## Cyprus: IMF Staff Report Excerpts (Content unit _cr13374) ## Source details **Canonical URL:** [Cyprus: IMF Staff Report Excerpts (Content unit _cr13374)](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13374.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13374.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13374.pdf.json) --- ### Extended Arrangement and Financing - Three-year Extended Arrangement under the Extended Fund Facility approved on May 15, 2013: SDR 891 million (563 percent of quota; about €1 billion). - Purchases made/to be made: - Two purchases of SDR 74.25 million (about €86 million) each have been made so far. - Another purchase of SDR 74.25 million is proposed to be released upon completion of the second review. - European Stability Mechanism disbursements since program approval: €4.5 billion (of €9 billion committed). ### Program Status and Implementation - Compliance and benchmarks: - All end-September quantitative performance criteria (PCs) were met with comfortable margins; all continuous PCs observed. - End-September and end-October structural benchmarks on Hellenic Bank recapitalization offer launch, AML legislation amendment, and assessment of BoC restructuring plan were met. - Legal framework for a central credit register met with a modest delay; end-December SB on fully recapitalizing Hellenic Bank met on November 1 without state aid. - Key implementation priorities going forward: - Ensure full implementation of banks’ restructuring plans to clean up balance sheets and restore credit to the private sector. - Advance fiscal structural reforms and accelerate privatization. - Program uncertainties: lingering financial sector vulnerabilities and challenges to policy implementation. ### Recent Economic Developments — Output, Demand, Prices, Labor - Output and demand: - Q3 output: -0.8 percent quarter-on-quarter (seasonally adjusted); -5.7 percent year-on-year. - Annualized growth decline for first three quarters of 2013: -5.5 percent (program projection for 2013 was -8.7 percent). - Sectoral negative growth in construction, manufacturing, banking, transport, trade, and other services. - Retail sale volumes: -2.8 percent y-o-y through September. - Tourism receipts through September: up by about 8 percent relative to 2012. - Imports: -21 percent y-o-y through September; Q3 import contraction moderated to -14.4 percent y-o-y. - Staff estimate: exports of goods grew 7.4 percent y-o-y in Q3 (note: including one-off transfer of economic ownership of mobile transportation equipment (€24.5 million) would raise reported increase to 14.4 percent). - Labor and wages: - Unemployment (Eurostat definition): 17 percent in October (seasonally adjusted); increase of close to 1 percentage point relative to end-June (after revisions). - Economy-wide compensation per employee: -4.5 percent y-o-y in first two quarters (after revisions). - Public sector: average reductions for H1: -8.1 percent. - Private sector: average reported wage decline close to -2 percent y-o-y; matched-employee decline more than double reported figure. - Additional wage adjustments: BoC cuts of 5-15 percent; construction sector new collective agreements with cuts of 25 percent. - Inflation: - HICP end-October: -0.5 percent (lowest since October 2009). - Year-to-date average inflation: 0.7 percent. - Core inflation end-October: -0.1 percent. - Price declines largely driven by energy; notable declines in clothing and furniture. ### Fiscal Performance through end-September and 2014 Budget - Fiscal outturn Jan–Sep 2013 (cash, ESA95; Millions of Euros; Percent of GDP): - Revenue — Program: 4,663; Prelim.: 4,894; Program (percent of GDP): 28.4; Prelim. (percent of GDP): 29.8. - Taxes on production and imports — Program: 1,673; Prelim.: 1,789; Program (percent of GDP): 10.2; Prelim.: 10.9. - Current taxes on income and wealth — Program: 1,222; Prelim.: 1,308; Program (percent of GDP): 7.4; Prelim.: 8.0. - Social contributions — Program: 1,012; Prelim.: 1,106; Program (percent of GDP): 6.2; Prelim.: 6.7. - Expenditure — Program: 5,511; Prelim.: 5,240; Program (percent of GDP): 33.6; Prelim.: 31.9. - Current expenditure — Program: 5,258; Prelim.: 4,993; Program (percent of GDP): 32.0; Prelim.: 30.4. - General Government balance — Program: -848; Prelim.: -346; Program (percent of GDP): -5.2; Prelim. (percent of GDP): -2.1. - General Government primary balance — Program: -402; Prelim.: 110; Program (percent of GDP): -2.4; Prelim. (percent of GDP): 0.7. - Key fiscal facts and revisions: - Cumulative primary fiscal balance through Q3: surplus of 0.7 percent of GDP; over-performance of 3.1 percent of GDP relative to program projections. - Revenues higher than expected by 1.4 percent of GDP. - Primary spending lower than projected by 1.7 percent of GDP (about half from restraint in intermediate consumption, compensation, and social transfers; remainder from deferred resolution-related compensation payments). - Government financing in Q3 achieved by rolling over short-term debt and using program financing; deposits broadly unchanged around €1.5 billion (excluding €1.5 billion ESM bond disbursement earmarked for coops recapitalization). - 2013 end-year and 2014 targets: - Revised 2013 primary deficit target (cash basis): 2.6 percent of GDP (from 3.3 percent). - 2014 primary deficit target: 3.3 percent of GDP (from 4.2 percent); includes measures of 2.1 percent of GDP already approved in 2013 taking effect in 2014 plus additional 0.3 percent of GDP consolidation measures. ### Fiscal Measures and Consolidation Quantities - 2014 fiscal measures (Percent of GDP): - Approved Measures: 2.4 - Revenues total: 1.6 - Increase in the VAT standard and reduced rates: 0.4 - Increases in excise rates: 0.2 - Increase in pension contributions: 0.5 - Increase in the withholding tax on interest from 15 to 30 percent: 0.1 - Increase in the bank levy from 0.095 to 0.150.1 (note: presented as in source) - Reduction in exemptions of pension contributions and increased taxation of lottery winnings *0.1 - Other: 0.2 - Expenditure total: 0.8 - Reduction of nominal wage and allowances: 0.4 - Further reduction in allowances and overtime *0.1 - Rationalization of social transfers: 0.2 - Targeting of the social pension *0.1 - Consolidation magnitudes: - 2014 budget contains 2.1 percent of GDP in measures approved at program outset, and 0.3 percent of GDP in new permanent measures. - Total consolidation effort in 2014: 3.5 percent of GDP. - Total fiscal adjustment for 2013–14: 9.4 percent of GDP (including 4.5 percent in 2013 budget and additional tightening). - Estimated underlying negative fiscal impulse: 1.6 percent of GDP for 2014 and 4.2 percent of GDP for 2013–14 combined. ### Banking Sector Restructuring and Financial Stability - Agreed priorities for financial sector policy: - Complete recapitalization and restructuring of financial institutions; clean up banks’ balance sheets; gradually restore payment system functioning; enhance supervision for SSM; strengthen AML implementation. - Bank of Cyprus (BoC): - BoC holds about 50 percent of total financial sector assets. - BoC restructuring plan covers 2013–17: forecasted loan losses comparable to PIMCO adverse scenario and KPMG fair valuation; front-loaded provisions; gross loans decline through end‑2015 then stabilize through 2017; operational efficiency target: cost reduction of about 50 percent vs 2012 (about ¾ already realized). - CBC to monitor progress via KPIs and quarterly targets; CBC completed assessment of BoC plan against four criteria. - Hellenic Bank: - Sale of shares worth about €100 million (bought largely by two private domestic firms and one foreign investor). - Conversion of junior debt: about €255 million. - Capital need cited: €294m. - New ownership shares: New large shareholder 1 29.9%; New large shareholder 2 29.9%; New large shareholder 3 15%; Other new shareholders 2%; Existing shareholders 23%. - Bank fully capitalized on November 1; Core Tier I reached 9.5 percent. - Cooperative Credit Sector: - Initial steps: unit in Ministry of Finance to manage state stake; merger of 38 CCIs into nine entities; new CCB board; first draft restructuring plan finalized. - €1.5 billion program funds deposited in designated CBC account pending fair value assessment and EC approval. - Agreed preconditions for state aid injection: restructuring plan endorsed by future CEO with quarterly targets; independent fair value assessment. Submission of plan and fair value assessment are end-January 2014 SBs. - Mergers of remaining 58 CCIs into 9 institutions expected by end‑March 2014 (existing SB), capitalization aiming CT1 ratio of 9% at sector and 4% at individual level. ### Private Sector Debt Restructuring — Principles and Timeline - Core approach: - Targeted case-by-case debt restructuring for viable troubled borrowers; tailored modalities (term extensions, temporary interest rate reductions, limited principal discounts). - Avoid uniform write-downs to prevent strategic defaults and preserve payment culture. - Operational/governance measures: - Banks to define and monitor KPIs on debt restructuring starting Q1 2014. - CBC to complete onsite assessment of banks’ loan workout units by end-March 2014 (structural benchmark). - Legal/incentive framework: assessment of insolvency law for corporates and individuals to be completed before end-2013; legislation to allow mediation services considered. - Implementation milestones (selected): - Oct–Dec 2013: decree for CCI recapitalization approved; independent firm appointed for fair valuation; relationship framework between CCB and MoF finalized; CEO appointment for CCB. - Jan 2014: completion of fair valuation; submission and approval of CCB restructuring plan; injection of state aid; legislative steps for mediation. - Feb–Mar 2014: completion of recapitalization and merger into 18 institutions (timeline noted across documents). ### Public Debt Sustainability — Baseline and Stress Scenarios - Baseline projections: - Public debt revised to 113.7 percent of GDP in 2013. - Debt expected to peak at 126 percent of GDP in 2015 (baseline projections statement); alternative baselines show peak in 2014–2015 depending on table. - Debt projected to decline toward about 105 percent of GDP by 2020. - 2014 debt ratio revised to about 122 percent of GDP. - Stress-test outcomes and vulnerabilities: - Deeper/protracted recession scenario: debt ratio 130–145 percent of GDP by 2020. - Growth shock with fiscal shock: debt about 160 percent of GDP by 2020. - Combined with higher financial sector needs (twice identified coop needs): debt close to 170 percent of GDP by end of program period, falling to about 150 percent by 2020. - Banking-system contingent liability scenarios (selected): - Scenario 1 (additional €1.5 billion): covered by buffer; no financing implications. - Scenario 2 (additional €1.5 billion on top of Scenario 1): debt increases to 130 percent of GDP in 2016 and to 117 percent by 2020. - Scenario 3 (Scenario 2 + 2 s.d. real GDP shock): debt increases to 166 percent of GDP in 2016 and to 153 percent by 2020. - Additional numeric highlights: - Public gross financing needs (selected percents of GDP): 14.2, 18.0, 18.9, 21.4, 18.9, 18.5, 11.8, 22.9, 10.6, 14.5, 16.3 (2011–2020 series as presented). - Effective interest rate (percent): 5.1, 4.0, 4.4, 3.5, 2.8, 2.6, 2.7, 3.5, 3.9, 4.1, 4.6 (2011–2020). ### External Sector and External Debt Sustainability - Current account and trade: - Current account surplus of 7.4 percent of GDP in Q2 2013 (compared with deficits of about 11.4 percent a quarter earlier [revised from 12.4] and about 4 percent a year earlier). - Trade balance registered a surplus of 6.5 percent of GDP driven by sharp import compression. - External debt trends and projections: - Short-run gross external debt expected to decline from about 450 percent of GDP at end-2012 to 355 percent of GDP at end-2013. - Baseline projection to reach about 300 percent of GDP by 2020. - IIP expected to gradually improve, reaching 85 percent of GDP by 2020. - Stress-test outcomes (selected bound-test results): - CA shock: external debt around 318 percent of GDP. - Growth shock: around 332 percent of GDP. - Interest-rate shock and combined shock: around 349 percent of GDP. - Gross external financing needs (selected values): - In US$ billions: 52.1, 81.2, 109.4, 85.3, 79.0, 55.0, 44.1, 41.7, 39.9, 39.4, 40.3, 40.3, 40.0 (multi‑year series). ### Policy Recommendations, Risks, and Mitigating Factors - Key policy recommendations: - Maintain momentum of bank restructuring, NPL workout, and supervision strengthening in preparation for SSM integration. - Implement targeted private sector debt restructuring framework with strong incentives for cooperation and safeguards against strategic default. - Continue fiscal consolidation while protecting vulnerable groups via GMI and improving revenue administration and PFM. - Accelerate privatization to realize targeted proceeds (objective: raise €1.4 billion by 2018) and consider debt-to-asset swap (~€1 billion by mid-2014). - Gradually relax payment restrictions/capital controls according to milestone-based roadmap once preconditions met (notably cooperative sector recapitalization). - Strengthen AML/CFT supervision and implement follow-up on audit findings. - Main risks: - Banking crisis uncertainty: weak confidence, deposit outflows, protracted deleveraging, discovery of additional capital needs. - Policy implementation risks: political tensions (e.g., between President and CBC Governor), social resistance to reforms, litigation risks from resolution actions. - Debt sustainability risks under macro-fiscal and contingent liability shocks. - Mitigating factors: - BoC and Hellenic Bank capitalized above minimum requirements; sizeable program buffer; possible re-profiling of deposits and targeted government guarantees; technical assistance scaled up; recent court denials limited litigation escalation. ### Program Monitoring, Conditionality, and Financing Outlook - Quantitative and structural conditionality: - All end-September and continuous PCs met; proposed modifications to selected end-December PCs noted. - Structural benchmarks: most met; new SBs agreed with deadlines (entrust legacy Laiki voting rights, CCB restructuring submission, AML/CFT unit strengthening, CBC assessment of loan workout units, social welfare design approval). - Financing outlook and assurances: - Projected financing needs in 2014: €3 billion. - Planned disbursements from ESM/IMF: about €2.5 billion. - Expected distribution of central bank profits: €400 million to be distributed by end-March. - Deposits expected around €850 million at end-2013. - Identified measures include privatization preparations and a potential debt-to-asset swap (~€1 billion by mid-2014). - IMF arrangement schedule (Table of reviews and purchases): - Recurrent purchases of SDR 74.25 million scheduled across reviews through March 15, 2016; total SDR 891.00 (563.21% of quota). - Capacity to repay the Fund: - Debt service to the Fund expected to peak at less than 2 percent in 2020. - Outstanding credit to the Fund expected to peak at 563 percent of quota in 2016. - External and public debt expected to peak in 2014 and 2015, respectively. *Source: IMF staff report excerpts (Content unit _cr13374).* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Extended Arrangement and Financing - On May 15, 2013, the Executive Board approved a three-year Extended Arrangement under the Extended Fund Facility in the amount of SDR 891 million (563 percent of quota; about €1 billion). - Two purchases of amounts equivalent to SDR 74.25 million (about €86 million) each have been made so far; another purchase of the same amount is proposed to be released upon completion of the second review. - The European Stability Mechanism has released €4.5 billion since the program approval (of €9 billion committed). ### Program Status and Policy Implementation - The program is on track: all end-September quantitative performance criteria (PCs) were met with comfortable margins, and all continuous performance criteria were observed. - End-September and end-October structural benchmarks (SBs) on launching the recapitalization offer for Hellenic Bank, amending anti-money laundering (AML) legislation, and assessing the restructuring plan for Bank of Cyprus (BoC) were met; the benchmark on adoption of a legal framework for a central credit register was met with a modest delay. - The end-December structural benchmark on fully recapitalizing Hellenic Bank was met on November 1, without recourse to state aid and with the participation of foreign investors. - Significant progress has been made in restructuring and recapitalizing the banking sector, including foreign participation in the share capital of one domestic bank. - Going forward: efforts must concentrate on ensuring full implementation of banks’ restructuring plans to clean up balance sheets and pave the way for a return of credit to the private sector. - Fiscal structural reforms are proceeding, but strong resolve is needed to kick-start the privatization process. - The program remains subject to large uncertainty given lingering financial sector vulnerabilities and continued challenges to policy implementation. ### Recent Economic Developments — Output and Demand - The recession through September, though deep, has not been as large as expected. - Third quarter output fell by 0.8 percent quarter-on-quarter (seasonally adjusted) and 5.7 percent year-on-year (y-o-y), bringing the annualized growth decline for the first three quarters to 5.5 percent, against the original program projection of 8.7 percent for 2013. - Negative growth was recorded in construction, manufacturing, banking, transport, trade, and other services. - Retail sale volumes fell by 2.8 percent y-o-y, pointing to consumption smoothing by households; anecdotal evidence cites dissolution of some provident funds allowing households to dip into long-term savings. - Tourism receipts through September were up by about 8 percent relative to 2012, reflecting a shift toward Russian and other non-EU tourists with a higher propensity to spend. - Imports contracted sharply, recording 21 percent y-o-y compression (contributing to trade balance improvement); in the third quarter the contraction in imports moderated to 14.4 percent y-o-y. - Staff’s estimate: exports of goods grew 7.4 percent y-o-y in the third quarter (note: including a one-off transfer of economic ownership of mobile transportation equipment (€24.5 million) would raise the reported increase to 14.4 percent). ### Labor Market and Wages - The unemployment rate (harmonized Eurostat definition) reached 17 percent in October (seasonally adjusted), largely driven by voluntary retirement schemes in BoC and Laiki Bank (more than 1,500 redundancies); this is an increase of close to 1 percentage point relative to end-June figures (which were revised downward by about 1 percentage point due to a larger labor force and employment than previously estimated). - Economy-wide compensation per employee declined by 4.5 percent y-o-y in the first two quarters (after statistical revisions). - In the public sector, reductions for the first half of the year averaged 8.1 percent. - For the private sector, the average reported wage decline was only close to 2 percent y-o-y; when evaluating only matched employees who remained in their job, the average decline is more than double the reported figure. - Additional wage adjustments: agreed cuts of 5-15 percent in BoC; cuts of 25 percent negotiated in new collective agreements in the construction sector; further negotiations reportedly ongoing in the broader banking sector and in large construction firms. ### Inflation and Prices - Headline inflation (HICP) reached -0.5 percent in October, the lowest level since October 2009. - Year-to-date average inflation stands at 0.7 percent. - Core inflation stood at -0.1 percent at end-October. - The decline in prices was largely driven by energy, with notable declines also in clothing and furniture. ### External Sector and External Adjustment - The current account moved to a surplus of 7.4 percent of GDP in the second quarter. - This compares with deficits of about 11.4 (revised from 12.4) and 4 percent of GDP a quarter and a year ago, respectively. - The turnaround was largely driven by an improvement in the trade balance, which registered a surplus of 6.5 percent of GDP on the back of sharp import compression. - The income balance improved, reflecting lower income paid as external liabilities continued to decline and a temporary boost in receipts on portfolio equity. - High-frequency indicators suggest that external adjustment continued in the third quarter, likely driven by exports of goods growth and tourism rebound while import contraction moderated. ### Political and Institutional Context - Developments in Europe (modest euro-zone recovery, ECB accommodative stance, favorable collateral policies, progress toward banking union) remain supportive of the program and bank liquidity needs. - Domestic political support for some program elements is weakening: - Opposition party AKEL strongly criticizes the program; other parties expressed reservations about privatization and private sector debt restructuring. - Labor unions are mobilizing against austerity measures and privatization, with demonstrations planned in mid-December. - Tensions between the President and Central Bank Governor, and within top management of the Central Bank of Cyprus (CBC), complicate decision making and hinder confidence in the financial sector. *December 6, 2013 — EXECUTIVE SUMMARY (Cyprus IMF staff report)* ### 8. Fiscal performance through end-September continued to be better than programmed. ### _cr13374 - 8. Fiscal performance through end-September continued to be better than programmed. ### Fiscal outturn through end-September - The cumulative primary fiscal balance through the third quarter registered a surplus of 0.7 percent of GDP, an over-performance of 3.1 percent of GDP relative to program projections. - Revenues were higher than expected by 1.4 percent of GDP, on account of smaller-than-projected declines in direct and indirect tax collections and social contributions, given the relatively better growth outturn. - Primary spending was lower than projected by 1.7 percent of GDP: - About half of the lower primary spending was due to restraint in intermediate consumption, compensation of employees and social transfers. - The rest reflected a postponement of resolution-related compensation payments to pension funds from September to October. - Relative to outturns in percent of GDP a year ago: - Direct taxes rose, supported by the increase in the corporate income tax, the tax on interest income, and the withholding tax in the broader public sector (as wage cuts in this sector were implemented via increased withholding). - Social spending on unemployment benefits and pensions increased. - These increases were partly compensated by a decline in other current