek Organisation of Football Prognostics S.A. (OPAP) and the National Lottery for winnings of EUR 5,000 or more. - I.26 Abolish all exceptions currently in place for paying the annual company levy of EUR 350. - Additional permanent revenue measures for 2013 adopted prior to the first disbursement: - I.27 Ensure additional revenues from property taxation of at least EUR 75 million by: (i) updating the 1980 prices through application of the CPI index for the period 1980 to 2012; and/or (ii) amending tax rates and/or (iii) amending value bands. - I.28 Increase the statutory corporate income tax rate to 12.5%. - I.29 Increase the tax rate on interest income to 30%. - I.30 Increase the bank levy on deposits raised by banks and credit institutions in Cyprus from 0.11% to 0.15% with 25/60 of the revenue earmarked for a special account for a Financial Stability Fund. - I.31 Complete the increase in fees for public services by at least 17% of the current values. ### Fiscal measures with effect in 2014 - Expenditure measures - I.32 Ensure a reduction in total outlays for social transfers by a at least EUR 28.5 million to be achieved through streamlining and better targeting of child benefits and educational grants, and abolition of social cohesion benefits provided by the welfare services. - I.33 Implement a further reduction in emoluments of public and broader public sector employees and pensioners by a flat rate reduction of 3% on all wages. - I.34 Introduce a fee on monthly transportation cards for the use of public transportation services by students and pensioners. - I.35 Introduce as of the budget year 2014 structural reform measures in the educational system, notably, a reduction of the number of teachers seconded to the Ministry of Education and Culture, the removal of 1:1.5 teaching time ratio from evening schools of general and technical and vocational education, the elimination of teaching time concession to teachers for being placed in two or more educational districts, the elimination of mentoring components for pre-service and in-service training for newly appointed teachers and the reduction of the cost of afternoon and evening programmes. - Revenue measures - I.36 Extend the application of the temporary contribution on gross earnings and pensions of public and private sector employees up to 31 December 2016 as follows: EUR 0 – 1,500: 0%; EUR 1,501 – 2,500: 2.5%; EUR 2,501 – 3,500: 3.0%; and > EUR 3,501 - : 3.5%. - I.37 Increase the standard VAT rate from 18% in 2013 to 19% in 2014. - I.38 Increase the reduced VAT rate from 8% to 9%. - I.39 Increase excise duties on energy, i.e., on oil products, by increasing the tax rate on motor fuels (petrol and gasoil) by EUR 0.05. - I.40 Increase the contributions, as of 1.1.2014, of salaried employees and employers to the GSIS by an additional 1 percentage point on pensionable earnings, i.e. 0.5 of a percentage point from employees and 0.5 of a percentage point from employers and 1 percentage point in the case of self-employed persons. *Annex 1 — Budgetary measures adopted by Cyprus in or after December 2012* ### 2.3 CBC to establish co-operation mechanisms with CySEC, the Cyprus Bar Association and ICPAC (for accountants) for exch ### _cr13293 - 2.3 CBC to establish co-operation mechanisms with CySEC, the Cyprus Bar Association and ICPAC (for accountants) for exch ### 1. Co-operation mechanisms - CBC to establish co-operation mechanisms with CySEC, the Cyprus Bar Association and ICPAC (for accountants) for exchanging information and ensuring supervisory coordination. - Timeline: Q3 – 2013 ### 2. Suspicious Transaction Reporting (STR) - Changes in the legal framework. - 3.1 MOKAS to reiterate and clarify through further training the requirements to report STRs, including the new duty to report issues relating to tax crimes as of December 2012, in coordination with relevant supervisory authorities. - Timeline: Q1 - 2014 ### 3. Transparency of beneficial ownership - Objective: Ensure that transparency and availability of beneficial ownership information is in line with international standards and best practice. - 4.1 Access to information - 4.1.1 Revision of Trust and Company Services Providers Law as appropriate and AML Law to ensure that adequate, accurate and timely information on the beneficial ownership of Cypriot legal persons and arrangements can be provided to the domestic competent authorities and their foreign counterparts; and revise the directives and circulars issued by supervisory authorities (CBC, CySEC, Cyprus Bar Association, ICPAC). - 4.1.2 In the case of nominees, either: - a) require nominee directors and nominee shareholders to disclose the identity of their nominator to the company and to the company register; or - b) require that all nominee directors and nominee shareholders be authorised or otherwise regulated (i.e. as lawyers, accountants or TCSPs) and maintain information on the identity of their nominator, which is to be made available to the competent authorities upon request. - A record of director's or shareholder's nominee status will be accessible through the registers under the TCSP Law, which list all regulated persons (i.e. lawyers, accountant and TCSPs). - Timeline(s): Q3 – 2013 Q3-2013 - 4.2 Company Registry - Efficiency of Companies’ Registrar as an important aid to CDD. - 4.2.1 Carry out a third party review of the functioning of the Companies’ Registrar and communicate results to the programme partners, and ensure the department of the registrar is appropriately resourced. - Timeline: End 2013 - 4.3 Register of Trusts - Enhance the transparency of trusts in line with international standards and best practice. - 4.3.1 CY to establish trust registries with the supervisory authorities for all express trusts established under CY law, where the name of the trust and the name and address of the trustee will be contained therein. The trust registers will be accessible by the supervisory authorities in order to facilitate them in their supervisory duties. - Timeline: Q3 - 2013 ### 4. Supervision of financial institutions - 5.1 Revise the AML/CFT supervisory structure within the CBC, ensuring it is adequately resourced - 5.1.1 Revise and/or establish organisation structure and management within the CBC’s Banking Supervision and Regulation Department (BSRD) to address AML/CFT matters, in order to conduct adequate, timely and proactive risk-based AML/CFT supervision. - Timeline: Q4 – 2013 - 5.1.2 CBC to ensure adequate human resources and technical capacity to undertake effective AML/CFT supervision. The level of resources should be commensurate with the size, complexity, and risk profiles of the financial institutions operating in the system. To meet this objective, if deemed necessary by the CBC, hire AML/CFT experts with the necessary professional skills and experience (e.g. foreign supervisors retired or on leave) – subject to necessary confidentiality restrictions. - Timeline: Q4 - 2013 - 5.2 Develop risk-based supervisory tool(s) for offsite surveillance/monitoring activities prior to implementation - 5.2.1 Design, develop, adopt and pilot, for a selected group of financial institutions, a risk assessment methodology and tool(s) that provides for: - a comprehensive analysis of inherent ML/TF risks within the following risk factors: customers, products & services, geographic locations/areas, and delivery channels; - an assessment of the internal control environment that should be in place to mitigate and/or control the inherent ML/TF risks, as identified and measured; - institutional risk profiles; - specific AML/CFT supervisory strategies (adapted to institutional risk profiles). - Timeline: Q4 - 2013 - 5.3 Develop risk-based supervisory tool(s) for onsite inspections prior to implementation - 5.3.1 Design, develop, adopt and pilot, for a selected group of financial institutions, a methodology for onsite activities, including the necessary examination/verification procedures for onsite inspections. Examination procedures, should include, at a minimum: - Corporate Governance; - Risk Assessment Systems; - Policies & Procedures; - Compliance Function; - Internal & External Audit Functions; - Training Program. - Timeline: Q1 – 2014 - 5.4 Establish Formal AML/CFT Training Program - 5.4.1 Establish a formal AML/CFT training program for CBC staff to ensure adequate implementation of the offsite and onsite tools. Develop and deliver customised AML/CFT training to supervisory staff in topics including, but not limited to: - newly developed offsite and onsite risk-based tools; - customer acceptance policies; - customer due diligence (CDD); - monitoring of transactions; - identification and reporting of STR; - funds transfers; - correspondent banking; - recordkeeping; - compliance function; - internal controls; - audit functions; - corporate governance; - risk assessment systems - Timeline: Q2 – 2014 - 5.4.2 Provide CBC supervisory staff with ongoing training to ensure adequate knowledge of risks and supervisory techniques. - Timeline: Ongoing - 5.5 Implement adequate supervision - 5.5.1 CBC to establish corrective actions and follow-up on the cases revealed by Deloitte. Apply appropriate