## _cr14180 ## Source details **Canonical URL:** [_cr14180](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14180.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14180.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14180.pdf.json) --- ### Extended Arrangement and Financing - A three-year Extended Arrangement under the Extended Fund Facility approved on May 15, 2013 in the amount of SDR 891 million (563 percent of quota; about €1 billion). - Four purchases of amounts equivalent to SDR 74.25 million (about €84 million) each made so far; another purchase of the same amount proposed to be released upon completion of the fourth review. - The European Stability Mechanism released €4.75 billion (of €9 billion committed); an additional €600 million expected to be disbursed in early July. - Program expected to be fully financed over the next 12 months; available government deposits of about €1.3 billion in early May (including €0.2 billion of CBC profits transferred to the government); expected proceeds of €0.1 billion from transfer of coinage function in June; planned cash disbursements from the ESM/IMF of €2.3 billion; projected financing needs of €2.6 billion over the next year. - IMF purchase schedule: Amount of Purchase 74.254 (Millions of SDR) and Percent of Quota 46.93% for each scheduled purchase; Total: 891.00 (Millions of SDR), 563.21% (Percent of Quota). ### Program Status, Conditionality, and Staff Recommendation - All end-March and continuous performance criteria (PCs) met. - Compliance with structural benchmarks (SBs) mixed: - Two SBs related to the cooperative credit sector were met. - Two bank supervision SBs: one fulfilled partially and one with delay. - SB related to legacy Laiki expected to be achieved partially with delay. - Fiscal structural SB on revenue administration fulfilled with slight delay; SB related to welfare reform yet to be achieved (timelines noted elsewhere). - For the fourth review staff supports completion of the fourth review and proposed modifications to performance criteria. - Proposed end-June quantitative PC modifications: raise the floor on the primary balance; raise the ceiling on primary expenditure to reflect restructuring of called government guarantees (expected cash payments of about 0.3 percent of GDP booked under other capital transfers); increase ceiling on government debt to account for effect of called guarantees to entities outside general government (about 0.5 percent of GDP) and to accommodate slight delay of asset swap with the CBC to the third quarter. - Seven new or modified SBs proposed (selected deadlines included: end-July, end-September, end-October, end-November, end-December 2014, end-January 2015). ### Recent Economic Developments and Outlook - Q1 2014: Output contracted by 4.1 percent year-on-year and 0.7 percent quarter-on-quarter; recession continued to moderate and performance somewhat better than expected under the program. - Growth projections: - 2014 growth projection revised to -4.2 percent (more than ½ percentage point better than at third review). - 2015 expected growth 0.4 percent (half the rate projected during last review). - Medium-term: by 2020 private consumption and investment projected to remain some 10 and 45 percent below their 2008 peaks, respectively. - Labor market and inflation: - Unemployment rate fell slightly to 16.4 percent in April from a revised 16.7 percent at end-2013. - Youth unemployment 42.3 percent in March. - Deflation slowed to 0.1 percent in May; core inflation edged up to 0.2 percent in May. - Unit labor costs declined more than those of most euro-area countries. - External sector: - Current account deficit narrowed to 1.9 percent of GDP at end-2013, compared with a deficit of 6.9 percent of GDP in 2012. - Trade balance recorded a surplus of 1.9 percent of GDP. - Real effective exchange rate (unit labor cost based) declined by about 9 percent since its peak in mid-2011. - Tourism: first quarter receipts down by 5.3 percent relative to a year ago; tourist arrivals recovered in April and May. - Macroeconomic projection series (selected): - Real GDP growth series (percent): 2.5, -2.4, -5.4, -4.2, 0.4, 1.6, 2.0, 2.2, 2.1, 1.8, 1.8 (years shown). - Inflation (GDP deflator, percent): 3.1, 1.6, -1.5, 0.2, 1.3, 1.7, 2.1, 2.2, 2.0, 2.1, 2.1. - Unemployment (percent): 3.6, 5.4, 6.3, 7.9, 11.9, 15.9, 18.6, 18.0, 16.8, 15.2, 13.8, 12.2, 10.9 (selected years). ### Fiscal Developments and Policies - End-March cumulative primary fiscal surplus reached 0.6 percent of GDP, better than the target by 0.7 percent of GDP. - Outperformance due to higher-than-expected tax revenues (by 0.3 percent of GDP) and some one-off factors. - April cumulative primary surplus reached 1.5 percent of GDP due to CBC dividends transferred to the state (1.1 percent of GDP) and continued positive tax revenue trends. - 2014 primary deficit target tightened to 1.6 percent of GDP (MEFP ¶9); revision of 0.4 percent of GDP largely reflects higher growth. - Medium-term fiscal path: - Primary balance projected to strengthen toward 4 percent of GDP in 2018. - Medium-term primary balance targets include CBC dividends of about 0.6 percent of GDP per year in 2015–16. - Primary balance expected to turn positive in 2016. - Stock of government guarantees: €3 