and capital expenditure. - Preliminary data through end-October confirm a continuation of these trends. - The government met financing needs in the third quarter by rolling over short-term debt and using program financing, with deposits remaining broadly unchanged at around €1.5 billion. - Deposits do not include the September €1.5 billion ESM bond disbursement earmarked for the recapitalization of coops. ### General Government, January-September 2013 — Program vs Preliminary (Millions of Euros)(Percent of GDP) - Revenue - Program: 4,663 - Prelim.: 4,894 - Program (percent of GDP): 28.4 - Prelim. (percent of GDP): 29.8 - Taxes on production and imports - Program: 1,673 - Prelim.: 1,789 - Program (percent of GDP): 10.2 - Prelim. (percent of GDP): 10.9 - Current taxes on income and wealth, etc - Program: 1,222 - Prelim.: 1,308 - Program (percent of GDP): 7.4 - Prelim. (percent of GDP): 8.0 - Social contributions - Program: 1,012 - Prelim.: 1,106 - Program (percent of GDP): 6.2 - Prelim. (percent of GDP): 6.7 - Other revenue - Program: 756 - Prelim.: 691 - Program (percent of GDP): 4.6 - Prelim. (percent of GDP): 4.2 - Expenditure - Program: 5,511 - Prelim.: 5,240 - Program (percent of GDP): 33.6 - Prelim. (percent of GDP): 31.9 - Current expenditure - Program: 5,258 - Prelim.: 4,993 - Program (percent of GDP): 32.0 - Prelim. (percent of GDP): 30.4 - Intermediate consumption - Program: 585 - Prelim.: 548 - Program (percent of GDP): 3.6 - Prelim. (percent of GDP): 3.3 - Compensation of employees - Program: 1,863 - Prelim.: 1,812 - Program (percent of GDP): 11.3 - Prelim. (percent of GDP): 11.0 - Social transfers - Program: 1,858 - Prelim.: 1,820 - Program (percent of GDP): 11.3 - Prelim. (percent of GDP): 11.1 - Interest - Program: 446 - Prelim.: 456 - Program (percent of GDP): 2.7 - Prelim. (percent of GDP): 2.8 - Subsidies - Program: 74 - Prelim.: 60 - Program (percent of GDP): 0.4 - Prelim. (percent of GDP): 0.4 - Other current expenditure - Program: 433 - Prelim.: 291 - Program (percent of GDP): 2.6 - Prelim. (percent of GDP): 1.8 - Capital Expenditure - Program: 252 - Prelim.: 248 - Program (percent of GDP): 1.5 - Prelim. (percent of GDP): 1.5 - General Government balance - Program: -848 - Prelim.: -346 - Program (percent of GDP): -5.2 - Prelim. (percent of GDP): -2.1 - General Government primary balance - Program: -402 - Prelim.: 110 - Program (percent of GDP): -2.4 - Prelim. (percent of GDP): 0.7 - General Government primary spending - Program: 5,065 - Prelim.: 4,784 - Program (percent of GDP): 30.8 - Prelim. (percent of GDP): 29.1 ### Contextual and operational notes from the text - The revenue outperformance reflected smaller-than-projected declines in direct and indirect tax collections and social contributions, tied to the relatively better growth outturn. - About half of the primary spending undershoot was from restraint in intermediate consumption, compensation of employees and social transfers; the remainder from postponement of resolution-related compensation payments to pension funds from September to October. - Direct taxes rose year-on-year, supported by increases in corporate income tax, the tax on interest income, and the withholding tax in the broader public sector (implementation of wage cuts via increased withholding). - Social spending on unemployment benefits and pensions increased relative to a year ago. - Preliminary data through end-October confirm continuation of the described fiscal trends. *Source: IMF staff (General Government, January–September 2013 cash data, ESA95 classification; program = First review program projections).* ### 0.011 to 0.025. Using ### _cr13374 - 0.011 to 0.025. Using ### Deleveraging and Growth Impact - Using assumptions in the text, the growth impact of deleveraging in Cyprus could be around 0.2-0.4 percentage points per year over 5-10 years. - Output per capita is expected to be significantly lower compared to the pre-crisis period. - Empirical calibration based on Jorda et al. (2011): - Estimated level of average yearly excess credit of 8 percent of GDP in 2006-08 relative to the average during the preceding decade was used to estimate potential output loss for Cyprus. - The cross-country results of the original study and the calibrated growth path for Cyprus are substantially better than the program’s growth projection; this difference may partly reflect the absence in that comparison of other factors such as the impact of the large fiscal adjustment underway. ### Private Sector Indebtedness (figures and trends) - Private sector debt to GDP (Percent; 2011) shows Cyprus among the highest, alongside Luxembourg and Ireland (figure elements). - Corporate and household MFI s' debt to GDP (Percent) and time-series charts through Q2-13 indicate trends in: - Loans to non-financial corporations (Billions of Euros) - Loans to households (Billions of Euros) - Short-term and Long-term MFI loans - Non-financial corporate leverage (Debt/Equity ratio) - Household leverage (Debt/Financial Assets ratio) - Sources for the charts: Central Bank of Cyprus, Cystat, Eurostat, and IMF staff estimates. ### Public Debt Sustainability - Baseline projections: - Public debt expected to peak at 126 percent of GDP in 2015. - Debt expected to decline gradually toward 105 percent of GDP by 2020. - 2013 debt ratio revised down slightly to 113.7 percent of GDP. - For 2014, debt was revised down to about 122 percent of GDP. - Vulnerabilities and stress scenarios: - A deeper or more protracted recession would lead to a debt ratio of 130-145 percent of GDP by 2020. - If such a growth shock is associated with a fiscal shock (higher interest rates and a lower primary surplus) the debt ratio would be about 160 percent of GDP by 2020. - When combined with higher financial sector needs (twice as large as identified needs for the coops), the shock would exhaust the program buffer and result in a debt ratio of close to 170 percent of GDP by the end of the program period, falling to about 150 percent of GDP by 2020. - Financing needs and maturities: - Laiki recapitalization bond of €2.3 billion (principal plus capitalized interest) coming due in mid-2017. - About €5.6 billion of existing medium- and long-term debt maturing during 2016-2020. - Additional official resources may be needed if market access is not successfully restored. ### External Debt and External Position - Short-run gross external debt projection: - Expected to decline from about 450 percent of GDP at end-2012 to 355 percent of GDP at end-2013. - Long-run projection: - External debt expected to continue to fall, reaching about 300 percent of GDP by 2020. - International investment position (IIP): - IIP expected to gradually improve, reaching 85 percent of GDP by 2020. - External debt sustainability remains highly dependent on continued external adjustment, prospective economic rebound, and remains vulnerable to interest rate shocks. ### Financial Sector Policy: Bank of Cyprus (BoC) Restructuring and Other Banks - Agreed priorities for financial sector policy: - (i) complete recapitalization and restructuring of financial institutions; - (ii) clean up banks’ balance sheets by restructuring loans of troubled borrowers; - (iii) gradually restore normal functioning of the payment system; - (iv) enhance banking supervision to prepare for the single Supervisory Mechanism (SSM); - (vi) strengthen AML implementation. - BoC-specific points: - BoC holds about 50 percent of total financial sector assets. - BoC restructuring plan aims to: (i) revamp domestic core business and work out non-performing loans; (ii) separate non-core activities in a special unit managing large construction and real estate loans; (iii) normalize funding conditions; (iv) strengthen risk management capacity; and (v) streamline operational costs and maintain adequate capitalization. - CBC completed its assessment of the plan against four criteria: overall soundness and consistency with macro-prudential objectives; realism of prudential financial indicators and assumptions; robustness to shocks; and consistency with European guidelines on bank viability. - Liquidity support: need for flexibility on ELA collateral policies; government guaranteed bank bonds to be considered only as a last resort. - Funding plan assumes only moderate loan book deleveraging and reliance on divestment of non-core or non-viable operations abroad and cash from maturing government debt securities. - NPL workout: staff stressed appointing experienced external managers; approving clear policies that allow tailor-made solutions for large exposures and a general approach for small borrowers while preserving payment; ensuring adequate incentives (including for compensation) to maximize recovery values. - Contingency planning: plan includes sensitivity analysis (higher interest rates, funding costs, NPLs, probabilities of default, recovery rates); success in reducing operating costs below 50 percent of net income seen as critical; about ¾ of the needed cost reductions have already materialized. - BoC plan prudently focuses on increasing the capital ratio over time rather than maximizing return on equity. - CBC committed to monitor the bank’s progress via key performance indicators and operational targets and to approve a set of quarterly targets and terms of a quarterly progress report (prior action for completion of the review). - Bank of Cyprus Restructuring Plan (key quantitative and qualitative elements): - Plan will guide the bank’s activities through 2017. - Forecasted loan losses: comparable to those identified under PIMCO’s adverse scenario and KPMG fair valuation, spread over 2013-17, with significant front-loading. - Loan growth: decline in gross loans through end-2015 due to disposal of foreign activities, then broadly constant through 2017 as new lending gradually recovers. - Operational efficiency target: cost reduction of about 50 percent compared to 2012; about ¾ of this target already realized through a staff voluntary redundancy scheme. - Normalizing funding conditions: reduce reliance on central bank financing gradually, use cash from maturing government debt securities, divestment of operations abroad, limited access to covered bond markets from 2014, recoveries from NPLs, limited loan book deleveraging. - Enhancing capital position: lower risk-weighted assets via higher loan loss provisions, loan deleveraging, disposal of non-core assets; generate profits as new lending recovers toward 2016; cost cutting to reduce cost income ratio. ### Other Bank Developments - Hellenic Bank recapitalization: - Sale of shares worth about €100 million (bought largely by two private domestic firms and one foreign investor). - Conversion of junior debt amounting to about €255 million. - Capital need: €294m (figure annotation). - New ownership structure shares: New large shareholder 1 29.9%; New large shareholder 2 29.9%; New large shareholder 3 15%; Other new shareholders 2%; Existing shareholders 23%. - Bank fully capitalized on November 1; Core Tier I capital reached 9.5 percent and is expected to remain above capital requirements based on the PIMCO due diligence exercise through the program period. ### Cooperative Credit Sector Recapitalization and Restructuring - Initial steps taken: - Establishment of a unit in the Ministry of Finance to manage the state’s future stake in the sector. - Merger of 38 cooperative credit institutions (CCIs) into nine entities. - Appointment of a new board for the Cooperative Central Bank (CCB). - Finalization of the first draft of the restructuring plan for the sector. - Delays and funds: - Delays in appointment of a CEO for the CCB and need for a fair value assessment delayed injection of public funds (€1.5 billion program funds have been deposited in a designated CBC account for this purpose). - Agreed next steps (key actions for the next 3-6 months): - Strengthening governance arrangements: complete relationship framework between the CCB and the MOF management unit as a prior action to ensure commercial operation within restructuring plan boundaries. - Recapitalizing the CCB via state aid: two preconditions for injecting public funds—(i) restructuring plan endorsed by future CEO and including quarterly targets before submission to the European Commission for state aid approval; (ii) consolidated balance sheet of the CCB and CCIs subjected to an independent fair value assessment. Submission of the restructuring plan and completion of the fair value assessment are an end-January 2014 structural benchmark. - Enhancing communication strategy: CCB board will publish a short-term roadmap with key steps through the next six months to build market credibility. - Finalization: mergers of remaining 58 CCIs into 9 institutions expected to be finalized by end-March 2014 (existing structural benchmark), at which point the capitalization of the new entities will be completed, aiming to maintain a CT1 ratio of 9 and 4 percent at the sector and individual level, respectively. *Sources: Central Bank of Cyprus, Cystat, Eurostat, and IMF staff estimates.* ### 21. The success of banks’ and coops’ restructuring strategies depends critically on progress ### 21. The success of banks’ and coops’ restructuring strategies depends critically on progress ### Private sector debt restructuring: principles and steps - Core finding: Dealing decisively with troubled borrowers is essential to clean up banks’ balance sheets and restore credit to the economy. - Agreed approach: Targeted case-by-case debt restructuring rather than across-the-board write-downs, recognizing a more gradual private sector deleveraging may result. - Targeting criteria and modalities: - Focus on troubled but viable borrowers, classified according to the degree of insolvency or cash-flow mismatch. - Tailored modalities include term extensions, temporary interest rate reductions, or limited principal discounts. - Risks of uniform write-downs: - Could damage payment culture and open the door for strategic defaults, leading to further increases in NPLs and exhaustion of capital buffers. - Operational and governance measures: - Banks to define and monitor key performance indicators on debt restructuring (e.g., number of loans restructured, cash collections), starting in Q1 2014. - CBC to complete an onsite assessment of operational capacity of banks’ loan workout units (end-March 2014 structural benchmark). - Legal/incentive framework: - Authorities to complete assessment of the insolvency law for corporates and individuals before end-2013 to identify legal impediments and develop an action plan and timetable for the next review. - Legislation to allow creation of mediation services considered, but may be addressed within broader legal framework review. ### Implementation timeline (selected milestones) - October 2013: - Decree for recapitalization of cooperative credit institutions approved. - Appointment of new CCB board. - First draft of restructuring plan. - November 2013: - Independent firm appointed to complete fair valuation of CCIs’ assets and liabilities. - December 2013: - Completion of relationship framework between CCB and MoF. - Appointment of CEO for CCB. - January 2014: - Completion of fair valuation assessment. - Submission and approval of restructuring plan. - Injection of state aid into the CCB. - February–March 2014: - Completion of recapitalization and merger of CCIs into 18 institutions. ### Lessons from Ireland and Iceland (Box 3): comparative evidence and implications for Cyprus - Contextual statistics: - Private sector indebtedness peaked at more than 500 percent of GDP in Iceland and 300 percent in Ireland in the decade preceding the global crisis. - NPLs rose to about 60 percent in Iceland and 25 percent in Ireland. - Cyprus’s private sector indebtedness stands at close to 300 percent in 2013. - Cyprus NPLs reached 46 percent of total loans and could rise up to 60 percent under PIMCO’s stress scenario. - Measures used in Ireland and Iceland (high-level summary): - Iceland: generalized rescheduling of inflation and exchange-rate indexed household debt; fast-track write downs of deeply underwater mortgages; tax incentives for corporates; significant buffers in newly-resolved banks. - Ireland: arrears management framework; government-sponsored AMC funded with government participation (NAMA); selective debt relief and forbearance on mortgages; reformed insolvency framework. - Outcomes and timing: - Iceland: took banks about five years to address bulk of troubled loans. - Ireland: after three years banks had yet to decisively initiate loan workouts. - Implication for Cyprus: - Cyprus established upfront an Arrears Management Framework and a Code of Conduct for borrowers and creditors. - Banks are strengthening internal loan-workout processes by establishing specialized units (including, for BoC, a unit dealing exclusively with the large real-estate portfolio). - Authorities plan to review and strengthen the insolvency framework and strengthen incentives to facilitate voluntary workouts. - Recapitalization based on conservative and forward-looking estimates so case-by-case restructuring can be implemented without excessive stress on bank profitability and capitalization. ### Payment restrictions and capital controls - Authorities reiterated commitment to milestone-based roadmap for lifting payment restrictions and capital controls (MEFP ¶11). - Remaining pre-condition before second phase of relaxations: - Submission of cooperative sector final restructuring plan and recapitalization. - Assessment of bank liquidity and deposit trends to be supportive. - Next relaxation steps: - Abolition of remaining restrictions requiring automatic renewal of fixed-term deposits. - Elimination of limits for free transfer of deposits within the domestic banking system. - Communication and assessment: - Market participants appear not well-informed of progress; strengthening market confidence through effective communication emphasized. - Need to fine-tune impact assessment analysis of relaxation measures on banks’ liquidity and expand methodologies, including independent analyses and surveys, to assess market confidence before second-phase relaxation proceeds. ### Supervision and regulation - Progress achieved: - Passage of legislation to establish a credit register (met end-September structural benchmark with a two month delay). - Integration of CCI supervision into the CBC. - Issuance of guidelines on loan origination and reporting of NPLs, including instructions on how to assess income of borrowers and instituting repayment ability as overriding criterion for approval of new credit. - Asset impairment and provisioning: - Two-step approach agreed: - Step 1: banks will enhance disclosure practices associated with non-performing loans, in accordance with new guidelines. - Step 2: banks required to adopt full guidelines for asset impairment and provisioning for the 2014 financial statements. - Implementation requires development of proper IT facilities by banks. - Caps on lending rates: - Authorities and interlocutors highlighted lack of liquidity and called for caps on lending rates to boost lending. - Staff opposed caps on lending rates, arguing they would introduce distortions in pricing of risk and impede credit; stressed resumption of credit depends on bank restructuring and cleanup of balance sheets. - Integration with European initiatives: - Adoption of prompt corrective actions (initially planned for end-December 2013) extended to end-June 2014 in the context of SSM establishment. - Assessment of supervisory framework’s compliance with best practices postponed until clarity on national authorities’ responsibilities for Basel Core Principles implementation. - CBC governance and planning: - CBC to complete its work plan and main objectives for 2014 to ensure sufficient budgetary and staff resources. - Need to strengthen governance of CBC by clarifying allocation of tasks and responsibilities within top management. ### Anti-money laundering (AML) framework - Progress: - AML legal framework revised on September 5, meeting end-September structural benchmark. - Improvements in supervision of professions (lawyers, accountants, administrative services providers) through supervisory framework reforms and increased staffing of professional regulatory bodies. - Financial intelligence unit increasing international exchange of financial intelligence. - Remaining actions: - CBC to strengthen AML/CFT supervisory function (end-February structural benchmark) by developing an onsite supervisory plan to gradually resume onsite inspections next year and boosting staffing. - CBC to finalize follow-up work on Deloitte audit findings by end-January. ### Fiscal policy: 2013–2014 targets and budget implications - 2013 end-year primary deficit target revised: - Revised down by 0.7 percent of GDP (MEFP ¶14). - Revenue projections adjusted upward by 0.6 percent of GDP due to revenue over-performance. - Execution of capital expenditure revised down by 0.1 percent of GDP. - Resulting conservative revision: primary deficit target (cash basis) revised down to 2.6 percent of GDP from 3.3 percent of GDP. - Adjustor modification requested to include additional compensation to the Laiki pension fund to take place later this year or early next year; adjustor already includes possibility for additional resolution-related compensation to other pension funds as established during the first review. - 2014 budget and targets: - 2014 primary deficit target revised down to 3.3 percent of GDP from 4.2 percent of GDP (MEFP ¶15). - Revision reflects net effect of 0.7 percent of GDP due to revised higher tax base for 2013 and expected one-off revenues (including dividends and central bank profits), more than offsetting effect of a deeper recession in 2014. - Includes measures of 2.1 percent of GDP already approved in 2013 which take effect in 2014, plus an additional 0.3 percent of GDP of consolidation measures beyond those required under the program (further rationalization of allowances and overtime and introduction of income criteria to target social pensions). - Staff cautioned about potentially negative impact of additional consolidation on growth but agreed the limited new measures do not compromise delivery of services to the most vulnerable and were assessed not to imply an excessive fiscal impulse. - Authorities agreed to amend the budget to explicitly reflect the new macroeconomic framework and revised targets as a prior action. *International Monetary Fund — Cyprus: Selected chapter content (paragraphs 21–26 and Box 3).