enforcement actions with regard to any breaches of compliance, and apply sanctions if applicable. - Timeline: Q3 - 2013 - 5.5.2 On a quarterly basis, in the context of the programme review, starting Q4 2013 the CBC will on a confidential basis, share anonymised information with the programme partners, by granting access to supervisory assessments and information about enforcement actions applied for non-compliance and /or violations of laws and regulations. - Timeline: Q4- 2013, ongoing - Subsequent actions after development of tools (5.2 and 5.3): - 5.5.3.1 Implement and adjust the new risk-based offsite analytical tool(s) using the results of the pilot reviews, and develop an onsite supervisory program for 2014. - Timeline: Q2 - 2014 - 5.5.3.2 Assign institutional ML/TF risk profiles to financial institutions reviewed under the pilot exercise. - 5.5.3.3 Develop customised supervisory strategies for financial institutions reviewed under the pilot exercise. - 5.5.3.4 Apply the risk-based off-site analytical tools, assign ML/TF risk profiles, and developed customised supervisory strategies to all financial institutions under its responsibility. - 5.5.4.1 CBC to start implementing the new examination/verification procedures in line with the inspection program for 2014, and to adjust/fine-tune the procedures using the results of the pilot inspections. - 5.5.4.2 CBC to update the institutional risk profile and supervisory strategy based on the results of the pilot inspection. - Timeline for 5.5.4 series: Q2 - 2014 ### 5. Supervision and monitoring of lawyers, accountants and TCSPs - 6.1 Align resources with risks — Establish an effective monitoring structure for AML/CFT matters - 6.1.1 Ensure adequate human resources and technical capacity to undertake effective AML/CFT monitoring. The level of resources should be commensurate with the size, complexity, and risk profiles of each business and professional. To meet this objective, if deemed necessary by the supervisory authorities, hire AML/CFT experts with the necessary professional skills and experience (e.g. professionals having performed monitoring or supervision of these professions abroad) – subject to necessary confidentiality restrictions. - Timeline: Q4 - 2013 - 6.2 Develop risk-based tool(s) for Offsite surveillance/monitoring activities prior to implementation - 6.2.1 Design, develop, adopt, and pilot a risk assessment methodology and tool(s) that provides for: - a comprehensive analysis of inherent ML/TF risks within the following risk factors: customers, products & services, geographic locations/areas, and delivery channels; - an assessment of the internal control environment that should be in place to mitigate and/or control the inherent ML/TF risks, as identified and measured; - risk profiles; - specific AML/CFT monitoring strategies (adapted to institutional risk profiles). - Timeline: Q1-2014 (CBA and ICPAC) Q3-2014 (CySEC) - 6.2.2.1 Implement the new offsite analytical tool(s) through pilot reviews of a selected group of business and professionals. Adjust/fine-tune the offsite analytical tool(s) using the results of the pilot reviews. - 6.2.2.2 Assign ML/TF risk profiles to businesses and professionals reviewed under the pilot exercise. - 6.2.2.3 Apply the risk-based off-site analytical tools, assign ML/TF risk profiles, and developed customized supervisory strategies to all business and professions under monitoring. - Timeline: Q2-2014 (CBA and ICPAC) Q3-2014 (CySEC) - 6.3 Develop risk-based tool(s) for Onsite inspections prior to implementation - 6.3.1 Design and develop a methodology for onsite activities, including the necessary examination/verification procedures for onsite inspections. Examination procedures, should include, at a minimum: - Risk Assessment Systems - Policies & Procedures - Compliance Function - Timeline: Q2 – 2014 (CBA and ICPAC) Q3-2014 (CySEC) - Training Program - 6.4 Establish Formal AML/CFT Training Program - 6.4.1 Establish formal AML/CFT training program and develop and deliver customised AML/CFT training courses. Develop and deliver customised AML/CFT training to supervisory staff in topics including, but not limited to: - newly developed offsite and onsite risk-based tools - customer acceptance policies - customer due diligence (CDD) - monitoring of transactions - identification and reporting of STR - recordkeeping - compliance function - risk assessment systems - Timeline: Q2– 2014 (CBA and ICPAC) Q4-2014 (CySEC) - 6.5 Implement adequate supervision - 6.5.1 On a quarterly basis, in the context of the programme review, starting