billion (20 percent of GDP); sizeable contingent liabilities associated with government guarantees amount to 20 percent of GDP. - PDMO actions: database of guarantees to be completed by mid-July; first quarterly risk assessment report by end-September; institutional arrangements for guarantees by end-September; manual/guidelines by end-January 2015. - Debt management: - Significant maturities due after program period: 37 percent of GDP in 2017–20, of which 14 percent of GDP in 2017 alone. - Authorities committed to develop debt management strategy by end-October (new SB). - Debt-to-asset swap to reduce public debt by approximately €1 billion to be completed by end-July. ### Financial Sector Conditions, NPLs, and Restructuring - Deposits and liquidity: - Aggregate deposits declined by about 2 percent in the first five months of 2014, compared to a 20 percent fall during end March–December, 2013 (excluding bailed-in amounts). - During April and May 2014 the system experienced net inflows for the first time since 2012; freeing of domestic payment flows and release of €1.3 billion of Bank of Cyprus’ frozen deposits in February–April shortened deposit maturities (deposits maturing in less than 3 months now represent about half of total deposits). - BoC to release another €0.6 billion in equal tranches in July and September and decide on the release or extension of the last €1 billion in frozen deposits at end-July. - Reliance on central bank emergency liquidity support is over 30 percent of total deposits (close to 60 percent of GDP). - Nonperforming loans (NPLs) and provisions: - NPLs of the core domestic banking sector represented 52 percent of gross loans (close to 140 percent of GDP) at end-March. - Corporate NPLs 55 percent; largest 30 exposures represent a fifth of corporate NPLs. - Owner-occupied housing loan NPLs around 36 percent. - Banks booked new provisions of about €5 billion in 2013; provision coverage of NPLs stabilized at about 36 percent at end-February (in line with restructuring plans), below European average of 50 percent. - Credit trends: - Non-financial private sector credit fell 8.4 percent y-o-y in the first four months of 2014 (5.2 percent for residents) compared to 10 percent at end-2013. - Both corporate and household credit continued to decline; lending survey indicates weak demand and tightening supply with relatively high lending rates. - Capitalization and restructuring: - CET1 capital of the core domestic sector close to 11 percent. - Cooperative credit sector consolidated into 18 institutions and recapitalized to meet regulatory minima (end-March SB met). - BoC divested operations in Ukraine, Romania, and Serbia ahead of schedule; Hellenic Bank sold its Russian subsidiary in early June. - Transition to the Single Supervisory Mechanism (SSM) and preparations for the comprehensive assessment are straining capacity short run; SSM and SRM expected to improve long-run confidence. ### Policy Measures to Tackle NPLs and Strengthen Supervision - Enhancing banks’ operational capacity: - Reassigning and training staff; improving processes and IT systems. - BoC shifted 500 staff to specialized NPL unit; cooperative sector has 173 dedicated staff. - External audit assessments of BoC’s and coops’ operational capacity completed in May; CBC required BoC and coops to submit action plans to address shortcomings. - Strengthening arrears management framework: - CBC reviewing compliance; completion of CBC review extended to end-July; banks to develop action plans; CBC to reassess and issue recommendations by end-November (new SB). - Monitoring restructuring targets: - BoC and coops submitted progress reports in April and May on NPLs, number of restructured loans, collection rates, re-defaults, early arrears. - Preliminary findings: backlogs of restructuring and recovery cases; CBC supervisory units presented assessments and recommendations for BoC to CBC board at end-May (partially meeting SB); coops expected to do so with delay (modified end-July SB). - Auditing past lending and restructuring decisions: - Special internal audit of unduly favorable past treatment of former/current managers and major shareholders to be evaluated by CBC by end-January 2015 (new SB); civil action required where applicable. - Credit register: - Operationalize country-wide credit register by end-September to improve borrower information and supervision. - Governance and resolution: - Regulatory minimum CET1 capital agreed at 8 percent; average CET1 close to 11 percent. - Advisor to be appointed for disposal process of Laiki assets by end-June; entrusting voting rights in BoC extended to end-September (modified SB). - Amendments to resolution law submitted to parliament to ensure independence of Resolution Authority. ### Legal Framework Reform for Debt Restructuring and Foreclosure - Authorities to finalize reform strategy and approve by government by end-July (new SB) after impact assessment of debt restructuring options. - Amend foreclosure law by end-June to facilitate private auctions without government interference for mortgaged properties (immediate effect except primary residences). - New foreclosure legislation for primary residences to enter into effect at end-2014 together with adoption of insolvency framework (end-December