* ### 27. The authorities requested revisions to public debt and government guarantee ceilings ### The authorities requested revisions to public debt and government guarantee ceilings ### Revisions to debt and guarantee ceilings - Authorities requested modest downward revision to the end-2013 and Q1 2014 debt ceilings to reflect intention to roll over less short-term debt given the comfortable cash position. - Proposed inclusion of an adjustor to the 2014 debt ceiling to address the uncertain disbursement path of an EIB loan financing projects already in the budget. - Requested modification of the December 2013 guarantee ceiling downward by €120 million to: - exclude a pre-existing guaranteed EIB loan related to the Vassilikos power plant (uncertainty whether disbursement will occur this year or next) and instead introduce an adjustor; and - allow for a small increase in guarantees to accommodate needs of ongoing sewerage projects. - Proposed increase of the 2014 guarantee ceiling by a similar amount to accommodate new EIB loans to domestic banks guaranteed by the state. - Assessment: The limited size of envisaged schemes does not materially alter debt sustainability outlook and would facilitate provision of credit to SMEs, addressing tight liquidity and difficulty obtaining trade credit. ### Fiscal measures for 2014 (Percent of GDP) - Approved Measures 2.4 - Revenues 1.6 - Increase in the VAT standard and reduced rates 0.4 - Increases in excise rates 0.2 - Increase in pension contributions 0.5 - Increase in the witholding tax on interest from 15 to 30 percent 0.1 - Increase in the bank levy from 0.095 to 0.150.1 - Reduction in exemptions of pension contributions and increased taxation of lottery winnings *0.1 - Other 0.2 - Expenditure 0.8 - Reduction of nominal wage and allowances 0.4 - Further reduction in allowances and overtime *0.1 - Rationalization of social transfers 0.2 - Targeting of the social pension *0.1 - Source: IMF staff estimates. - Note: * indicates New 2014 budget measures. ### The 2014 budget and the 2013-2014 Fiscal Impulse (key quantitative findings) - 2014 budget contains 2.1 percent of GDP in measures approved at the outset of the program, and 0.3 percent of GDP in new permanent measures. - Total consolidation effort in 2014: 3.5 percent of GDP (measures plus other tightening like reduced early retirees and lower capital spending). - Total fiscal adjustment for 2013-14: 9.4 percent of GDP (including 4.5 percent of GDP in the 2013 budget and additional tightening). - Underlying negative fiscal impulse: estimated at 1.6 percent of GDP for 2014 and 4.2 percent of GDP for 2013-14 combined. - Illustrative comparison: Cyprus adjustment slightly less than Ireland (4.7 percent of GDP) and Portugal (6.5 percent of GDP) in first two years of programs. Estimated Fiscal Impulse (In percent of GDP) - Change in the Primary Deficit (+ means reduction) (A=B+C+D+E) 0.6 -0.7 -0.1 - Net impact of one-offs (B) 1.5 -0.3 1.2 - Fiscal adjustment (C) 5.9 3.5 9.4 - Program revenue measures 2.1 1.6 3.8 - Program expenditure measures 2.4 0.8 3.2 - Other tightening 1/ 1.3 1.1 2.4 - Estimated macro shock (D) -6.5 -3.8 -10.3 - Revenue -6.0 -3.0 -8.9 - Social transfers -0.6 -0.8 -1.4 - Net impact of nominal GDP change on ratios -0.3 -0.1 -0.4 - Estimated fiscal impulse of automatic stabilizers (F=D/2) 3.3 1.9 5.2 - Net estimated fiscal impulse (+means contractionary) (C-F) 2.6 1.6 4.2 - Memorandum item: Ratio of fiscal adjustment over the macro shock (C/D) 89.8 92.9 90.9 - Source: IMF staff estimates - 1/ In 2013, includes end of large investment projects, tight control over goods and services spending, and higher reduction of government employment than anticipated. In 2014, includes reduction in early retirements and further reduction in capital budget due to end of projects. ### Structural fiscal reforms: welfare, revenue administration, public financial management, and privatization - Welfare reform (GMI): - Introduction of a General Minimum Income (GMI) scheme to protect vulnerable groups, expand social assistance to the working poor and those who exhausted unemployment benefits. - GMI financed by consolidating, streamlining, and better targeting other social benefits to stay within 2014 fiscal envelope. - Micro-dataset based on latest household budget survey to inform final costing; will be updated for current labor market conditions and benefit changes. - Structural benchmarks: finalize social welfare system design (type, level, eligibility for GMI and remaining benefits) by end-March 2014; full implementation by June-2014. - Revenue administration: - Short-term: work program of targeted joint audits by Internal Revenue Department (IRD) and VAT Services (VS); drafting legal amendments to increase enforcement powers and establish self-assessment (existing end-December structural benchmark). - Contextual indicators cited in the content: - VAT Gap (2006): Cyprus (2009 estimate) 14; EU-25 average 12.0 - Shadow economy (percent of GDP, 2012): Cyprus 26; EU 27 18.4 - Tax debt to annual net revenue (2011): Cyprus 34.0; OECD average 11.4 - Long-term: integrate IRD and VS into a single function-based tax administration; endorsed by Council of Ministers in October; governance structure established; implementation expected within the next 2-3 years. - Public financial management: - Drafting of the Fiscal Responsibility and Budget Systems Law (FRBSL) to be adopted by end-December 2013 (existing structural benchmark); law to provide legal basis for public investment management (including PPPs), set up a Fiscal Council, and establish transparent management of natural resource revenues. - Treasury assumed responsibility for monthly collection and reporting of key financial indicators; first report finalized. - Amendments being prepared to assign monitoring of guarantee stock to the Public Debt Management Office and to include a “Statement of state-owned enterprises and semi-government entities” as an Appendix to the 2014 budget. - Privatization: - Objective to raise €1.4 billion by 2018 and realize efficiency gains. - Need to maximize value and avoid fire sales; finalize and approve privatization plan specifying portfolio, expected receipts, timetable, and preparatory steps. - Approval of plan is a prior action for the ESM disbursement. - Authorities committed to speed up legal and institutional framework completion in early 2014. - Identified swap: initiate independent appraisal to complete swap of about €1 billion of debt held by the CBC for state-owned assets by mid-2014. ### Program modalities, conditionality, and monitoring - Prior actions implemented for second review: - CBC approval of BoC’s proposed quarterly targets and reporting terms. - Finalization of agreement between Ministry of Finance and CCB on relationship framework. - Submission to Parliament of amendments to the 2014 budget in line with revised macro-fiscal framework. - Quantitative performance criteria (PCs): - All end-September and continuous PCs met. - Proposed modifications to four end-December PCs: (i) general government primary balance; (ii) general government primary expenditure; (iii) stock of general government debt; (iv) accumulation of government guarantees. - Debt ceiling change mainly due to lower expected short-term debt in 2013 and introduction of an adjustor to accommodate proceeds of direct loans included in 2014 budget (TMU ¶10). - Guarantees ceiling adjusted to accommodate government guaranteed EIB loans to support SMEs and timing of disbursements; adjustor to lift guarantees ceiling if EIB loan to EAC for Vassilikos materializes. - Quantitative PCs proposed for end-March 2014. - Structural benchmarks: - All but one benchmark met; one implemented with two-month delay. - New benchmarks include (with deadlines): entrust voting rights of legacy Laiki’s shares (end-January 2014); submission of CCB restructuring plan and independent fair value assessment (end-January 2014); establishment of effective AML/CFT unit (end-February 2014); CBC assessment of banks’ loan workout units (end-March 2014); approval of final design of reformed social welfare system (end-March 2014). ### Risks to program and mitigating factors - Major risks: - Uncertain banking crisis impact: weak confidence may delay deposit and credit growth; protracted deleveraging could prolong recession, harm asset quality, raise capital needs; asset quality review could uncover additional needs. - Policy implementation challenges: tensions between executive and central bank or within bank management could delay critical financial sector policies; rising unemployment and worse social conditions could threaten fiscal consolidation and impede structural reforms/privatization. - Litigation risks: legal claims related to resolution losses in Laiki and BoC, and prospective claims related to Hellenic Bank recapitalization, could require compensatory damages increasing fiscal cost. - Mitigating factors: - BoC and Hellenic Bank are fully capitalized above minimum requirements, providing margin under prudent assumptions. - Program buffer sizeable: could cover additional fiscal needs under a severe growth shock or more than doubling of state aid needs for coop sector; unused buffer would lower debt levels. - Roadmap to relax payment restrictions gradually provides predictability; re-profiling of deposit maturities and possibility of additional government guarantees provide maneuvering room. - Technical assistance being stepped up to mitigate implementation risks. - Litigation risks moderated so far: recent applications for injunctions denied by district courts. ### Financing assurances and near-term financing outlook - Projected financing needs in 2014: €3 billion. - Planned disbursements from the ESM/IMF: about €2.5 billion. - Expected distribution of profits from the Central bank: €400 million expected to be distributed by end-March (MEFP ¶21). - Deposits expected around €850 million at end-2013. - These elements ensure adequate financing prospects for the next 12 months. - Additional measures: preparations for privatization ongoing; identified assets and initiation of independent appraisal to complete swap of about €1 billion of CBC-held debt for state-owned assets by mid-2014. *Source: IMF staff estimates and IMF mission documents in the provided content.* ### 36. Capacity to repay the Fund remains adequate (Table 7). Debt service to the Fund as a ### _cr13374 - 36. Capacity to repay the Fund remains adequate (Table 7). Debt service to the Fund as a ### Capacity to repay the Fund - Debt service to the Fund as a percentage of exports or GDP is expected to remain manageable. - It is expected to peak at less than 2 percent in 2020. - Outstanding credit to the Fund is expected to peak at 563 percent of quota in 2016. - External and public debt (as a percentage of GDP) are expected to peak in 2014 and 2015, respectively (Annex II). - External and fiscal adjustment, coupled with a resumption of economic growth, is expected to put debt firmly on a downward trend (Table 9, and Annex I). - While Cyprus’s capacity to repay the Fund seems robust, banking system related shocks (Annex I) could undermine it. ### Macroeconomic and fiscal performance - The authorities have exceeded fiscal targets with comfortable margins and met the requirements of all program structural benchmarks. - The economic contraction has been severe, with unemployment rising and the recession expected to continue through next year. - Fiscal targets through end-September were met with significant margins, helped by better-than-anticipated macroeconomic outturns and continued prudent execution of the 2013 budget, which includes a significant consolidation effort. - The end-year fiscal targets were tightened somewhat, locking in some of the over-performance during the first nine months of this year. - The 2014 budget is described as appropriately conservative and includes a small amount of additional high quality permanent measures beyond program requirements. ### Financial sector restructuring and stability - Significant progress has been made with restructuring and recapitalizing the financial sector. - Bank of Cyprus, now under new management, has put in place a restructuring plan aiming to return the bank to profitability. - Hellenic Bank was fully recapitalized without public support and with significant foreign direct investment, ahead of the program deadline. - The restructuring of the cooperative sector has started, with a number of mergers already completed in accordance with the draft restructuring plan. - Key next steps for coops: - Finalize the recapitalization and restructuring of coops. - Strengthen governance arrangements, finalize the restructuring plan, and complete a fair value assessment of coops as key preconditions for the injection of state aid in the sector. - Complete the consolidation of the sector to ensure the viability of remaining institutions. - Keep the public well informed about the objectives of the strategy and progress toward these. - Non-performing assets and private sector indebtedness: - Decisive action to deal with non-performing assets is essential to restore credit to the economy. - Banks have significant legacy non-performing loans and face a continued deterioration of asset quality given the economic downturn. - Dealing with troubled borrowers and cleaning up banks’ balance sheets is key to facilitate an orderly deleveraging and pave the way for the economic recovery. - Authorities need to ensure an adequate private sector debt restructuring framework, providing strong incentives to promote mutual cooperation and discourage strategic defaults, while avoiding political interference (via imposition of interest rate caps) with prudent allocation of credit. - Banks need to set clear policies and targets and report on progress with debt restructuring. - Payment restrictions: - Payment restrictions need to continue to be relaxed in line with the authorities’ roadmap, while safeguarding financial stability. - To ensure adequate conditions for additional relaxations, the authorities will need to strengthen their communication to markets and fine-tune their analysis of confidence and liquidity trends. - Adequate liquidity from the Eurosystem is also critical. - Supervision, regulation, and AML framework: - Authorities have taken steps including the integration of supervision of banks and coops, setting up a credit register, and strengthening reporting guidelines. - Going forward, authorities need to build on these efforts and prepare for the integration of the supervisory and regulatory framework into broader European initiatives. - Strengthen the supervision of banks’ compliance with the recently-enhanced AML/CFT legal framework. ### Policy recommendations and risks - Policy implementation: - The challenge is to maintain the momentum of policy implementation going forward, given resistance to reforms from vested interests and the severe economic contraction. - There is no room for implementation slippages given still significant risks. - Social protection and structural reform: - Protecting vulnerable groups during the downturn should remain a high priority. - Staff welcomes the authorities’ renewed commitment to implementing a generalized minimum income scheme with broad coverage and adequate targeting in the first half of next year. - Fiscal efforts need to be complemented with steps to advance structural reforms and jump-start the privatization process. - Further steps are needed to improve budget processes and strengthen revenue collections by combating tax evasion and modernizing the tax administration to achieve efficiency gains. - Privatization efforts need to be accelerated to secure financing targets and improve overall economic efficiency. - Financing and program buffer: - A more protracted recession could lead to additional financing needs and put debt sustainability at risk. - The program buffer provides a cushion against additional financing needs. - Authorities need to ensure the timely allocation of central bank profits and proceed with the planned debt-to-asset swap to secure financing and debt targets. - Overall imperative: - Continued impeccable policy implementation remains critical to setting in motion a virtuous cycle of confidence and growth. *International Monetary Fund — Staff appraisal excerpts from the Cyprus program documentation.* ### 46. On the basis of progress to date and policy commitments going forward, staff supports ### On the basis of progress to date and policy commitments going forward, staff supports the completion of the second review and the proposed modifications to performance criteria. ### Staff recommendation - Staff supports the completion of the second review and the proposed modifications to performance criteria. ### Real economy: key historical outcomes and projections (percent change, unless otherwise indicated) - Real GDP: 3.6, -1.9, 1.3, 0.4, -2.4, -7.7, -4.8, 0.9, 1.9, 2.3, 2.2, 1.9, 1.8 (2008–2020) - Domestic demand: 8.0, -7.0, 1.9, -1.5, -4.2, -12.4, -7.2, 0.4, 1.6, 2.5, 2.7, 2.5, 2.4 - Consumption: 7.4, -4.6, 1.4, 1.0, -2.6, -9.2, -6.3, 0.3, 1.5, 2.2, 2.5, 2.3, 2.2 - Private consumption: 7.8, -7.5, 1.5, 1.3, -2.5, -10.7, -6.7, 1.3, 2.8, 3.5, 3.1, 2.6, 2.4 - Public consumption: 6.1, 6.8, 1.0, -0.3, -3.1, -4.1, -5.2, -3.2, -3.1, -2.2, 0.6, 0.8, 1.3 - Fixed investment: 6.0, -9.7, -4.9, -8.7, -19.6, -28.5, -14.0, 1.2, 3.1, 4.7, 4.5, 4.2, 3.9 - Inventory accumulation (contribution): 0.9, -1.5, 1.8, -0.7, 1.4, -0.6, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0 - Foreign balance (contribution): -5.1, 6.0, -0.7, 2.0, 2.0, 5.1, 2.2, 0.5, 0.3, 0.0, -0.4, -0.5, -0.5 - Exports of goods and services: -0.5, -10.7, 3.8, 4.4, -2.7, -5.8, -2.9, 1.7, 2.7, 3.3, 3.3, 3.3, 3.3 - Imports of goods and services: 8.5, -18.6, 4.8, -0.2, -6.4, -16.0, -8.0, 0.8, 2.3, 3.7, 4.5, 4.7, 4.7 - Potential GDP growth: 2.4, 1.7, 1.6, 1.7, -1.5, -7.4, -4.6, 0.0, 0.6, 1.4, 1.6, 1.7, 1.8 - Output gap (percent of potential GDP): 2.8, -0.8, -1.2, -2.4, -3.3, -3.6, -3.8, -3.0, -1.8, -0.9, -0.3, -0.1, 0.0 - HICP (period average): 4.4, 0.2, 2.6, 3.5, 3.1, 0.8, 1.0, 1.5, 1.7, 1.7, 1.8, 1.9, 2.0 - HICP (end of period): 1.8, 1.6, 1.9, 4.2, 1.5, -0.3, 1.0, 1.5, 1.7, 1.7, 1.8, 1.9, 2.0 - Unemployment rate EU standard (percent): 3.7, 5.4, 6.3, 7.9, 11.9, 16.7, 19.8, 19.0, 17.7, 16.0, 14.6, 13.2, 12.0 - Employment growth (percent): 2.2, -0.3, -0.2, 0.3, -4.1, -6.3, -4.4, 0.8, 1.7, 2.2, 2.0, 1.8, 1.6 ### Public finance: balances, revenue, expenditure, debt (percent of GDP) - General government balance: 0.9, -6.1, -5.3, -6.3, -6.4, -5.9, -6.6, -5.2, -2.0, -1.1, -0.4, -0.5, -0.8 - Revenue: 43.1, 40.1, 40.9, 39.9, 40.0, 41.2, 40.6, 40.0, 40.6, 41.3, 41.7, 42.0, 42.1 - Expenditure: 42.1, 46.2, 46.2, 46.3, 46.4, 47.1, 47.2, 45.2, 42.6, 42.4, 42.1, 42.5, 42.9 - Primary Fiscal Balance: 3.8, -3.6, -3.0, -4.0, -3.3, -2.6, -3.3, -2.1, 1.2, 3.0, 4.0, 4.0, 4.0 - General government debt: 48.9, 58.5, 61.3, 71.5, 86.6, 113.7, 122.1, 126.2, 122.7, 116.6, 112.2, 108.5, 105.3 Detailed fiscal components (percent of GDP): - Tax revenue: 30.6, 26.4, 26.5, 26.4, 25.9, 26.4, 26.2, 26.2, 26.7, 27.0, 27.2, 27.2, 27.3 - Indirect taxes: 17.7, 15.2, 15.4, 14.6, 14.9, 14.7, 14.9, 15.0, 15.3, 15.5, 15.5, 15.7, 15.7 - Direct taxes: 12.9, 11.2, 11.1, 11.7, 11.1, 11.7, 11.4, 11.2, 11.3, 11.4, 11.5, 11.5, 11.6 - Social security contributions: 7.8, 8.7, 8.9, 8.8, 9.1, 8.7, 9.1, 8.8, 8.7, 8.8, 8.9, 8.9, 9.0 - Current expenditure: 38.2, 40.7, 40.9, 41.7, 42.6, 43.8, 44.1, 42.2, 39.6, 39.0, 38.8, 39.1, 39.5 - Wages and salaries: 14.6, 16.2, 15.8, 16.1, 15.9, 16.0, 15.5, 14.9, 14.2, 13.9, 13.8, 13.7, 13.6 - Social Transfers: 12.2, 13.5, 14.4, 14.7, 15.2, 15.7, 16.8, 16.2, 15.0, 14.5, 14.2, 14.4, 14.5 - Interest payments: 2.8, 2.6, 2.2, 2.4, 3.2, 3.3, 3.3, 3.1, 3.2, 4.1, 4.3, 4.5, 4.8 - Capital expenditure: 4.0, 5.5, 5.2, 4.5, 3.8, 3.3, 3.1, 3.1, 3.0, 3.3, 3.3, 3.4, 3.4 - Memorandum: Primary balance (percent of GDP): 3.8, -3.6, -3.0, -4.0, -3.3, -2.6, -3.3, -2.1, 1.2, 3.0, 4.0, 4.0, 4.0 - Note: Projections for 2015-18 include 4 percent of GDP in unspecified additional fiscal measures as agreed under the program. It is assumed that 70 percent of the measures are on the spending and the rest on the revenue side. ### Balance of payments and external sector (percent of GDP and millions of euros) - Current account balance (percent of GDP): -15.6, -10.7, -9.8, -3.4, -6.9, -1.4, 0.3, 0.2, 0.0, -0.3, -0.7, -1.0, -1.4 - Trade balance (goods and services, percent of GDP): -11.4, -5.5, -6.2, -4.3, -3.1, 1.7, 3.9, 4.0, 4.1, 4.0, 3.6, 3.3, 3.0 - Goods balance: -32.4, -25.5, -26.8, -24.3, -21.8, -17.2, -15.5, -15.5, -15.6, -15.8, -16.2, -16.6, -17.1 - Services balance: 21.0, 19.9, 20.6, 20.1, 18.7, 19.0, 19.4, 19.5, 19.7, 19.8, 19.8, 19.9, 20.1 - Financial account, net (percent of GDP): 16.1, 10.9, 9.5, 4.4, 4.8, -29.9, -16.9, -14.5, -3.1, 0.0, 0.8, 1.4, 2.0 - Direct investment: -5.2, 13.2, 0.4, 0.7, 6.8, 0.2, 0.5, 4.3, 4.7, 3.1, 3.0, 4.0, 4.0 - Portfolio investment: -74.2, -101.1, -11.1, 32.2, 30.1, 59.2, 3.2, -4.2, -3.1, -2.6, -2.5, -2.5, -4.2 - Other investment: 93.8, 98.2, 19.0, -28.8, -32.4, -89.4, -20.7, -14.6, -4.7, -0.5, 0.3, -0.1, 2.2 - Program financing (percent of GDP): 0.0, 0.0, 0.0, 0.0, 0.0, 29.5, 15.8, 13.6, 2.6, 0.0, -0.3, -0.6, -0.8 - European Union: 0.0, 0.0, 0.0, 0.0, 0.0, 27.9, 13.6, 11.4, 2.1, 0.0, 0.0, 0.0, 0.0 - IMF: 0.0, 0.0, 0.0, 0.0, 0.0, 1.6, 2.2, 2.1, 0.5, 0.0, -0.3, -0.6, -0.8 Selected levels (millions of euros): - Nominal GDP (billions of euros): 17.2, 16.9, 17.4, 17.9, 17.7, 16.4, 15.8, 16.2, 16.8, 17.5, 18.2, 18.9, 19.6 - Table 3: Gross financing requirement including a buffer (May-December and projections, millions of euros): - 2013: 5,800.5; 2014: 3,821.6; 2015: 3,621.6; 2016: 2,128.6; 2017: 3,899.9 - Government components (2013–2017): Government gross financing requirement 3,556.4; 3,014.4; 2,969.9; 1,929.5; 3,899.9 - Program official financing sources (2013–2017): IMF 258.4; 344.5; 344.5; 86.1; 0.0; ESM 4,585.0; 2,150.0; 1,850.0; 350.0; 0.0 ### External financing requirements and sources (Table 5 highlights, millions of euros) - Gross financing requirements (2012–2020): 60,086; 61,352; 32,869; 30,722; 29,027; 28,348; 28,739; 28,505; 28,293 - Current account deficit ("-" = CA surplus) (millions): 1,217; 230; -51; -35; 25; 31; 31; 19; 90; 272 - Medium- and long-term debt amortization (2012–20, millions): 5,800; 12,140; 4,406; 4,205; 4,064; 4,057; 4,811; 4,958; 5,414 - Short-term debt amortization (2012–20, millions): 53,069; 48,982; 28,513; 26,552; 24,961; 24,231; 23,741; 23,242; 22,442 - Financing gap and official support (millions): - FINANCING GAP: 0; 4,843; 2,494; 2,194; 436; 0; 0; 0; 0 - ESM: 0; 4,585; 2,150; 1,850; 350; 0; 0; 0; 0 - IMF: 0; 258; 344; 434; 48; 6; 0; 0; 0 ### Monetary and financial sector indicators (Table 6 highlights) - Aggregated balance sheet of other MFIs (assets, end of period, billions of euros): 118.1, 139.4, 135.0, 131.4, 128.1, 90.5, 89.2, 88.0, 88.3, 89.2, 90.5, 92.0, 93.7 (2008–2020) - Claims on Cypriot resident non MFIs (end of period, billions): 47.2, 50.3, 54.0, 58.2, 60.6, 54.2, 50.6, 48.7, 48.6, 48.8, 49.2, 49.7, 50.5 - Private sector excluding brass plates: 39.4, 42.7, 46.5, 48.6, 49.3, 45.4, 41.7, 39.5, 39.3, 39.6, 39.9, 40.4, 41.1 - Deposits of non-residents (end of period, billions): 51.7, 66.6, 60.6, 56.5, 51.3, 27.2, 26.7, 26.3, 25.7, 25.7, 26.1, 26.9, 27.3 - Cypriot resident broad money (M2, end of period, billions): 40.6, 42.2, 46.6, 45.0, 44.6, 32.8, 31.7, 31.9, 32.9, 34.2, 