Q4-2013, the CySEC, CBA and ICPAC will, on a confidential basis, share anonymised information with the programme partners by granting access, to supervisory assessments and information about enforcement actions applied for non-compliance and /or violations of laws and regulations. - Timeline: Q4 – 2013, ongoing - Subsequent steps after development of tools (6.2 and 6.3): - 6.5.2 Implement the new offsite analytical tool(s) through pilot reviews of a selected group of lawyers, accountants and TCSPs. Adjust/fine-tune the offsite analytical tool(s) using the results of the pilot reviews, and come-up with a supervisory program for 2014. - Timeline: Q3 – 2014 (CBA and ICPAC) Q4-2014 (CySEC) - 6.5.3 Implement the new examination/verification procedures through pilot onsite inspections of a selected group of lawyers, accountants and TCSPs. Adjust/fine-tune the procedures using the results of the pilot inspections. - Timeline: Q3 – 2014 (CBA and ICPAC) Q4-2014 (CySEC) *Source: _cr13293 - 2.3 CBC to establish co-operation mechanisms with CySEC, the Cyprus Bar Association and ICPAC (for accountants) for exch* ### 5. Prior Actions for the first review have been met. On September 5, 2013, the ### _cr13293 - 5. Prior Actions for the first review have been met. On September 5, 2013, the ### Prior Actions and Legislative Measures - On September 5, 2013, the House of Representatives adopted new legislation establishing the legal framework for an appropriate ownership and governance structure to manage the government’s majority stake in the cooperative credit sector. - On September 5, 2013, the House of Representatives adopted amendments to the cooperative and banking sector laws making the Central Bank of Cyprus the single supervisor for the cooperative sector. - On September 5, 2013, the House of Representatives adopted amendments to the current anti-money laundering (AML), companies, and international trusts laws, fulfilling the end-September structural benchmark to strengthen the AML legislative framework. ### IMF Review Outcome and Disbursement - The Executive Board completed the first review of Cyprus’s performance under a three-year, SDR 891 million Extended Fund Facility (EFF) arrangement. - The completion of the review enables the disbursement of SDR 74.2 million (about €84.7 million, or US$113.1 million). - Total disbursements under the arrangement after this tranche would reach SDR 148.5 million (about €169.4 million, or US$226.2 million). - The Executive Board approved the authorities’ request for modification of performance criteria on September 2013 fiscal targets. - The EFF arrangement, approved on May 15, 2013, is part of a combined financing package with the European Stability Mechanism (ESM) amounting to €10 billion. ### Program Objectives and Rationale - Objectives: stabilize the country’s financial system, achieve fiscal sustainability, and support recovery of economic activity to preserve the welfare of the population. - Emphasis on continued fiscal prudence given high macroeconomic uncertainty. - Roadmap approach: payment restrictions to be eased gradually based on achieving specific milestones in the banking sector strategy while retaining flexibility for unanticipated developments. ### Banking Sector Actions and Financial Stability Measures - Independent valuation of Bank of Cyprus (BoC) and Cyprus Popular Bank (CPB) balance sheets completed on July 26; final deposit conversion rate agreed at 47.5 percent. - Resulting outcomes: - New BoC capitalized at a core tier 1 ratio of around 12 percent and taken out of resolution. - On August 1, BoC regained its eligible counterparty status for ECB normal monetary policy operations. - Cooperative credit institutions (CCIs): - Capital needs and viability assessed, enabling development of a comprehensive recapitalization and restructuring strategy. - Prior actions approved by parliament established legal framework to facilitate recapitalization and restructuring of the CCI sector and to strengthen supervision by establishing the Central Bank as single supervisor. - Banking supervision and transparency enhancements: - New classification of nonperforming loans effective since July 1. - Unified data reporting system for commercial and cooperative banks implemented. - Financial stability indicators under a new framework available on the Central Bank of Cyprus website as of July 23. - Liquidity and collateral issues: - BoC had been burdened with €9 billion of ELA from the resolution of CPB. - Assets pledged as collateral by banks suffer haircuts averaging more than 50 percent across government/government