35.5, 36.8, 38.1 - Private sector credit excluding brass plates (percent of GDP, memorandum): 230.0, 253.6, 267.2, 272.1, 278.1, 276.5, 264.4, 244.1, 234.7, 226.6, 219.2, 213.5, 209.3 ### Gross financing of IMF arrangement and schedule of reviews and purchases - Table 7: Existing and prospective Fund credit (stock, millions of SDRs): Stock 0.0, 222.8, 519.8, 816.8, 891.0, 884.8, 835.3, 736.3, 594.0 (2012–2020) - Table 8: Schedule of Reviews and Purchases (availability date, millions of SDR, percent of quota): - May 15, 2013: 74.25, 46.93% — 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, 563.21% ### Capital controls and restrictive measures (selected limits, euros) - Cash withdrawals (per day per person): Natural person: 300; Legal person: 300 then 500 - Cashless payments/transfers w/o justification: - To other credit institutions in Cyprus (natural person per month): 5,000; 15,000; 15,000 - To other credit institutions in Cyprus (legal person per month): 5,000; 75,000; 75,000 - Purchases of goods and services w/o mandatory justification (per transaction): 5,000; 300,000; no limitation - Transactions to institutions abroad within normal business w/o Committee's approval: 5,000; 500,000; 1,000,000 - Payments via debit or credit card (per month): 5,000; No limit; No limit - Exports of euro notes or foreign currency per person per journey: 1,000; 3,000; 3,000 - Monthly transfer of deposits/funds abroad regardless of the purpose: 5,000; 5,000; 5,000 - Opening of new accounts: prohibited except for limited exceptions in earlier lists; later entries show "No 1/" for restrictions and references to prior approval by the committee. ### Selected reforms completed (policy measures and completion dates) - Implemented reform of the COLA wage indexation mechanism in the public sector by extending its freeze to the end of the program and limiting its application to 50 percent of the price index thereafter — December 2012 - Adopted the 2013 and medium term budget with consolidation measures for 2013-16 of about 7 percent of GDP — December 2012 - Reformed the General Social Insurance Scheme and government pension scheme, and freeze public sector pensions — January 2013 - Legislated a medium-term budget framework, including rolling three-year budget projections - Rolled over and extended the maturity of €1 billion of domestic debt held by residents through a voluntary debt exchange covering maturities falling due in 2013-15 and rolled over the €1.9 billion recapitalization bond of Laiki — June 2013 - Independently assessed banking sector capital needs — February 2013 - Adopted a modern bank resolution law — March 2013 - Completed resolution of Laiki and disposed of Greek operations — March 2013 - Conducted independent fair valuation of Laiki and BoC assets, and completed BoC recapitalization and exit from resolution — July 2013 - Performed assessment of capital needs and viability of all CCIs — June 2013 - Recapitalized Hellenic Bank from private sources — October 2013 - Harmonized NPL classification to best practice — September 2013 - Unified supervision of CCIs and banks under the CBC — September 2013 - Passed legislation to prohibit banks and coops from lending to their independent board members and removing board members in arrears on debts to their banks — September 2013 - Established the legal framework for a credit register — November 2013 - Finalized a code of conduct for banks and a loan arrears framework — September 2013 - Strengthened the AML framework through legislative amendments and commissioned audits and assessments — December 2012; August 2013; September 2013 ### MEFP commitments for the financial sector (selected deadlines and rationale) - Banks under restructuring required to publish quarterly reports — End-December 2013 - Quarterly report on team monitoring BoC's compliance with quarterly targets — End-December 2013 - Inject state funds in the CCB in exchange for common shares — After approval of restructuring plan by the EC - Resolution Authority to instruct Special Administrator to entrust voting rights of legacy Laiki equity stake in BoC to an independent consulting or auditing firm — End-January 2014 - Present detailed roadmap for full disposal of legacy Laiki's assets — End-January 2014 - Complete fair value assessment of the CCB's and CCI's assets and submit final restructuring plan of CCIs to the EC — End-January 2014 - Merge CCIs into up to 18 institutions to be recapitalized — End-March 2014 - CBC to require Hellenic Bank to submit business plan through end-2015 including capital and funding plans — End-March 2014 - CBC to finalize action plan for supervision of cooperative credit sector and be fully operational by end-March 2014 — End-September 2013; End-March 2014 - CBC to increase minimum CT1 capital requirement to 9 percent — End-December 2013 - CBC to issue guidelines on asset impairment and provisioning — End-December 2013 - Submit legislation to Parliament to introduce early corrective measures — End-June 2014 - CBC to request a standalone assessment against the “Basel Core Principles for Effective Banking Supervision” — End-2015 - Credit register to be operational — End-September 2014 - Implement a framework for seizure and sale of loan collateral — End-December 2014 ### MEFP commitments for the fiscal sector (selected deadlines and rationale) - Complete costing of guaranteed minimum income (GMI) scheme and refine means testing — End-December 2013 - Approval by Council of Ministers of design of social welfare reform system — End-March 2014 - Adopt legal framework for new social welfare system — End-May 2014 - Implement new social welfare system — End-June 2014 - Reform plan on revenue administration to be approved — End-December 2013 - Adopt short-term measures to fight tax evasion — End-December 2013 - Amend Public Debt Management Law to assign responsibility for monitoring stock of guarantees to Public Debt Management Office — End-December 2013 - Adopt a law on fiscal responsibility and budget systems — End-December 2013 - Include a statement of SOEs and semi-government entities as an appendix to the budget — End-December 2013 - Adopt privatization plan aiming for proceeds of at least €1.4 billion by end-2018 — End-December 2013 - CBC to decide asset swap so as to contribute approximately EUR €1bn to reduction of public debt — End-June 2014 ### Debt trajectory (percent of GDP) - General government debt (baseline, percent of GDP): Baseline (First Review) 85.8, 114.1, 123.0, 125.7, 121.7, 115.9, 111.7, 108.1, 105.0 (2012–2020) - Revised Baseline (percent of GDP): 86.6, 113.7, 122.1, 126.2, 122.7, 116.6, 112.2, 108.5, 105.3 (2012–2020) *Source: Eurostat; Central Bank of Cyprus; and IMF staff estimates.* ### Annex 1. Public Sector Debt Sustainability Analysis ### Annex 1. Public Sector Debt Sustainability Analysis ### Baseline outlook and key projections - Debt ratio revised to 113.7 percent of GDP in 2013. - Debt revised to about 122 percent of GDP in 2014 due to reprogramming of ESM disbursements. - Re-profiling of ESM disbursements resulted in a slightly higher debt ratio in 2016. - Primary balance is expected to improve gradually to a primary surplus of 4 percent of GDP by 2018. - Revisions in 2013 mainly reflect a stronger revenue outlook; 2014 revisions reflect a higher tax base for 2013, expected one-off revenues, and 0.3 percent of GDP in additional measures. - Nominal GDP movements did not materially affect the 2013 ratio because a downward revision in the 2012 deflator offset a relative expected improvement in growth. ### Overall assessment and vulnerabilities - Full implementation of the program can place Cyprus’s debt on a sustainable trajectory, but high debt levels, uncertain growth prospects, and contingent liabilities from the financial sector make the debt trajectory highly vulnerable to shocks. - Gross financing needs and debt-level benchmarks signaling elevated risk: - Debt-level benchmark: 85 percent of GDP. - Gross financing needs benchmark: 20 percent of GDP. - Almost all DSA tests point to Cyprus as a high risk country; only two risk indicators are low risk: the share of short-term debt and the share of debt in foreign currency. - Market indicators (still high spreads and external financing needs) point to high risk classification. - Vulnerabilities of debt structure: - Large external financing needs mostly reflect maturing short-term debt and large uninsured foreign bank deposits. - Reprogramming of uninsured deposit maturities, Bank of Cyprus restructuring, and capital controls mitigate abrupt outflow risk, though some outflow risk remains during phase-out. - Relatively low and fixed interest rate of official liabilities mitigates interest rate and financing risks. - Bond yields and spreads are imperfect market-perception indicators given small and highly illiquid markets. ### Realism of baseline assumptions - Growth and deflator projection errors relative to other program countries remain within the inter-quartile range. - Cross-country evidence and calibrated growth paths (Jorda et al. (2011) methodology) provide comfort on the conservativeness of the program’s growth projection. - Primary balance projections for 2011 and 2012 remain close to the median versus comparator groups. - Assessment of fiscal adjustment realism is mixed: - Level of cyclically adjusted primary balance is borderline realistic. - Three-year adjustment is considered ambitious. - Authorities implemented measures estimated at around 7 percent of GDP in 2013 and 2014. - Estimation of structural fiscal balance and output gap is unusually uncertain in the current deep recession. ### Sensitivity and stress-test results (macro-fiscal shocks) - Baseline tests indicate high vulnerability: under adverse shocks, fan charts and stress tests suggest debt could reach 130-150 percent of GDP by 2020. - Specific stress-test outcomes: - Growth risk (decline in growth by two historical standard deviation ≈ 5.2 percentage points in 2014 and 2015; non-interest revenue deterioration of 0.4 percent per percentage point of growth reduction; deflator decline 0.25 percentage points per point of growth): debt increases to 159 percent of GDP by 2016 and 147 percent of GDP by 2020. - Primary balance risk (planned fiscal adjustment in 2015-2018 reduced by 50 percent, implying average worsening of primary balance in 2015-2018 of about 1 percent of GDP): debt increases to 126 percent of GDP in 2016 and to 114 percent of GDP by 2020. - Interest rate risk (shock increasing real interest rate by slightly over 3 percentage point each year during 2013-2020): debt reaches 125 percent of GDP in 2016 and 120 percent of GDP in 2020. - Combination of macro-fiscal risks (growth, interest rate, and primary balance shocks occurring simultaneously): debt reaches 162 percent of GDP in 2016 and remains broadly around that level in 2020. - Inflation risk (deflator growth lower than baseline; customized shock 2): debt increases to 126 percent of GDP in 2016 and to 114 percent of GDP in 2020. - Medium-term growth risk (slower and prolonged deleveraging; deflator lower by 0.25 ppt per point of growth): debt increases to 134 percent of GDP in 2016 and remains broadly around that level in 2020. - Risks related to asset swap, additional CBC dividends, and privatization proceeds: materialization would fully exhaust the buffer and lead to an increase in 2020 debt by about 5 percent of GDP. ### Banking-system contingent liability scenarios - Three contingent liability scenarios analyzed: - Scenario 1 (subsumed in baseline): Additional €1.5 billion (about 13 percent of GDP) financial sector needs (increase in sector-wide identified needs by about 100 percent, or more than a doubling of coops’ needs). This amount can be covered by the existing buffer and has no implications for financing or debt sustainability. - Scenario 2 (customized shock 1): Adds an additional €1.5 billion to scenario 1 (total increase in sector-wide identified needs by about 200 percent). This shock increases debt to 130 percent of GDP in 2016 and to 117 percent of GDP in 2020. - Scenario 3 (contingent liabilities shock): Scenario 2 plus a 2 standard deviation real GDP growth shock (additional capital needs materialize due to deterioration in macro outlook). Debt increases to 166 percent of GDP in 2016 and to 153 percent of GDP in 2020. ### Additional numeric highlights from baseline DSA table (selected) - Public gross financing needs: 14.2, 18.0, 18.9, 21.4, 18.9, 18.5, 11.8, 22.9, 10.6, 14.5, 16.3 (percent of GDP for 2011–2020 respectively as presented). - Real GDP growth (in percent): 2.7, 0.4, -2.4, -7.7, -4.8, 0.9, 1.9, 2.3, 2.2, 1.9, 1.8 (for 2011–2020 where given). - Inflation (GDP deflator, in percent): 3.0, 2.3, 1.6, 0.4, 1.0, 1.5, 1.8, 1.9, 1.9, 1.9, 2.0 (for 2011–2020 where given). - Nominal GDP growth (in percent): 5.8, 2.7, -0.9, -7.3, -3.9, 2.4, 3.7, 4.3, 4.2, 3.9, 3.9 (for 2011–2020 where given). - Effective interest rate (in percent): 5.1, 4.0, 4.4, 3.5, 2.8, 2.6, 2.7, 3.5, 3.9, 4.1, 4.6 (for 2011–2020 where given). - Cumulative change in gross public sector debt (2011–2020): 25.6 (percent of GDP as cumulative change). *Source: IMF staff, Annex 1. Public Sector Debt Sustainability Analysis (Cyprus).* ### Annex 2. External Sector Debt Sustainability Analysis ### Annex 2. External Sector Debt Sustainability Analysis ### Recent External Debt Trends - External debt declined from about around 450 percent of GDP at end-2012 to roughly 370 percent of GDP by end-2013Q2. - The banking system’s external debt fell from about 280 percent of GDP to 210 percent of GDP over the same period. - Claims on the financial sector were mostly short-term debt in the form of deposits. - As a result of the decline, the banking sector now accounts for less than 60 percent of Cyprus’s external debt (compared with almost ¾ at end-2012). ### Baseline Projections and Scenarios - Baseline projection: external debt contracts from 355 percent of GDP at end-2013 to about 300 percent of GDP by end-2020. - Scenario values (selected figures shown in the annex charts/tables): - Historical scenario (illustrative): 438 (external debt in percent of GDP shown in figure). - Baseline scenario (illustrative): 301 (external debt in percent of GDP shown in figure). - Historical scenario five-year projection path (selected): 355.8, 367.6, 384.4, 398.8, 410.2, 421.3, 428.4, 437.6 (percent of GDP). - Debt-stabilizing non-interest current account (long-run constant balance) presented in table A2.1 (values shown in the annex). ### Vulnerabilities and Stress Tests - External debt dynamics are vulnerable to macroeconomic shocks: - A lack of external adjustment—e.g., weaker external competitiveness or significant fiscal slippages—(historical scenario) would lead to an unsustainable external debt path. - A shock of higher interest rates on external debt (200 basis points above baseline assumptions) would significantly slow the reduction in external debt. - Bound-test scenario outcomes (selected values from figures): - CA shock: external debt around 318 (percent of GDP). - Growth shock: external debt around 332 (percent of GDP). - Interest-rate shock: external debt around 349 (percent of GDP). - Combined shock: external debt around 349 (percent of GDP). - Individual shocks are permanent one-half standard deviation shocks; combined scenarios shown include permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance in some presentations. ### Identified External Debt–Creating Flows and Key Dynamics (selected from Table A2.1) - Baseline: External debt series (percent of GDP): 447.4 (2008), 544.1 (2009), 491.9 (2010), 468.2 (2011), 448.5 (2012), 355.8 (2013), 369.3 (2014), 364.0 (2015), 352.2 (2016), 338.0 (2017), 324.5 (2018), 311.2 (2019), 301.0 (2020). - Change in external debt (selected): 100.3, 96.7, -52.3, -23.6, -19.8, -92.7, 13.5, -5.3, -11.8, -14.3, -13.4, -13.3, -10.2. - Identified external debt-creating flows (4+8+9) (selected): -12.2, 51.6, 20.6, -39.0, 36.9, 25.3, 16.0, -6.8, -10.5, -10.0, -8.9, -8.4, -7.1. - Current account deficit, excluding interest payments (percent of GDP, selected): 6.6, 2.1, 0.9, -5.4, -4.2, -10.1, -11.9, -11.8, -11.7, -11.4, -10.9, -10.5, -9.9. - Net non-debt creating capital inflows (negative, percent of GDP, selected): 20.0, 7.0, 1.8, -7.2, -12.8, -12.1, -1.1, -3.5, -4.1, -2.6, -2.5, -3.5, -3.2. - Automatic debt dynamics (percent of GDP, selected): -38.8, 42.5, 17.8, -26.4, 53.9, 47.5, 29.0, 8.5, 5.3, 3.9, 4.5, 5.6, 6.0. - Contribution from nominal interest rate (selected): 9.0, 8.6, 8.9, 8.8, 11.1, 11.5, 11.5, 11.5, 11.8, 11.7, 11.6, 11.5, 11.3. - Contribution from real GDP growth (selected): -10.7, 8.9, -7.2, -2.0, 12.5, 36.0, 17.5, -3.0, -6.4, -7.8, -7.2, -5.9, -5.3. - Contribution from price and exchange rate changes shown in table (formula defined in notes). ### Gross External Financing Needs (selected) - Gross external financing need (in billions of US dollars): 52.1, 81.2, 109.4, 85.3, 79.0, 55.0, 44.1, 41.7, 39.9, 39.4, 40.3, 40.3, 40.0. - Gross external financing need (in percent of GDP, selected values shown): 206.5, 346.0, 473.6, 343.1, 346.5 (table presents multi-year series and 5-year aggregates). ### Key Macroeconomic Assumptions Underlying Baseline (selected) - Real GDP growth (in percent): 3.6, -1.9, 1.3, 0.4, -2.4, 0.2, 2.4, -7.7, -4.8, 0.9, 1.9, 2.3, 2.2, 1.9, 1.8. - GDP deflator in US dollars (change in percent): 12.0, -5.3, -2.9, 7.2, -6.1, 1.0, 8.1, 3.5, 2.8, 2.9, 2.9, 2.9, 2.9, 1.9, 2.0. - Nominal external interest rate (in percent): 3.0, 1.8, 1.6, 1.9, 2.2, 2.1, 0.6, 2.5, 3.2, 3.2, 3.4, 3.5, 3.6, 3.7, 3.8. - Growth of exports (US dollar terms, in percent): 10.4, -17.0, 1.0, 12.0, -8.4, -0.4, 12.3, -1.6, 0.2, 4.4, 5.3, 6.1, 6.2, 5.3, 5.4. - Growth of imports (US dollar terms, in percent): 21.5, -24.6, 2.2, 7.0, -10.7, -0.9, 17.5, -11.8, -4.6, 4.1, 5.1, 6.4, 7.1, 6.2, 6.3. - Current account balance, excluding interest payments (percent of GDP): -6.6, -2.1, -0.9, 5.4, 4.2, 0.0, 4.9, 10.1, 11.9, 11.8, 11.7, 11.4, 10.9, 10.5, 9.9. - Net non-debt creating capital inflows (percent of GDP): -20.0, -7.0, -1.8, 7.2, 12.8, -1.8, 12.8, 12.1, 1.1, 3.5, 4.1, 2.6, 2.5, 3.5, 3.2. ### Policy Implications and Recommendations - Continued external adjustment is critical to ensure external sustainability over the projection period. - Continued decline in the size of the financial system and reduced use of nonresident deposits would improve external sustainability and reduce gross financing needs. - Scenarios underscore the importance of maintaining external competitiveness, avoiding fiscal slippages, and limiting exposure to higher external interest rates. *Source: Annex 2. External Sector Debt Sustainability Analysis* ### 6. We will also strengthen the management of legacy Laiki’s equity stake in BoC. Legacy ### _cr13374 - 6. We will also strengthen the management of legacy Laiki’s equity stake in BoC. Legacy ### Legacy Laiki shareholding and management of BoC stake - Legacy Laiki is the single largest shareholder in BoC, with a shareholding of 18 percent of total shares. - Legacy Laiki remains under resolution, pending the planned sale of its foreign subsidiaries. - By end-January 2014, the Resolution Authority will present a detailed roadmap for the full disposal of legacy Laiki’s assets, while maximizing value for creditors. - Pending disposal of legacy Laiki’s shares in BoC, the Resolution Authority will instruct the Special Administrator to entrust (by end-January 2014) the voting rights of these shares to a well-recognized and independent consulting or auditing firm(s) or international institution(s) (structural benchmark). ### Hellenic Bank (HB) recapitalization and business planning - On November 1, HB increased its share capital by the issuance of €100 million in shares to three private funds, including a foreign participant, which brought its capitalization level to 9.5 percent CT1. - The bank secured the conversion of €255 million of junior bonds into CT1 eligible instruments, thus exceeding the capital requirements determined by the PIMCO due diligence exercise under the adverse scenario by about €60 million. - The CBC will require HB to submit by end-March 2014 a business plan through end-2015, including capital, and funding plans. ### Cooperative credit sector restructuring and governance - The Ministry of Finance has set up a specialized unit to manage the state’s future stake in the sector. - Nine mergers of 38 CCIs have been completed, and a draft restructuring plan for the sector has been finalized. - Prior action: The Ministry of Finance will agree with the CCB on the terms of the relationship framework to define responsibilities and governance boundaries between the state as majority owner and the board and senior management of the bank. - CBC requirement (initial step): new board of CCB to publish, by end-November 2013, a roadmap agreed with the CBC specifying key interim actions for the next three months, including: - (i) the appointment of the new CEO, - (ii) measures to bolster the independence and qualification of the CCI Boards, - (iii) actions to retain customers, - (iv) measures to impede further asset deterioration, and - (v) measures to prepare the transfer of NPLs to specialized units within the sector. - By end-January 2014, we will: - (i) complete an independent fair value assessment of the CCB and CCIs’ assets aimed at quantifying the size of the government’s stake in the sector; and - (ii) submit the final restructuring plan to the European Commission, reflecting the views of the new Board and top management (structural benchmark). - Immediately following approval of the plan by the European Commission, we will inject €1.5 billion of state funds into the CCB. - The CCB will recapitalize the CCIs as the 18 mergers are completed and their new Boards are appointed; the recapitalization process will be completed by end-March 2014 (existing structural benchmark). - The 18 CCIs will be subject to independent external audits starting with 2013 accounts. ### Private sector debt restructuring framework - Objectives: revamp corporate and household debt restructuring to facilitate loan workouts and cleanup of banks’ balance sheets; support restructuring of troubled borrowers based on international experience and best practices; minimize incentives for non-cooperation and strategic loan defaults. - Four critical fronts: - Establishment of a framework to facilitate negotiations between borrowers and creditors: - CBC completed first review of banks’ compliance with the Code of Conduct (CoC). - CBC provided recommendations for full implementation by banks. - By end-November, CBC will publish supplementary information on the CoC to enhance public awareness and facilitate implementation. - By end-May 2014 the CBC will complete a second round of inspections to verify banks’ compliance with the CoC and impose sanctions as needed. - Adoption by banks of an effective arrears management strategy: - In late October 2013, CBC completed its review and made recommendations for banks’ strategies to