guaranteed asset classes. - An adjustor proposed to allow a maximum of €2.9 billion in additional government guarantees to enhance BoC’s pool of Eurosystem eligible collateral. ### Fiscal Performance and Public Finance Measures - Fiscal performance through end-June exceeded expectations. - Total budget balance and primary balance exceeded targeted values by 2.3% and 1.6% of GDP respectively (in ESA95 terms). - Significant financing measures: - Authorities rolled over €1 billion of maturing domestic debt and the €1.9 billion CPB recapitalisation bond. - Significant restructuring of Cyprus’s bi-lateral loan with Russia. - Further debt-reducing measures planned, including privatizations and a €1 billion debt swap held by the CBC for state-owned assets. - The €1 billion debt swap was postponed from end 2013 to mid 2014 to allow more time for asset valuation. - As a result of timing changes, the authorities requested a modification of the end September public debt performance criterion. ### Economic Developments and Labor Market - Q2 and first-half activity: - Revised Q2 GDP figures point towards a 5.3% decline for the first semester. - Unemployment: - Increased from 11.7 percent in June 2012 to 17.3 percent in June 2013. - Rapid increase in youth and long-term unemployment, with rates more than twice that of total unemployment. - BoC and CPB employee exits (first voluntary exit schemes in late 2012/early 2013; second voluntary exit scheme at end-July 2013) contributed to unemployment increases; second scheme effects expected in Q3 unemployment figures. - Sectoral impacts: - Pronounced decline in construction. - Disruptions to financial intermediation weighed on services. - Net exports provided significant positive contribution to GDP growth due to a drag on imports and a small increase in exports. - Risks and vulnerabilities: - Severe credit shortage and frozen corporate working capital. - Without credible solutions to banks’ funding pressures, lending likely to remain frozen. - Potential for further household and corporate defaults and propagation of losses through the economy. - Concerns over deterioration of confidence in banking system and spillovers to professional business services and financial services' exports. ### Structural Reforms and Policy Measures Going Forward - Banking sector: - BoC to submit capital and funding plans and a strategic restructuring plan to the Central Bank; new Board of Directors appointed following shareholders’ AGM on September 10. - Strategy to recapitalize other banks finalized; supervision and regulation policies strengthened. - Debt restructuring framework to be revamped to enable fair and expeditious restructuring across the banking sector. - Merge and expand databases of the two existing credit registers to aid loan origination and informed lending decisions. - AML and supervisory improvements: - Action plan agreed with programme partners to address legal framework and implementation shortcomings. - Central Bank to review its AML/CFT supervisory structure on the basis of relevant Basel Core Principle and FATF standards. - All auditor-revealed cases possibly involving misclassification of customer risk and suspicious transactions will be followed up. - Revenue administration and public administration: - Substantial overhaul of revenue administration, including integration of the Internal Revenue Department and the VAT Service, expected to increase compliance, improve efficiency, and reduce administrative costs. - Significant reform of the social welfare system to better target overlapping benefits and ensure effective social protection. - Independent external review of public administration underway by the World Bank and the UK government to review size, employment conditions and functional organisation of public services; reforms to follow based on findings. ### Assessment, Risks, and Program Conditionality - Program implementation status: - All performance criteria met, structural benchmarks delivered, and all pending prior actions completed as reported by authorities. - Program risks: - Risks to the program described as substantial; no room for implementation slippages. - Continued strong ownership and steadfast policy implementation deemed critical for program success. - Authorities’ request: - Authorities requested the Board’s approval of the completion of the first review and associated modifications of performance criteria. *International Monetary Fund press release and Executive Director statement, September 2013.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13293.pdf_