implement the new framework for arrears management. - By end-November 2013, CBC will require banks to submit by end-January 2014 their revised strategies and a detailed implementation plan for arrears management approved by their boards (including pre-packaged programs, and general policies to deal with small and large troubled borrowers, respectively). - By end-November 2013, CBC will define key performance indicators for progress on loan restructuring and instruct banks to report quarterly on progress beginning end-March 2014. - By end-March 2014, the CBC, with external technical support, will complete an in-situ assessment of the operational capacity of the banks’ loan workout units to implement their plans (structural benchmark). - Review of corporate and personal insolvency framework: - By end-December 2013 we will carry out a review of the corporate and household debt-restructuring framework and prepare a report identifying impediments and measures to address them. - As needed, by end-February 2014 we will submit legislation to parliament to implement these measures. - Creation of mediation services: - By end-January 2014, we will pass legislation to expand the role of the Financial Ombudsman to mediate debt-restructuring negotiations between banks and borrowers. ### Ensuring adequate liquidity and normalizing financial flows - The Central Bank of Cyprus will continue to monitor closely the liquidity situation of the banking system and stands ready to take appropriate measures to maintain sufficient liquidity in the system, following the procedures and rules of the Eurosystem. - The government stands ready to consider the issuance of additional government funding guarantees up to € 2.9 billion - in line with state aid rules and in compliance with the provisions of our Public Debt Management Law - if there is a clear need to safeguard financial stability. ### Roadmap for easing administrative measures and capital controls - Committed to published milestone-based roadmap to gradually ease administrative measures and capital controls while safeguarding financial stability. - August-October 2013: restrictions on wire transfers and opening of new accounts were relaxed. - Central Bank actions: - Fine-tune technical impact assessment of relaxation measures on banks’ liquidity and methodologies to assess market confidence. - By end-December 2013, appoint an independent specialized panel of experts to study current market conditions, including through well-targeted surveys and focus groups. - The panel will issue a report by end-January 2014 containing main recommendations, a communication strategy and an action plan to inform actions during the second stage of the roadmap. ### Financial sector supervision and regulation - Legislation to establish a comprehensive credit register (end-September 2013 structural benchmark) was passed by Parliament on November 28. - CBC issued guidelines on loan origination requiring loan decisions be based primarily on borrowers’ cash flow rather than asset-based lending. - By end-December 2013: - Issue guidelines on asset impairment and provisioning and the treatment of collateral in provisioning to bring accounting practices up to the most conservative international level. - Issue mandatory disclosure requirements to ensure banks regularly communicate progress in restructuring loan portfolios and operations. Disclosure requirements become effective for the publication of the 2013 financial statements. - CBC will require banks to submit by end-February 2014 an action plan to fully implement these guidelines in the preparation of their 2014 financial statements. - By end-January 2014: - CBC will complete its annual supervisory program detailing objectives and activities for 2014, including a tentative timeframe to gradually resume regular on-site inspection of commercial and cooperative banks, staffing, cost and budget, and main training programs. - Clarify allocation of tasks and responsibilities in the governance structure of the bank and address staffing issues related to retention and recruitment. - Require banks to submit the 2014 work program of their internal audit departments to the CBC. - By end-June 2014: stand ready to submit draft legislation to introduce early corrective measures to enhance supervisory powers to address capitalization issues. - By end-January 2014: amend as necessary the resolution law and define procedures to ensure the effectiveness of the resolution authority. ### Strengthening AML/CFT implementation - Recent actions: amended legal AML/CFT framework (end-September structural benchmark), commissioned external audit of AML implementation by banks, articulated an action plan to strengthen implementation. - Exchange of information: - Following September 2013 revision of the AML law, the Financial Intelligence Unit (FIU) will compile on a quarterly basis statistics on financial information exchanged with other FIUs, both upon request and spontaneously, with a breakdown by country. - Starting from the forthcoming 2012 annual report (which will be posted on the web), the FIU statistics will also include information on spontaneous exchanges of information broken down by country, in addition to information already provided on exchanges upon request. - Follow-up on AML audit findings: - The CBC has progressed with follow-up on the auditor’s findings regarding possible breaches of compliance with AML requirements by banks and will complete this work by end-January 2014. - AML supervision by CBC: - CBC will adopt a plan for 2014 aimed at strengthening the effectiveness and adequacy of resources of the AML/CFT supervisory function for financial institutions (end-February 2014 structural benchmark). - Onsite supervision will be stepped-up over the program period to a level commensurate to the size, complexity, and risk profiles of the financial institutions operating in the system. ### Fiscal policy: 2013 outturn and 2014 targets - 2013 outturn: - Maintained a cumulative primary surplus of 0.7 percent of GDP by end-September 2013. - Met end-September primary balance and primary spending targets with margins exceeded by 3.2 and 1.7 percent of GDP, respectively. - 0.9 percent of GDP was due to postponing from the third quarter to October the compensation of Laiki pension funds for resolution-related losses. - Revised end-year primary deficit target for the general government (cash terms) to 2.6 percent of GDP (relative to 3.3 percent of GDP at the time of the first review). - 2014 target: - Target a primary deficit of 3.3 percent of GDP on a cash basis. - This is better than envisaged under the original program by 1 percent of GDP, reflecting a net effect on revenues (0.7 percent of GDP) of a higher 2013 base and some limited additional measures (0.3 percent of GDP). - Measures include: rationalization of allowances and overtime of public employees; better targeting of the social pension by introducing income criteria; reducing exemptions on pension contributions of previously exempted groups; increasing the taxation of lottery winnings. - Amendment of the 2014 draft budget incorporating a revised macroeconomic framework and revised targets is a prior action for completion of the second review. - Budgetary impact associated with eventual exploitation of hydrocarbon resources will be consistent with program’s medium-term fiscal and public debt targets. - Refrain from introducing any tax amnesties during the program period. ### Support for SME credit and government guarantees - In 2014 the government will guarantee up to €115 million to banks for borrowing from the EIB for SME on-lending, to provide trade credits to SMEs, and other ongoing projects. - The end-December 2013 ceiling will be adjusted downwards to reflect reduced probability of disbursement of the loan to EAC related to the Vassilikos power plant and updated guarantees for other projects. - An adjustor of up to €130 million will be included in case the loan to EAC is actually disbursed. - Debt ceilings for end-December 2013 and end-March 2014 will also be adjusted to accommodate proceeds of the direct loans included in the 2014 budget to be spent in 2014. ### Structural fiscal reforms: social welfare, tax administration, PFM, and privatization - Social welfare reform: - New system centered on a Guaranteed Minimum Income (GMI) scheme to ensure adequate and equitable protection while preserving work incentives. - By end-November 2013 define level of basic needs and composition of minimum consumption basket. - By end-December 2013 complete costing of the GMI to determine benefit level and eligibility criteria and refine means-testing mechanism. - Final design, including decisions on type, level and eligibility criteria for GMI and any remaining benefits, consistent with the 2014 and medium-term budget ceilings, will be approved by the Council of Ministers by end-March 2014 (structural benchmark). - Reform will be implemented by end-June 2014 (existing structural benchmark). - Revenue administration reform: - On October 30, Council of Ministers empowered the Ministry of Finance to initiate the revenue administration reform and established governance structure including a High-Level Steering Committee and an Executive Technical Committee. - Project manager and head of integration reform project team have been appointed; work underway. - Reform implementation plan to be approved by government by end-December 2013. - By end-December 2013, adopt short-term measures to establish a work program of joint audits to target high-risk taxpayers and large traders. - Legislative amendments to increase collection enforcement powers of the revenue administration and establish full self-assessments for all income taxpayers (existing structural benchmark). - Initial steps to identify compliance risks. - Public financial management reforms: - A Fiscal Responsibility and Budget Systems Law will be adopted by end-December 2013 (existing structural benchmark). - Amendment to the Public Debt Management Law will be approved by end-December 2013, assigning responsibility for monitoring the stock of guarantees to the Public Debt Management Office. - Since September, Treasury department assumed responsibility for monthly collection and reporting of key financial indicators for the general government. - A “Statement of state-owned enterprises (SOE) and semi-government entities” will be included as an appendix to the 2014 budget. - Privatization objectives: - Targeted proceeds of €1.4 billion by end-2018. - Prepare a plan specifying the portfolio of state-owned assets eligible for privatization, estimate of expected receipts, and timetable for individual transactions; plan to be adopted by the Council of Ministers in early December 2013. - By end-January 2014, adopt the institutional and legal framework to govern the privatization process, including establishment of a unit within the Ministry of Finance to implement the privatization plan. *International Monetary Fund — Selected passages from the Cyprus program document contained in the supplied content unit.* ### 21. In line with our program commitments, we continue to undertake measures to limit ### _cr13374 - 21. In line with our program commitments, we continue to undertake measures to limit ### Measures to limit financing needs - Restructured bilateral loan with Russia: extended maturities and a lower interest rate. - CBC Board to decide on allocation of central bank profits of €0.4 billion (in line with CBC duties under the Treaties and the Statute) to be distributed to the government in 2014 after finalizing its financial accounts by end-March 2014. - Inventory of state assets completed, enabling a debt-to-asset swap to be decided by the CBC in accordance with its rules and the Treaty; aims to reduce public debt by approximately €1 billion by end-June 2014. ### Program monitoring, conditionality, and publication - Implementation of program policies monitored through quarterly PCs and reviews. - Program includes continuous performance criteria, indicative targets, and structural benchmarks as defined in the attached Technical Memorandum of Understanding (TMU). - Continuous performance criteria include: - Non-accumulation of external payment arrears (standard). - Non-intensification of restrictions of payments and transfers for current international transactions or introduction of multiple currency practices. - Authorities authorize IMF to publish the Letter of Intent and attachments, and the related staff report. ### Key quantitative conditionality (selected figures from Table 1; millions of euros) - Floor on the general government primary balance (cumulative since January of the corresponding year): - Sep-13 Target: -402 - Sep-13 Actual: 110 - Dec-13 Target: -435 - Mar-14 Target: 24 - Jun-14 Target: -224 - Sep-14 Target: -94 - Ceiling on the general government primary expenditure: - Sep-13 Target: 5,065 - Sep-13 Actual: 4,784 - Dec-13 Target: 7,205 - Mar-14 Target: 1,530 - Jun-14 Target: 3,204 - Sep-14 Target: 4,804 - Ceiling on the stock of general government debt: - Sep-13 Target: 18,521 - Sep-13 Actual: 18,403 - Dec-13 Target: 18,668 - Mar-14 Target: 18,658 - Jun-14 Target: 18,042 - Sep-14 Target: 18,380 - Ceiling on the accumulation of new general government guarantees: - Sep-13 Target: 145 - Sep-13 Actual: -2.2 - Dec-13 Target: 25 - Mar-14 Target: 65 - Jun-14 Target: 90 - Sep-14 Target: 115 - Ceilings on the accumulation of external arrears, domestic arrears, and tax refund arrears by the general government (cumulative): - External arrears ceiling: 0 (Sep-13 target and actual; Dec-13, Mar-14, Jun-14, Sep-14 targets all 0) - Domestic arrears ceiling: 0 (Sep-13 target and actual; Dec-13, Mar-14, Jun-14, Sep-14 targets all 0) - VAT refund arrears ceiling: - Sep-13 Target: 10 - Sep-13 Actual: -7 - Dec-13 Target: 10 - Mar-14 Target: 10 - Jun-14 Target: 10 - Sep-14 Target: 10 Notes on definitions (from TMU) - Floor on GGPCB (performance criterion): general government cash primary balance defined as general government cash balance (GGCB) minus general government interest receipts plus general government interest payments. - GGCB = 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 excluded from revenue. - Floor on GGPCB measured cumulatively from the start of each calendar year. - Privatization receipts defined as receipts from disposal to private owners by a government unit of the controlling equity of a public corporation or quasi-corporation. - Adjustors to GGPCB floor: - End-December 2013 target adjusted downwards by payments to compensate pension funds for losses related to the resolution of Cyprus Popular Bank up to €163 million; if deferred to 2014, adjustor applied to end-March 2014 target for remainder up to cumulative €163 million. - 2014 targets adjusted downwards by dividends received from the CBC and the semi-government organizations. ### Debt, guarantees, and arrears specifications - General government debt: total outstanding gross liabilities as defined by ESA95; measured at nominal value; program exchange rate applies to non-euro denominated debt. - Adjustments to debt ceiling: - Upwards/downwards for revisions to the stock of end-March 2013 general government debt. - Upwards by debt arising from payments for bank restructuring under the program’s banking sector support and restructuring strategy (including loans, equity investments, unrequited recapitalization, purchases of troubled assets). - Upwards by amounts disbursed under the EIB loan to finance projects authorized in the 2014 budget under the National Strategic Reference Framework. - Ceiling on new general government guarantees includes domestic and external guarantees and extensions of maturities beyond initial contractual provisions. - Excludes guarantees under a risk sharing instrument of the EU structural funds that do not create contingent liabilities for the Cypriot State. - Stock of guarantees at end March 2013: €3.1 billion. - Adjustments to guarantees ceiling: - Upwards for issuance of government guaranteed bonds to be used in monetary policy operations to boost BoC’s liquidity up to €2.9 billion. - Upwards for issuance of government guarantees for the EAC Vassilikos Power Plant Phase IV loan up to €130 million. - External payment arrears defined as payments on debt to non-residents contracted or guaranteed by the general government not made within seven days after falling due. - Stock of external payment arrears as of end-March 2013: €0. - Domestic expenditure arrears defined as unpaid invoices past due by 90 days (or 90 days after initiation if no due date specified). - Stock of domestic expenditure arrears as of end-March 2013: €0 million. - VAT refund arrears: unpaid VAT refunds past the legislative due date. - Stock of VAT refund arrears as of end-March 2013: €140 million. ### Structural benchmarks and timelines (selected) - Prior actions (met before Board meeting): - CBC approval of BoC quarterly targets and terms of a quarterly report on progress. - Agreement between Ministry of Finance and the CCB on relationship framework between bank owners and the bank. - Submission to parliament of amendments to the 2014 budget in line with program macroeconomic framework and revised targets. - Performance criterion (continuous): No measures to intensify restrictions on payments and transfers for current international transactions or introduce multiple currency practices (status: Met). - Structural benchmarks (selected with deadlines and status): - Adopt the legal framework for a central credit register: End-September 2013 (Completed on November 28). - Revise the anti-money laundering legal framework: End-September 2013 (Met). - CBC to instruct Hellenic Bank to launch an offer for private participation in the bank's capital: End-September 2013 (Met). - CBC to prepare an assessment of BoC's restructuring, business, funding and capital plans: End-October 2013 (Met). - Recapitalize Hellenic Bank in line with capital needs identified by the PIMCO exercise: End-December 2013 (Met). - Proposed new structural benchmarks (deadlines): - Resolution Authority to instruct Special Administrator to entrust voting rights of legacy Laiki equity stake in BoC to independent consulting/auditing firm(s) or international institution(s): End-January 2014. - Completion of an independent fair value assessment of the CCB's and CCI’s assets and submission of final restructuring plan of the CCI sector to the European Commission: End-January 2014. - Adoption by the CBC of a plan to strengthen effectiveness and adequacy of resources allocated to the AML/CFT supervisory function (TMU ¶18): End-February 2014. - Completion by the CBC of an in-situ assessment of operational capacity of banks’ loan workout units to implement arrears management plans: End-March 2014. - Approval by the Council of Ministers of final design of the reformed social welfare system, including decisions on type, level and eligibility criteria for GMI and any remaining benefits, consistent with the 2014 and medium term budget ceilings: End-March 2014. - Existing structural benchmarks (deadlines): - Adoption of a law on fiscal responsibility and budget systems (TMU ¶16): End-December 2013. - Adoption of measures to fight tax evasion (TMU ¶17): End-December 2013. - Merger of the credit cooperative sector into a maximum of 18 institutions recapitalized to fulfill capital requirements under the law: End-March 2014. - Implementation of a new social welfare system to improve targeting and streamline administration costs: End-June 2014. ### TMU reporting, exchange rates, and AML/CFT supervisory requirements - Program exchange rates (those that prevailed on April 15): - €1 = U.S. 1.308099 dollar - €1 = 129.0309 Japanese yen - €1.15222 = 1 SDR - For program purposes, all foreign currency-related assets, liabilities, and flows evaluated at program exchange rates, except items affecting government fiscal balances, which are measured at current exchange rates. - CBC AML/CFT supervisory plan (end-February 2014 specification): - Develop 2014 supervisory program (full AML/CFT inspections and thematic reviews focused on third party introducers, Politically-Exposed-Persons, laundering of proceeds of tax evasion). - Allocate adequate resources and staffing: complement existing two full-time AML dedicated staff with a minimum of five additional experienced supervisors over the course of 2014. - By end-February, submit tenders to complement resources with external auditors with recognized supervisory experience, including AML/CFT, to support onsite inspections. - Quarterly, supervisory competent authorities to grant Fund staff confidential and anonymized access to supervisory assessments and enforcement action information starting Q4 2013. - CBC onsite supervision missions to start in the first quarter of 2014 and step-up during the year; number and quarterly profile of inspections and staffing objectives subject to periodic review by CBC and Fund. - Financial Intelligence Unit (FIU) reporting: - FIU to communicate to Fund staff, on a quarterly basis, detailed statistics on financial information exchanged with other FIUs, both upon request and spontaneously, with a breakdown by country. *Source: _cr13374 - 21. In line with our program commitments, we continue to undertake measures to limit* ### 19. Performance under the program will be monitored using data supplied to the IMF by the ### 19. Performance under the program will be monitored using data supplied to the IMF by the ### Monitoring framework - Performance under the program will be monitored using data supplied to the IMF by the Ministry of Finance, Cystat, and the Central Bank of Cyprus. - The authorities will transmit to the IMF staff any data revisions in a timely manner. - Table 1 describes the supporting data needed for monitoring of the quantitative targets, the required frequency of the data, the institution/department responsible for providing the data, and the timing for provision of the data. ### Reporting requirements — fiscal and public finance data - Detailed execution of revenues, expenditure and financing provided in EDP reporting format - Data Frequency: Monthly - Institution/Department responsible: MOF. Budget Department/Cystat Government Financial Statistics. - Maximum time lag for submission after the end of the reporting period: 27 days after the end of the month, except end-December data which will be provided30 days after the end of the month - Debt Issuance, Amortization, and interest cost details by type of debt instrument, maturity, currency, type of debt holder (resident, non-resident). Details on any financial balance sheet transactions - Data Frequency: Monthly - Institution/Department responsible: MOF. Public Debt Management Unit. - Maximum time lag: 27 days after the end of the month - Central Government Debt stock by type of debt instrument, maturity, currency, type of debt holder. Interest bill for each type of debt instrument on a monthly basis for the current year and the next year, and annual for each year thereafter until 2020 - Data Frequency: Monthly - Institution/Department responsible: MOF. Public Debt Management Unit. - Maximum time lag: 27 days after the end of the month - Budgetary Central Government deposits in the Consolidated Fund and in the Banking System - Data Frequency: Monthly - Institution/Department responsible: MOF. Public Debt Management Unit. - Maximum time lag: 5 days after the end of the month - Stock of expenditure and VAT refund arrears and their corresponding monthly flows (i.e. inflows, outflows) by type of expenditure - Data Frequency: Monthly - Institution/Department responsible: MOF. Customs & Excise Department, VAT Service - Maximum time lag: 15 days after the end of the month - Stock of government guarantees and their monthly flows by institution - Data Frequency: Quarterly - Institution/Department responsible: MOF. Treasury Department. - Maximum time lag: 27 days after the end of the month - Stock of external arrears - Data Frequency: Monthly - Institution/Department responsible: MOF. Treasury Department. - Maximum time lag: 15 days after the end of the month ### Reporting requirements — central bank and banking system - Assets and liabilities of the central bank - Data Frequency: Monthly - Institution/Department responsible: Central Bank of Cyprus - Maximum time lag: 30 days after the end of the month - Assets and liabilities of the domestic operations of the banking system – aggregate monetary balance sheet of credit institutions by institutional category - Data Frequency: Monthly - Institution/Department responsible: Central Bank of Cyprus - Maximum time lag: 30 days after the end of the month - Assets and liabilities of the banking system (consolidated, including foreign operations), aggregate balance monetary balance sheet of credit institutions by institutional category - Data Frequency: Quarterly - Institution/Department responsible: Central Bank of Cyprus - Maximum time lag: 45 days after the end of the reporting period - Individual operational balance sheet of the domestic operations of the largest banks and coops with detailed information on deposits (by maturity, currency, and type of depositor), central bank funding, interbank funding, debt securities, loans provided to the public and the private sector, 1/ - Data Frequency: Monthly - Institution/Department responsible: Central Bank of Cyprus - Maximum time lag: 30 days after the end of the month - Details for the largest banks and coops on liquid assets (cash and securities), liquidity position (i.e. the pool of assets eligible for ELA but not already encumbered), other assets and liabilities 1/ - Data Frequency: Daily - Institution/Department responsible: Central Bank of Cyprus - Maximum time lag: Next working day - Deposits by institution, currency, and residency and end-of-day liquidity buffers - Data Frequency: Daily - Institution/Department responsible: Central Bank of Cyprus - Maximum time lag: Next working day - Financial soundness indicators—core set, deposits, NPLs, capital adequacy ratios - Data Frequency: Quarterly - Institution/Department responsible: Central Bank of Cyprus - Maximum time lag: 60 days after the end of the month ### Operational note - 1/ Reporting requirements for cooperative banks will be revisited after the CBC becomes their supervisor. *CYPRUS — INTERNATIONAL MONETARY FUND* ### Appendix 2. Cyprus—Memorandum of Understanding on ### Appendix 2. Cyprus—Memorandum of Understanding on Specific Economic Policy Conditionality (European Commission) ### Key programme objectives - Restore the soundness of the Cypriot banking sector and rebuild depositors' and market confidence by thoroughly restructuring and downsizing financial institutions and strengthening supervision. - Continue the on-going process of fiscal consolidation in order to correct the excessive general government deficit by 2016, in particular through measures to reduce current primary expenditure, and maintain fiscal consolidation in the medium-term, in particular through measures to increase the efficiency of public spending within a medium-term budgetary framework, enhance revenue collection and improve the functioning of the public sector. - Implement structural reforms to support competitiveness and sustainable and balanced growth, allowing for the unwinding of macroeconomic imbalances, in particular by reforming the wage indexation system and removing obstacles to the smooth functioning of services markets. ### Financial sector reform — Key Objectives - The banking sector suffered from exposure to Greece and home-grown problems related to overexpansion in the property market and poor risk management practices. - The sector's vulnerability was amplified by its size relative to the domestic economy. - Problems were compounded by sensitivity of collateral valuations to property prices and supervisory gaps that delayed recognition of loan losses, producing significant under-provisioning. - Objective: considerable restructuring to restore solvency and viability, reinforce resilience and regain public confidence. ### Financial sector reform — Progress since July - BoC's new Board of Directors was elected by the AGM on 10 September 2013; on 22 October the BoD appointed a new CEO. - Authorities started implementing the strategy to restructure cooperative credit institutions and first mergers were completed according to the agreed timetable. - Hellenic Bank attracted significant private capital, including from foreign investors, and raised the required capital. - Gradual relaxation of administrative restrictions and capital controls continued in line with the milestones-based approach presented on 8 August. - The working plan for integration of cooperative supervision into the CBC was finalised. - The CBC issued a Directive on arrears management and a Code of Conduct for dealing with troubled borrowers. - Legislation for establishing a financial mediation service is being finalised. - Review of banks' asset impairment, provisioning and accounting practices by an external consultant was finalised. - A Directive on the regulatory framework on loan origination was issued (with slight delay). - Legal framework for a single credit register was finalised and submitted to the House of Representatives. - Amendment to the Banking Law was passed on 5 September 2013 limiting and regulating bank lending to members of the Board of Directors. - Amendments to anti-money laundering legislation enacted and trust registers set up to improve availability of beneficial ownership information. ### Regulation and supervision — Maintaining liquidity in the banking sector - 1.1. Authorities commit to continue implementing the roadmap for the gradual relaxation of restrictive measures published on 8 August 2013; roadmap identifies milestones for gradual liberalisation while taking into account indicators of investor confidence and financial stability, including liquidity. A number of restrictions have already been relaxed or lifted. By end-January 2014 the CBC will study current market conditions, including through well-targeted surveys and focus groups, to ensure further relaxations during the second stage remain consistent with financial stability. - 1.2. The CBC, in consultation with the ECB, will continue to closely monitor liquidity and stand ready to take appropriate measures to maintain sufficient liquidity in line with Eurosystem rules. Authorities stand ready to consider issuing additional government guarantees in line with State aid rules, if needed to safeguard financial stability. - 1.3. Domestic banks relying on central bank funding or receiving State aid must submit medium-term funding and capital plans to the CBC at the end of each quarter; these plans will be transmitted to the ECB, the EC, the ESM and the IMF. The Cooperative Central Bank and the Bank of Cyprus will submit their first plans together with their final restructuring plans. Plans should reflect anticipated deleveraging and reduced central bank borrowing while avoiding asset fire sales and a credit crunch. Reporting template and macroeconomic scenario provided by the CBC in coordination with the ECB. - 1.4. The CBC will update liquidity requirements by December 2014, after consultation with the ECB, the EC and the IMF and informing the ESM, to avoid concentrated exposure similar to that to Greek sovereign debt. ### Regulation and supervision of banks and cooperative credit institutions - 1.5. 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. Legislative changes will be submitted to the House of Representatives by end-February 2014 and implemented by end-2014, macroeconomic conditions permitting. Authorities commit not to introduce further impediments to seizure of assets pledged as collateral. - 1.6. A new definition of non-performing loans entered into force on 1 July 2013. The time series for non-performing loans will be published by end-December 2013, including historical observations reaching as far back as possible. - 1.7. The CBC will create a central credit register listing all borrowers and beneficial owners from commercial banks and cooperative credit institutions. Following establishment of the legal framework by mid-December 2013, the central credit register will be operational by end-September 2014. - 1.8. After due diligence and taking into account IFRS best practices, the CBC reviewed the regulatory framework on loan origination, asset impairment and provisioning, and treatment of collateral. New prudential regulations will be finalised by 31 December 2013 and will become effective for the publication of the 2013 financial statement concerning disclosure requirements. CBC will require banks to submit by end-February 2014 action plans for full implementation starting from their 2014 annual accounts. - 1.9. The CBC will consider introducing mandatory supervisory action based on capitalisation levels by 30 June 2014, taking into account developments in the Single Supervisory Mechanism. Technical assistance will be requested if required. - 1.10. The CBC will issue by end-November 2013 mandatory disclosure requirements to banks submitting restructuring plans. Starting with reference date end-December 2013, these banks will be required to publish quarterly reports describing progress with restructuring plans. Reports will contain key performance indicators to be developed by the CBC and communicated to banks in advance. - 1.11. The CBC will integrate stress-testing into regular off-site bank supervision, taking into account entry into force of CRD IV and CRR and related SSM developments. - 1.12. Following legal integration of cooperative supervision into the CBC, operational integration will be completed by end-March 2014 in line with the September 2013 action plan, including recruitment of experienced staff and application of CBC supervisory and regulatory model. - 1.13. By end-January 2014, the CBC will complete its annual supervisory program detailing objectives and activities for 2014, including tentative timeframe to gradually resume regular on-site inspection of commercial and cooperative banks (including review and implementation of provisioning requirements), staffing, cost and budget for each activity, and main training programs. CBC will clarify allocation of tasks and responsibilities in its governance structure to effectively carry out supervisory tasks in line with SSM requirements. Also by end-January 2014, the CBC will require banks to submit the 2014 work program of their internal audit departments. - 1.14. Accounts of cooperative credit institutions will be subject to independent annual audit by an external, recognised and independent auditing firm. The CBC will have the right to overturn the selection of an auditor by any cooperative credit institution. Consolidated accounts of cooperative credit institutions will be published beginning from 2013 annual accounts. - 1.15. The CBC will have sufficient staff to carry out its functions in full independence as stipulated by the Treaties. Legal obstacles to the CBC's ability to retain and employ necessary qualified staff should be removed prior to the granting of the third disbursement of financial assistance. - 1.16. Authorities will, in consultation with EC, ECB and IMF and informing the ESM, review the effectiveness of the Resolution Authority, including composition and governance, with a view to adopting legislative and operational changes by end-January 2014. ### Monitoring of corporate and household indebtedness - 1.17. Authorities will step up monitoring of corporate and household indebtedness and prepare quarterly reports including information on distribution of assets and liabilities across households and an assessment of debt-servicing capacity and refinancing activities. Data from surveys will be used until the credit register is fully operational. The Financial Stability Report, to be published yearly as of December 2013, will include an extended analysis on corporate and household indebtedness. The first quarterly monitoring report was received at the beginning of July 2013 and its scope and content will be further enhanced. - 1.18. Measures to deal with troubled borrowers will follow bank resolution and recapitalisation. A framework for targeted private-sector-debt restructuring will be established to facilitate new lending and diminish credit constraints. Ways will be explored to improve funding constraints of SMEs. - Banks will submit revised strategies and internal implementation plans (including pre-packaged programs and general policies to deal with small and large troubled borrowers) to the CBC by end-January 2014. By end-March 2014, the CBC, with external technical support, will complete an assessment of operational capacity of banks’ loan workout units. Banks will be required to report quarterly on restructuring progress and management of NPLs beginning end-March 2014, using specific performance indicators and targets (e.g. number of loans restructured, cash collections, etc.) to be determined by end-November 2013 by the CBC in consultation with EC, ECB and IMF and informing ESM. - By end-November 2013, the CBC will publish supplementary information on the Code of Conduct (CoC). By end-May 2014 the CBC will complete a second round of inspections to verify banks’ compliance with the CoC and impose sanctions as needed. - By end-December 2013 the authorities will perform a legal review of relevant legislation with technical assistance as needed. Based on this, legislation will be passed to expand the role of the Financial Ombudsman by end-January 2014 to achieve fair debt restructuring, while ensuring adequate resources for the service. - Authorities commit not to introduce any new administrative measures which would interfere with the setting of bank lending rates; in particular no ceilings on bank lending rates will be introduced. - The CBC will, with assistance of an external expert, review banks’ arrears management policies and practices, taking into account international best practices. This review will be completed by end-June 2014 and serve as basis for further policy recommendations. ### Increasing financial transparency - 1.19. The AML framework will be further strengthened in line with best practice. Although Cyprus' AML regime received an overall positive evaluation in the 2011 MONEYVAL report, the April 2013 audit by MONEYVAL and an independent auditor identified specific shortcomings. Authorities commit to enhance the AML framework under the timetable set out in the agreed AML Action Plan (see Annex 2) 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). Authorities committed to establish trust registers with the supervisory authorities (Action Plan – section 4.3.1). - Supervisory competent authorities will review off-site and on-site supervisory procedures and further implement a risk-based approach to AML supervision for financial and non-financial (lawyers, accountants and TCSPs) institutions (Action Plan – sections 5 and 6). - On a quarterly basis, starting Q4 2013 in the context of the programme review, supervisory competent authorities will share anonymised information with programme partners (confidentially), granting access to supervisory assessments and information about enforcement actions applied for non-compliance and/or violations. - Legal framework revised so adequate, accurate and timely information on beneficial ownership of Cypriot legal persons and arrangements can be provided to foreign counterparts related to money laundering and tax matters. - Prior to the granting of the third disbursement of financial assistance, authorities will ensure directives and circulars issued by supervisory authorities (CBC, CySEC, Cyprus Bar Association, Institute of Certified Public Accountants of Cyprus) are in line with relevant legislation and international standards. By 20 November authorities will provide an analysis of the adequacy of relevant CBC directives for review by programme partners. - Cypriot FIU will provide programme partners with a breakdown of requests made and received and spontaneous disseminations on a quarterly basis (within 14 days of end of quarter), starting Q4 2013, and publish this information on the FIU website annually. ### Recapitalisation and restructuring — Restoring adequate capital buffers - 1.20. The CBC will increase the minimum Core Tier 1 capital ratio from the present level of 8% to 9% by end-December 2013. By the same date the CBC will assess the impact of the entry into force of the Common Equity Tier 1 capital definition laid down in the CRDIV and CRR. Based on that assessment the CBC will define, by end-February 2014 and in consultation with the EC, ECB, IMF and informing ESM, the minimum capital requirements taking into account parameters of the balance sheet assessment and the stress test of the Single Supervisory Mechanism. This revision will not lead to a decrease in the minimum amount of capital held by banks. In the interim period until revised requirements enter into force, the CBC will prohibit any release of capital by banks found in the PIMCO exercise to face a capital shortfall. ### Recapitalisation and restructuring — Management of legacy Laiki - 1.21. By end-January 2014 the Resolution Authority will present a detailed roadmap for full disposal of legacy Laiki’s assets while maximizing value for creditors. Pending disposal of legacy Laiki’s shares in BoC and to ensure their adequate management, the Resolution Authority will instruct the Special Administrator to entrust by end-January 2014 the voting rights of these shares to a well-recognised and independent consulting or auditing firm(s) or an international institution(s). ### Recapitalisation and restructuring — Restructuring of Bank of Cyprus - 1.22. The CBC will instruct BoC to publish selected features of its restructuring plan before end- *Italic: Appendix 2. Cyprus—Memorandum of Understanding on Specific Economic Policy Conditionality (European Commission).* ### 2013. On the basis of the plan, prior to the granting of the third disbursement of financial ### _cr13374 - 2013. On the basis of the plan, prior to the granting of the third disbursement of financial assistance, the CBC will approve BoC’s proposed set of quarterly targets... ### Restructuring and recapitalisation — Hellenic Bank and cooperative credit institutions - Hellenic Bank - Following the successful recapitalisation with privately raised funds, the CBC will require Hellenic Bank to submit by end-March 2014 a business plan covering the period up to end-2015. - Cooperative credit institutions — capital needs and recapitalisation - The CBC assessed a total capital shortfall of EUR 1.5 billion for the cooperative credit institutions. - EUR 1.5 billion of state funds were deposited in a securities account with the CBC to boost confidence and will be injected into the Cooperative Central Bank in exchange for common shares after fair value assessment and EC approval of the restructuring plan. - The restructuring plan for the cooperative sector will be submitted to the EC by end-January 2014. - Terms and remuneration of public support will comply with EU State aid rules with due consideration for financial stability. - Benefiting cooperative credit institutions will be subject to specific management rules, restrictions, a restructuring process, and external monitoring by a trustee. - Mergers - Individual cooperative credit institutions will be merged into a maximum of 18 entities by end-March 2014, as set out in the strategy published in July 2013. - Unviable cooperative credit institutions will be required to merge with viable ones. - Capital injections and prudential ratios - Upon completion of each legal merger of affiliated cooperative credit institutions, the Cooperative Central Bank will inject sufficient capital to take a 99% stake and ensure compliance with the 4% individual core Tier 1 ratio. - These operations will be finalised by end-March 2014 to accelerate Board appointments and implement new governance guidelines. - At the consolidated level, the sector remains subject to the general minimum core tier 1 capital requirement of 9%. - Governance and oversight - A relationship framework between the State and the Central Cooperative Bank will be established prior to the granting of the third disbursement of financial assistance to ensure sound policies and restructuring measures while avoiding interference in commercial decisions and undue political interference. - Compliance with the relationship framework will be reviewed quarterly by the monitoring trustee, who will report any breaches to the EC. The authorities will inform the ECB, the ESM, and the IMF of the conclusions of that report. - Roadmap and operational measures - The CBC required the new board of the CCB to publish, by end-November 2013, a roadmap agreed with the CBC specifying key interim actions for the next three months, including: - (i) the appointment of the new CEO; - (ii) measures to bolster the independence and qualification of CCI Boards; - (iii) actions to retain customers; - (iv) measures to impede further asset deterioration; - (v) measures to prepare the transfer of NPLs to specialized units within the sector. - The Cooperative Central Bank will leverage external expertise (arrears management and corporate restructuring) and ensure recruitment of executive and senior management in line with international best practices. Selection criteria will be established by the Cooperative Central Bank and consulted by the Ministry of Finance with the EC, ECB, ESM and IMF. - Compliance will be assessed in quarterly progress reports of the Cooperative Central Bank on the implementation of the restructuring plan. - Monitoring - A CBC team has been appointed to closely monitor BoC’s compliance with quarterly targets, assess deviations, and define remedial actions; the team’s main activities report will be submitted quarterly to the CBC Board, starting with end-2013. - A quarterly report on progress relative to the proposed quarterly targets for the next 12 months will be submitted to the CBC by end-March 2014. ### Fiscal policy — key objectives and commitments - Overarching objectives - Continue fiscal consolidation to achieve: - a 3% of GDP primary surplus in 2017; - 4% of GDP in 2018; - and maintain at least such a level thereafter. - Achieve annual budgetary targets through high-quality permanent measures and additional measures in the outer years, particularly by reducing growth in the public sector wage bill, social benefits and discretionary spending, while minimising impact on vulnerable groups. - Fully implement fiscal consolidation measures for 2013 (listed in Annex 1 and in the Memorandum). - Correct the excessive general government deficit by 2016. - Maintain fiscal consolidation over the medium term and converge towards Cyprus' medium-term budgetary objective of a balanced budget in structural terms through expenditure containment, improved tax structure, and fiscal-structural measures, including implementation of a Medium-Term Budgetary Framework (MTBF) in accordance with EU specifications. - Monitoring, windfalls, and constraints - Authorities commit to full implementation of adopted fiscal measures for 2012-2014 and to regularly monitor budgetary effects; deviations will be evaluated and addressed in quarterly programme reviews. - Cash revenues above programme projections, including any windfall gains, will be saved or used to reduce debt; if over-performance is deemed permanent, it can reduce the need for additional measures in outer years. - Measures that could adversely affect tax compliance (e.g., tax amnesties) will not be undertaken during the programme period. - EU funds will be targeted to areas delivering the most important economic and social impact; national funds required for co-financing EU programmes will be ensured. - Cyprus shall provide all information necessary for monitoring of the economic adjustment programme in accordance with Regulation 472/2013 and consult ex-ante with the European Commission, the ECB and the IMF on policies not included in the Memorandum that could materially impact programme objectives. ### Fiscal policy in 2013 - The Cypriot authorities will achieve a budgetary outcome in line with the Council Recommendation of 16 May 2013 and the Commission's assessment of effective action of 6 September 2013. - They will rigorously implement the 2013 Budget Law (as amended) and agreed consolidation measures amounting to at least EUR 351 million. - In line with State aid rules, the Government shall not implement any measures involving State aid towards Cyprus Airways until the EC approves a restructuring plan. ### Fiscal policy in 2014 - Targets and fiscal stance - Based on current macroeconomic and fiscal projections and the draft 2014 Budget, Cyprus will achieve a general government primary balance deficit of EUR 483 million (3.1% of GDP) in 2014, respecting the EDP recommendation of a headline deficit of no more than 8.4% in 2014. - Cyprus will fully implement permanent measures for 2014 amounting to at least EUR 270 million (Annex 1). - The total amount of fiscal policy measures to underpin the 2014 budgetary targets will be included in the 2014 Budget Law. - Additional permanent measures (amounting to approximately ⅓% of GDP) as proposed in the draft 2014 Budget Law: - ensure additional expenditure savings by further reduction of public sector allowances and streamlining of overtime compensation, including by revising the formula for calculating overtime compensation on weekdays and weekends for state officers and apply the revision pro rata for hourly paid employees; - further targeting of social pensions; - abolition of income tax exemption for certain pension schemes; - reduction in the tax-free threshold for lottery gains; - introduction of a contribution of 3% on salaries of casual employees servicing on a contract basis, who receive gratuity, including volunteers of 5 years services and police constables. - Procedural commitments - Prior to the granting of the third disbursement of financial assistance, authorities will submit to the House of Representatives necessary amendments to the 2014 draft Budget Law to align it with revised macroeconomic and budgetary projections; any amendments that could materially affect programme objectives will be assessed and agreed with programme partners. - The 2013-2015 expenditure ceilings will be updated for 2014-2016 and will accompany the 2014 Budget Law document; presentation will evolve into a Fiscal Strategy Statement in line with MTBF requirements in Directive 2011/85/EU. - Any deviation from the 2013-2015 framework will be documented and reasons provided to programme partners. ### Fiscal policy in 2015-2016 - Targets - Based on updated budgetary projection, Cyprus will achieve: - a deficit of the general government primary balance of EUR 340 million (2.1% of GDP) in 2015; - a surplus of EUR 201 million (1.2% of GDP) in 2016. - These targets respect the EDP recommendation of a headline deficit of no more than 6.3% in 2015 and 2.9% in 2016. - Procedural timeline - After review and consultation with programme partners, the 2015 and 2016 Budget Laws will be adopted by December 2014 and December 2015, respectively. - The 2014-2016 expenditure ceilings will be updated for 2015-2017 and will accompany the 2015 Budget Law document. - In Q2-2016, the authorities will present 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; required measures will be included in the draft 2017 Budget Law. ### Fiscal-structural measures — objectives and selected reforms - Key objectives - Improve efficiency of public spending and budgetary process via an effective MTBF fully compliant with the Directive on budgetary frameworks and the TSCG. - Implement further pension reforms to address high projected increases in pension spending. - Control growth of health expenditure. - Enhance tax revenues via improved tax compliance and collection. - Reform public administration to improve functioning and cost-effectiveness (size, employment conditions, functional organisation). - Reform overall benefit structure to ensure efficient resource use and balance between welfare assistance and incentives to work. - Improve efficiency of state-owned and semi-public enterprises and initiate a privatisation programme. ### Pension reform - Context - Recent reforms (noted in Annex 1) and results of an actuarial study (peer reviewed in the Ageing Working Group of the Economic Policy Committee in September 2013) have addressed the projected increase in pension spending and secured long-term financial viability of the pension system through 2060; continued monitoring and further reform if needed remain important. - Measures implemented/agreed - Prior to the granting of the third disbursement of financial assistance, pass legislation ensuring total annual public pension benefits do not exceed 50% of the highest pensionable salary of the official's career for Members of the House of Representatives. - Ensure that all 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 by Q4-2013, to enter into force on 1 January 2014. ### Health care reform - Measures to be adopted to strengthen sustainability and efficiency of public health provision: - (a) 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 programme partners and all co-payments for using public health care services; - (b) Restructure public hospitals according to the action plan approved by the Council of Ministers at end-June 2013 and aim at full implementation by Q2-2015; - (c) 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. *Source: _cr13374 - 2013.* ### 2015. To this end, the government will present its detailed plan by January 2014; ### _cr13374 - 2015. To this end, the government will present its detailed plan by January 2014; ### Health system reform and NHS implementation - Government to present a detailed plan by January 2014. - Adopt by the Council of Ministers a binding set of contingency measures by Q4-2014, examples include: - 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. - Complete the IT-infrastructure necessary for implementing the NHS, and explore cost-effective web-based alternatives to the currently-defined IT tender by Q1-2014. - Review income thresholds for free public health care in comparison to eligibility criteria for social assistance, and ensure co-payments 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 Q4-2013. - Continue to code inpatient cases by the system of diagnosis-related groups (DRGs), achieving full coding of all inpatient cases in public hospitals by January 2014. - Adjust regular starting and ending working times in the Health Service back by half an hour to 7:30/8:30 – 15:00/16:00, and further reduce overtime and related costs to the wage bill by making working time more flexible so as to cover - as a minimum - service hours from 7:00 to 19:00 under regular working time (see 3.10.). - 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 - Provide for the 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. - FRBSL to include 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. - Will take on-board and deepen existing provisions transposing Council Directive 2011/85/EU and implementing 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 in Commission Communication COM(2012)342. - Implementing texts (on budget documentation and statistics) ensuring that adopted measures are fully effective by Q4-2013. - Expenditure controls to avert overspending and/or accumulating arrears: - Make sure central government spending commitments, as defined in the FRBSL, are subject to pre-commitment validation by Q4-2013, and of the general government by Q1-2014. All outstanding commitments should be timely and properly recorded and reported in the accounting system. - Improve monitoring of government guarantees through a risk assessment analysis. - Amend the Public Debt Management Law by end-December 2013 to ensure proper risk assessment of the outstanding stock of government guarantees and ensure appropriate human resources to that end. ### Public private partnerships (PPPs) - Update the inventory of PPPs, including contingent liabilities, as of 1 January 2014, and include it both in the annual budget law and in 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 their execution by: - establishing an effective gateway process that verifies the fiscal affordability of projects; - 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; - 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 enter into force on 1 January 2014. - Commit not to enter into any new tendering process and not to sign any new PPP contract before the implementation of the legal and institutional PPP framework, excluding any project having reached commercial close by end-October 2012. ### State-owned enterprises (SOEs), extra-budgetary entities, and privatisation - By Q4-2013, the Council of Ministers will examine a list of SOEs to be restructured or liquidated. - Complete the full inventory of real estate and land assets by Q4-2013, specifying which ones are ready for privatisation. - 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. - No additional SOEs will be created until the legal framework has been adopted. - Initiate a privatisation plan to improve economic efficiency, enhance competition, encourage capital inflows, and help restore debt sustainability: - Plan will include privatisation prospects of SOEs and semi-governmental organisations (SGOs), including CyTA (telecom), EAC (electricity), CPA (commercial activities of ports), as well as real estate/land assets and will be based on a prudent estimation of privatisation proceeds. - 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 adopted by the Council of Ministers prior to the granting of the third disbursement of financial assistance, after consultation with programme partners, and will include asset-specific timelines and concrete intermediate steps. - The specific legal and institutional framework for the privatisation process will be implemented by January 2014, 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 the revenue administration to reinforce efficiency and effectiveness of revenue collection and fight tax fraud and evasion; reform comprises short-term measures and a comprehensive long-term reform integrating IRD and VAT services. - Short-term programme to be implemented by Q4-2013, measures include: - Enact legislative changes to enhance tax collection and voluntary compliance by: - attributing 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; - harmonising the 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; - strengthening 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. - Improve efficiency and effectiveness of the administration by: - ensuring staff mobility between different tax administration entities in order to ensure appropriate staffing of entities with high revenue collection capacities; - optimising the 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); - enacting 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; - deciding on a joint audit programme for large taxpayers, to be conducted in 2014; - developing 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 measures: - A comprehensive compliance strategy that 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. - Full integration of the two tax departments will be completed in several phases and accompanied by flanking reform measures, such as development of a common tax procedure code. - After establishing project management, including a high level steering committee chaired by the Minister of Finance and an executive technical committee chaired by the Permanent Secretary, the authorities will: 1. develop a reform plan that reflects the recommendations of the TA received in February 2013 and further recommendations derived from future TA. The reform plan will be agreed with program partners and approved by the government by Q4-2013. *IMF staff report content (CYPRUS).* ### 2. reinforce the tax unit in the Ministry of Finance that is responsible for tax policy ### _cr13374 - 2. reinforce the tax unit in the Ministry of Finance that is responsible for tax policy ### Reinforce tax unit and monitoring - Reinforce the tax unit in the Ministry of Finance responsible for tax policy formulation and for monitoring the implementation of tax policy and the revenue performance (including by measuring the tax gap) by Q2-2014. ### Exchange of information on tax matters - Safeguard timely and effective exchange of information in regard to tax matters, fully ensuring the applicability of laws and standards governing international exchange of tax information. - Enhance practice of timely delivery of relevant and accessible tax information to other EU Member States. - Specific 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 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 to facilitate and expedite the identification of the taxpayer. - Implement recommendations from 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 shortcomings identified in the forthcoming evaluation of implementation issues. - In context of implementing Council Directive 2003/48/EC (EUSD) on taxation of savings income: - Continue to provide to the EC all necessary and available information/statistics extracted from data exchanged under 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 CBC will provide on an annual basis detailed sectoral deposit statistics with a breakdown of non-resident deposits by country. - Note: The Cypriot authorities have submitted Law N. 205(I)/2012 (enacted on 28 December 2012), transposing the Directive, to the European Commission. ### Immovable property tax reform - Objective: increase revenue, improve fairness by levying a recurrent property tax on current market values, and reduce overhead cost in tax base administration. - Commitments and timelines: - Implement a property price index that establishes the average market valuation in 2013 by square meter of habitable surface and land plot, taking into account recommendations from technical assistance; index shall be operational to provide imputed market valuations for each cadastral plot by Q2-2014, in time for immovable property tax collection in 2014. The 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. - Additional studies to be implemented by 1 January 2015: - Study on refining parameters of the imputed property market value index, including assessment of feasibility of a unit tax base for individual dwellings and a mechanism to dampen cyclical variations in the index. - Study on scope of consolidating collection and administration of the municipal recurrent property tax and sewage tax; review existing exemptions and derogations; report on scope of shifting revenues from transaction fees and taxes to recurrent taxation. Tender procedure and assignment of the study shall be concluded by Q4-2013. ### Public administration reform - Adjust working hours by December 2013: shift regular starting and ending working times back by half an hour to 7:30 - 8:30 and to 15:00 – 16:00; further reduce overtime and related costs by making working time more flexible to cover at 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. - Commission independent external review of possible further reforms with horizontal and sectoral elements. - Horizontal element (World Bank and UK public administration) to review: - Appropriate system of remuneration and working conditions/conditions of employment in the public sector relative to private sector and other EU countries. - Introduction of a new performance based appraisal system in the public sector linking performance with remuneration/increments. - Results of horizontal review to be presented by Q3-2014; based on findings, agree on reform, submit to House of Representatives for approval and implement by Q4-2014. - Sectoral element to examine role, competences, organisational structure and staffing of ministries/services/independent authorities; examine possibility of abolishing or merging/consolidating non-profit organisations/companies and state-owned enterprises; re-organisation/re-structuring of local government. - First batch (World Bank and UK public administration) covering Ministries of Agriculture, Education and Health, local government and Department of Registrar of Companies and Official Receiver: results by Q1-2014; reforms to be agreed, submitted to House and implemented by Q2-2014. - Second batch covering remaining Ministries and entities (Labour and Social Insurance, Communications and Works, Energy, Commerce, Industry and Tourism, Interior, Defense, Justice and Public Order, Foreign Affairs, Ministry of Finance including Treasury and Planning Bureau under PFM, all SOEs subject to decisions under 3.5, President’s Office and Council of Ministers, Constitutional and Independent Services): results by Q4-2015; reforms to be agreed, submitted to House and implemented by Q1-2016. ### Welfare system reform - Implement reform plan of the welfare system as of 1 July 2014 to ensure efficient use of public funds, balance welfare benefits and incentives to work, and enhance protection of vulnerable households. - Reform objectives and steps: - Consolidate existing social benefits by streamlining, merging some benefits, 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. - Specific actions and timelines: - Define level, composition and eligibility criteria of the new guaranteed minimum income scheme (GMI) based on minimum consumption basket and estimate overall costing by Q4-2013 (GMI will replace existing public assistance scheme). - Refine means testing by introducing a common definition of income sources, financial assets and movable and immovable property to ensure consistency of eligibility across schemes by Q4-2013. - Adopt final design of the reformed welfare system by the Council of Ministers by Q1-2014 after consultation with social partners, followed by consultation and review by programme partners; adopted reform will define all benefits, levels, eligibility criteria, and overall costing. - Ensure 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 human resources reassigned from other departments by April-2014, except education benefits (Ministry of Education and Culture) and benefits to displaced people (Ministry of Interior). - Draft legislation to be submitted for review to programme partners before submission to House of Representatives; law will be adopted by end-May 2014. - Reformed welfare system must be consistent with fiscal targets defined in the MoU. ### Labour market: objectives and reforms - Key objectives: - Implement reform of wage indexation to improve competitiveness and align wage formation with productivity. - Prepare and implement comprehensive reform of public assistance to balance income support and work incentives, target 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) reform for wages and salaries: - Lower frequency of adjustment: base period lengthened from six months to twelve months; indexation to take place on 1st January each year. - Mechanism for automatic suspension of application and derogation procedures during adverse economic conditions: 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 (as foreseen in section I.2 (Annex 1) of the agreement). - A tripartite agreement with social partners will be pursued for applying the reformed system in the private sector by end-2013; based on current 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: - Prepare detailed policy proposals to address shortcomings in activation policies and instruments for income support after expiration of unemployment insurance benefits; submit proposals to programme partners by end-2013 for review and consultation. - Proposed measures will include: - Develop coherent methodology for continuous monitoring and evaluation of activation programmes to be applied consistently across different schemes. - Develop appropriate IT infrastructure to automatize collection, processing and exchange of data across schemes and with social welfare administration. - Centralise administration of all activation programmes and enhance coordination across departments. - Enhance staff mobility to support administrative capacity of public employment services to meet increased demand. - Review and enhance cooperation between public employment service and benefit-paying institutions in activation of the unemployed. - Youth-specific actions: - Present by Q4-2013 a draft action plan for implementation of measures envisaged under the Youth Employment Initiative, in line with conclusions of the European Council of June 2013. - Design, management and implementation of youth measures shall be integrated within the broader activation system (section 4.3), coherent with welfare reform (section 3.11) and consistent with agreed budgetary targets. *CYPRUS INTERNATIONAL MONETARY FUND* ### 5. Goods and services markets ### 5. 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 Cyprus' competitive position. - Reinvigorate tourism competitiveness; tourism is one of Cyprus' largest sectors and a potential driver of future growth. - Improve regulation and administration related to the real estate sector to support housing market functioning and foster foreign demand amid downside risks. - Exploit domestic offshore natural gas potential to reduce energy import dependency and improve security and sustainability of energy supply; positive effects contingent on financing and planning infrastructure investments, designing efficient energy markets and an adequate regulatory regime. ### Services Directive: Sector-specific legislation - In accordance with EU law and the Services Directive, Cyprus will adopt necessary amendments to sector-specific legislation for: Construction services, Travel Agencies, Tourism services on beaches, Car rental services, prior to the granting of the third disbursement of financial assistance. - Cypriot authorities stand ready to adopt further necessary amendments for full implementation of the Services Directive. - 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. - Opinion of the Cypriot Commission for the Protection of the Competition (CPC) and of programme partners is required before adoption. ### Reform of regulated professions - Complete comprehensive review of requirements affecting access and exercise of all regulated professions by Q4-2013. - Eliminate requirements that are not justified or proportional by Q1-2014, following completion of the review. - Eliminate any existing total bans on the use of a form of commercial communication (advertising) in the veterinarians profession, as required by the Services Directive by November 2013. ### 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; - adopting 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 advocacy to safeguard and promote competition by Q4-2013. - Increase competition by ensuring powers and independence of National Regulatory Authorities (NRAs) remain effective, and enable NRAs to have necessary resources in line with duties and the EU Regulatory Framework. - Adopt any necessary legislative amendments by Q4-2013. ### Housing market and immovable property regulation - Address property market clearing, efficient seizure of collateral, and restore demand; legal disputes pose particular risk due to incomplete documentation and slow judicial procedures. - Implement guaranteed timeframes for issuance of building certificates and title deeds by Q1-2014. - Ensure 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 clearing of encumbrances on title deeds to be transferred to purchasers of immovable property by Q4-2014. - Publish quarterly progress reviews every three months, including executive commentaries on developments related to issuance of building and planning permits, certificates, title deeds, title deed transfers and related mortgage operations, starting end-July 2013. - Implement electronic access to registries of title deeds, mortgages, sales contracts and cadastre for monetary financial institutions and for all government services by Q4-2014. - Abolish any requirements on the proof of legal interest for access to these data by these bodies prior to the granting of the third disbursement of financial assistance. - Amend procedure on forced sale of mortgaged property to allow private auctions by amending relevant legislation and rules either by adopting similar principles of rules for immovable property recovery in bankruptcy regulations or by enacting new legislation by Q4-2013. - Improve pace of court case handling to eliminate court backlogs by Q1-2016 and provide for specialized judges by Q4-2013, with instructions for expeditious processing of commercial and immovable property law cases. ### Tourism - Present a progress report on implementation of the action plan twice per year (every March and September until the end of the programme), starting in Q4-2013, including assessment based on performance indicators. - Amend current hotel and other relevant legislation (e.g. immovable property law and town planning policies) to facilitate mixed-use developments by Q4-2013. - Provide a report on analysis and assessment of concrete needs based on existing and future air services agreements by Q4-2013; this report will form basis for an aeropolitical strategy aligned with EU external aviation policy and EU aviation agreements, ensuring sufficient air connectivity. - Launch strategy accompanied with a concrete action plan by Q1-2014; implementation of the action plan will be reviewed annually by Cypriot authorities starting in Q1-2015. ### Energy - Ensure immediate and correct full implementation of the Third Energy Package, particularly during and after sector transformation; provide clarity on intended use of 'isolated market' and 'emergent market' derogations and indicate intended duration of latter derogations. - Formulate a comprehensive strategy for rearrangement of the Cypriot energy sector; a living document developed under full authority of the Cypriot Government, to be presented to programme partners for consultation according to specified timeline. The strategy should include at least three key elements: 1. Roll-out plan for infrastructure required for exploitation of natural gas, covering required investments, associated costs, financing sources and methods, related ownership structure; related major planning risks and bottlenecks; projection of revenue streams over time; and an appropriate sales framework for off-shore gas supply (exports and domestic markets) aimed at maximising revenues; updated version by Q4-2013. - Prior to finalisation of forthcoming energy sector Government Agreement (GA) and supplementary agreements between the Republic of Cyprus and the Contracting Parties to a Production Sharing Contract, undertake a financial and budgetary impact analysis of the GA and its supplementary agreements. - Impact assessment will evaluate in detail potential financial and budgetary impact on general government position of various options for an LNG project development plan and financing arrangements, focusing on budgetary commitments that may arise before or at time of final investment decision. - GA and supplementary agreements shall be consistent with fiscal targets until 2016 and thereafter, as defined in this MoU. 2. Comprehensive outline of the regulatory regime (CERA) and market organisation for restructured energy sector and gas exports to introduce open, transparent, competitive energy markets, considering size of Cypriot economy, regional market integration, independent regulatory oversight, and EU targets for energy efficiency, renewable energy and carbon emissions. - Outline should include: description of envisaged institutional framework; type and scope of regulatory instruments; different forms of government ownership and involvement; sequence and timing of major actions and changes; potential for setting-up wholesale markets for gas and electricity (electricity open to non-producing traders); freedom for customers to choose supplier; full unbundling of gas suppliers and customers, in particular electricity companies. - Preliminary outline by Q4 2013, with view to final outline by Q2 2014. 3. Plan to establish institutional framework for 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. - Resource fund should have solid legal base and governance structure drawing on internationally-recognized best practices. - Establish clear rules governing inflows and outflows 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. - Develop the three key elements in parallel; strategy should account for uncertainty over actual size of domestic offshore commercially-viable natural gas fields and possible changes in international gas prices and demand. - Base projections on alternative world energy scenarios from an internationally-reputed organisation and secure appropriate technical assistance for technical aspects. ### Technical assistance - Cypriot authorities will provide an updated request for technical assistance needs during the programme period, including ongoing technical assistance projects by end-2013. - The request will identify and specify areas of technical assistance or advisory services considered essential for implementation of the MoU and where 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. *IMF staff compilation from “5. Goods and services markets”* ### 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. ### Fiscal measures with effect in 2012 — 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 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 %. ### Fiscal measures with effect in 2013 — 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 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. ### Fiscal measures with effect in 2014 — 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. - I.41 A reform of the tax system for motor vehicles with effect from budget year 2014, based on environmentally-friendly principles, with a view to raising 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. *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 ### _cr13374 - 2.3 CBC to establish co-operation mechanisms with CySEC, the Cyprus Bar Association and ICPAC (for accountants) for exch ### 2.3 CBC cooperation mechanisms - Action: CBC to establish co-operation mechanisms with CySEC, the Cyprus Bar Association and ICPAC (for accountants) for exchanging information and ensuring supervisory coordination. - Assessment: Compliant. ### Suspicious Transaction Reporting (STR) - Change: Changes in the legal framework. - Action 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. - Timing: Q1 - 2014. ### 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 Action: 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). - Status: Partially Compliant (CBC Directive). - 4.1.2 Action: 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. - Implementation note: 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). - Timing/Status: prior action — Compliant. - 4.2 Company Registry - Rationale: Efficiency of Companies’ Registrar as an important aid to CDD. - 4.2.1 Action: 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. - Timing: End 2013. - 4.3 Register of Trusts - Objective: Enhance the transparency of trusts in line with international standards and best practice. - 4.3.1 Action: 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. - Status: Compliant. ### Supervision of financial institutions - 5.1 Revise the AML/CFT supervisory structure within the CBC, ensuring it is adequately resourced - 5.1.1 Action: 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. - Timing: Q4 – 2013. - 5.1.2 Action: 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. - Timing: –31 January 2014. - 5.2 Develop risk-based supervisory tool(s) for offsite surveillance/monitoring activities - 5.2.1 Action: 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). - Timing: Q4 - 2013. - 5.3 Develop risk-based supervisory tool(s) for onsite inspections - 5.3.1 Action: 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. - Timing: Q1 – 2014. - 5.4 Establish Formal AML/CFT Training Program - 5.4.1 Action: 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. - Timing: Q2 – 2014. - 5.4.2 Action: Provide CBC supervisory staff with ongoing training to ensure adequate knowledge of risks and supervisory techniques. - Timing: Ongoing. - Note: The off-site supervisory tool will include monthly reporting by obliged entities on the breakdown by country of origin of the main depositors and the main beneficiaries of loans (and of their beneficial owners). - 5.5 Implement adequate supervision - 5.5.1 Action: 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. - Status/Timing: – Partially Compliant 31 January 2014. - 5.5.2 Action: 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. - Timing: Q4- 2013, ongoing. - Subsequent steps (post-development of tools in 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. - 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. - Timing for above: Q2 - 2014. - 5.5.4.1 Action: 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. - Timing: Q2 - 2014. - 5.5.4.2 Action: CBC to update the institutional risk profile and supervisory strategy based on the results of the pilot inspection. ### Supervision and monitoring of lawyers, accountants and TCSPs - Objective: Align resources with risks and establish an effective monitoring structure for AML/CFT matters. - 6.1 Align resources with risks / Establish monitoring structure - 6.1.1 Action: 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. - Timing: Q4 - 2013. - 6.2 Develop risk-based tool(s) for Offsite surveillance/monitoring - 6.2.1 Action: 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). - Timing: Q1-2014 (CBA and ICPAC) Q3-2014 (CySEC). - 6.2.2 Implementation steps: - 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. - Timing for implementation steps: Q2-2014 (CBA and ICPAC) Q3-2014 (CySEC). - 6.3 Develop risk-based tool(s) for Onsite inspections - 6.3.1 Action: 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; Training Program. - Timing: Q2 – 2014 (CBA and ICPAC) Q3-2014 (CySEC). - 6.4 Establish Formal AML/CFT Training Program - 6.4.1 Action: 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; etc. - Timing: (CBA and ICPAC) Q2– 2014; Q4-2014 (CySEC). - 6.5 Implement adequate supervision - 6.5.1 Action: 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. - Timing: Q4 – 2013, ongoing. - Subsequent steps: - 6.5.2 Action: 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. - Timing: Q3 – 2014 (CBA and ICPAC) Q4-2014 (CySEC). - 6.5.3 Action: 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. - Timing: Q3 – 2014 (CBA and ICPAC) Q4-2014 (CySEC). ### Macro and program context (selected findings from Press Release and Statement) - IMF action: Executive Board completed the second review under the Extended Fund Facility (EFF) arrangement and approved a disbursement. - Disbursement: SDR 74.2 million (about €83.5 million, or US$114 million). - Cumulative disbursements under the arrangement: SDR 222.7 million (about €250.4 million, or US$341.9 million). - EFF size: SDR 891 million (about €1 billion, or US$1.4 billion). - Combined financing package with the ESM: €10 billion. - Economic growth/outlook figures: - Real economic growth revised to -7.7 percent in 2013 (initial estimate -8.7 percent). - Annualized growth for the first three quarters: -5.5 percent. - Growth projections: -4.8 percent in 2014, and 0.9 percent in 2015. - Labour market: unemployment around 17 percent. - Fiscal action: The 2014 budget brings the total fiscal adjustment for 2013-14 to 9.4 percent of GDP. - Financial sector notes: restructuring and recapitalization progress; Hellenic Bank share capital increase oversubscribed including foreign direct investment. - Program risks and priorities: full and timely implementation of the adjustment program; strengthen bank supervision and regulation; implementation of the anti-money laundering framework; effective framework for private sector debt restructuring. *Source: _cr13374 - 2.3 CBC to establish co-operation mechanisms with CySEC, the Cyprus Bar Association and ICPAC (for accountants) for exch* ### 7.4 percent of GDP in the second quarter compared with a deficit of 4 percent of GDP a year ### _cr13374 - 7.4 percent of GDP in the second quarter compared with a deficit of 4 percent of GDP a year ### External sector / current account - Current account recorded a surplus of 7.4 percent of GDP in the second quarter compared with a deficit of 4 percent of GDP a year ago. - Most of the current account adjustment has emanated from lower imports. - Modest recovery in the eurozone has contributed to increased trade, evidencing Cyprus’s highly open economy. ### Public finances - Authorities remain determined to restore public finances to a sustainable footing and continued strong compliance with fiscal targets. - General government primary balance reached a surplus of €110 million during January–September 2013, comparing favourably with the forecast of a deficit of €402 million. - Primary balance as a percentage of GDP: 0.7 percent surplus compared with a forecast deficit of 2.4 percent — an over performance of 3.1 percent. - Drivers of outturn: better-than-expected revenue collection and prudent execution of discretionary spending. - End-year primary deficit target for general government revised to 2.6 percent of GDP from 3.3 percent, locking in some of the over-performance during the first nine months of the year. - 2014 target: authorities are targeting a primary deficit of 3.3 percent. - This is 1 percent of GDP less than envisaged under the original programme, reflecting the net effect on revenues (0.7 percent of GDP) of a higher 2013 base. - Provides additional high quality permanent measures beyond programme requirements (0.3 percent of GDP). ### Financial sector — stabilization and restructuring - State of affairs remains fragile despite progress; confidence in the system is still low although there has been a distinct deceleration in deposit outflows since end-September 2013. - Stabilizing the financial sector is the authorities’ key priority. - Bank of Cyprus: - Fully recapitalized and exited the resolution process since end July. - New Board of Directors elected in September and new Chief Executive Officer appointed. - Restructuring plan assessed favourably in compliance with the programme’s structural benchmark. - Plan objectives: clean up balance sheet, manage non performing loans, return to profitability, maintain adequate capitalization, ensure stable funding over the medium term. - Plan includes strategy to deal with troubled borrowers through creation of specialized units inside the bank. - Hellenic Bank: - On November 1, increased share capital from private sources, including foreign participants, satisfying two structural benchmarks for this and the next review. - Secured conversion of €255 million of junior bonds into CT1 eligible instruments, exceeding capital requirements determined by the PIMCO due diligence exercise under the adverse scenario by around 20 percent. - Cooperative Central Bank (CCB) and cooperative sector: - New Board of Directors elected at the CCB. - Authorities started consolidating the sector by merging 38 cooperative credit institutions into 9 entities based on a draft restructuring plan. - Ministry of Finance agreed on terms governing the relationship framework with the CCB to ensure commercial operation, as a prior action. - Supervision and regulation of cooperative credit institutions transferred to the Central Bank of Cyprus (CBC). - Central Bank of Cyprus (CBC) actions: - Completed review of banks’ practices regarding loan origination processes, asset impairment and provisioning, and the treatment of collateral in provisioning. - Finalized an Arrears Management Framework and a Code of Conduct for borrowers and creditors in line with international best practice. - Banks are establishing specialized units to deal with NPLs. - A review aimed at strengthening the insolvency framework is underway, enriched with technical assistance by the Fund. - Liquidity and capital controls: - Authorities will build on reforms to ensure credit institutions can support the economic recovery. - CBC committed to taking measures to maintain sufficient liquidity in the system in line with Eurosystem rules. - Initial easing of capital controls during August–October 2013 relaxed restrictions on wire transfers and opening of new accounts. - Following submission of cooperative sector’s final restructuring plan, the second phase of relaxations can begin, including abolition of remaining restrictions requiring automatic renewal of fixed-term deposits and elimination of limits for free transfer of deposits within the domestic banking system. - CBC will fine-tune technical impact assessment of relaxation measures on banks’ liquidity and study current market conditions, including through well-targeted surveys and focus groups, by end January 2014. - Experts from the Austrian National Bank are in Cyprus assisting the CBC in the design of a banking survey. ### Structural reforms - Authorities advancing ambitious structural reform agenda, including comprehensive social welfare reform: - Scheme introduces a general minimum income for vulnerable groups. - Will be financed by consolidating and better targeting other social benefits to remain within the 2014 envisaged envelope. - Revenue administration reforms: - Steps toward integration of the Inland Revenue Department and VAT services into a new function-based tax administration. - Short-term work programme of targeted joint audits prepared to be undertaken by the Internal Revenue Department and VAT Services. - Public financial management: - Drafting completed of the Fiscal Responsibility and Budget Systems Law, providing legal basis for efficient management of public investment projects, establishment of a Fiscal Council, and transparent management of natural resource revenues through the budget. - Privatization: - Cyprus Privatization Plan unanimously approved by the Council of Ministers on December 5. - Government intends to detail asset-specific timelines and intermediate steps for all state-owned enterprises envisaged for privatization. - Legal and institutional framework for privatization will be finalized; plan will be adjusted at regular intervals to reflect market developments with a view to maximizing revenues and potentially attracting foreign direct investment. - Broader reform priorities: - Overhaul of public administration, the health system, and tax administration. - Ambitious privatization program and reforms aim to regain competitiveness and generate foundation for a sustainable economic model. ### Conclusion and outlook - Cyprus has taken decisive action to address economic difficulties and restore stability, meeting commitments under the programme in terms of policy reforms and quantitative targets. - Steadfast implementation has produced tangible results with indications that recovery is taking place, providing room for cautious optimism. - Major challenges remain: deep recession, high unemployment, and an impaired banking system reluctant to provide credit. - European support example: EIB approval of new financing instruments for Cyprus for an amount of up to EUR 150 million. - Authorities appreciate such efforts and look forward to continuing discussions on improving sustainability of the programme. - Strong implementation attributed to staff’s programme design balancing ambitious conditionality with institutional capacity limitations of a small economy; continued vigilance is crucial. - Acknowledgement of Fund management, relevant area departments, and the EU’s “Support Group for Cyprus” for offering, structuring, and making possible extensive technical assistance across a vast number of areas. *Source: _cr13374 - 7.4 percent of GDP in the second quarter compared with a deficit of 4 percent of GDP a year* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13374.pdf_