modified SBs). - Task Force to prepare study on registered but untitled land sales contracts and underlying mortgages with recommendations by end-June. - Commitment: remove legal/administrative hurdles so pledged collateral can be recovered within maximum time-span of 1.5 years from initiation of proceedings (primary residences up to 2.5 years). ### AML/CFT and Transparency Measures - Strengthen AML/CFT framework across three areas: - Supervision of financial institutions: CBC resumed inspections; one bank inspected; CBC plans additional inspections; risk-based supervisory tools being tested; three letters requesting corrective actions issued following Deloitte’s audit. - Supervision of professions: risk-based tools developed for lawyers, accountants, administrative services providers. - Company transparency: Council of Ministers adopted action plan to address Registrar of Companies recommendations; amendments to streamline company registration/de-registration, strengthen enforcement, and update corporate information to enable timely access to beneficial ownership information. - Annex 2 actions and statuses listed for Customer Due Diligence, Reliance/Introduced Business, Suspicious Transaction Reporting, Transparency of Beneficial Ownership, Supervision of Financial Institutions, and Supervision of Lawyers/Accountants/TCSPs (detailed measures and timelines, many with Q2–Q4 2014 targets). ### Risks to the Outlook and Program Implementation - Downside external risks: - Potential re-intensification of geopolitical tensions in CIS region; sharper slowdown in Russia and further depreciation of the ruble (about a fifth of service exports go to Russia); weaker Euro area recovery. - Domestic risks: - Delays in addressing high NPLs could prolong deleveraging and liquidity tightening, possibly prolonging the recession. - Deflation risk and risk of deflationary spiral. - Reform fatigue and opposition (including to foreclosure and insolvency reforms) could reignite negative bank-sovereign-real sector feedback loops. - Uncertainty regarding comprehensive assessment implications for bank capital needs may dent confidence. - Mitigating factors: - Enhanced bank supervisory measures and accelerated insolvency framework expected to facilitate NPL workouts. - Recent successful capital-raising initiatives in Europe and investor interest (e.g., Hellenic Bank investment) may help boost capital buffers; sizeable program buffer (about 10 percent of GDP) provides cushion. - Stabilizing deposit trends, prudence on capital controls, availability of government guarantees, stepped-up authority resources, and renewed political support following European parliamentary elections. - Program peak exposure to the Fund occurs in 2016 at 563 percent of quota or 6 percent of GDP; debt service to the Fund remains manageable but risks persist given large post-program financing needs and macroeconomic uncertainty. ### Public and External Debt Indicators, Financing Needs, and Market Access - External debt: - External debt fell to just under 350 percent of GDP at end-2013 from 450 percent of GDP a year earlier. - Net international investment position deteriorated slightly to -86 percent of GDP at end-2013 compared with -82 percent in 2012. - Public debt projections (selected series, percent of GDP): 64.0, 86.6, 111.5, 119.9, 124.4, 121.9, 115.2, 110.2, 106.1, 102.8, 99.5 (series shown). - Public gross financing requirements (Table 3, Millions of euros): Gross financing requirement including buffer: 5,839.7 (2013 May-December); 3,383.1 (2014); 3,433.1 (2015); 1,987.4 (2016); 3,344.0 (2017). Government portion of gross financing requirement and official financing sources (IMF and ESM) detailed in Table 3. - External financing requirements (Table 5, Millions of Euros): Gross financing requirements: 60,086 (2012), 61,881 (2013), 34,862 (2014), 32,595 (2015), 30,551 (2016), 29,416 (2017), 29,734 (2018), 29,388 (2019), 29,477 (2020). Short-term debt amortization and financing gaps shown in table. - Market developments: On June 18, €750 million raised in sale of five-year notes; issuance four times oversubscribed. ### Structural Reforms and Social Safety Net - Social safety net reform: - Authorities committed to implementing Guaranteed Minimum Income (GMI) in July; expected to increase coverage and reduce poverty while remaining budget neutral. - 2014 financing expected to cover reform costs in second half of year (about 0.2 percent of GDP). - Monitoring unit to be established to assess GMI outcomes by end-June. - Privatization: - Privatization expected to reduce public debt by about 8 percent of GDP by 2018. - Head of new privatization unit appointed; unit to be fully operational by end-June. - Preparations focused on commercial activities of the ports authority (CPA) and state-owned telecom (Cyta); legislation to convert Cyta into a limited liability company by end-year. - Revenue administration: - Taxes owed but not paid estimated at 6 percent of GDP. - Enabling law consolidating two tax authorities submitted May 8 and adopted June 5. - Management team appointment by end-July; common taxpayer database by end-September; single registration process and integrated large taxpayer unit by end-December. - Prior action: legislative amendments adopted to establish self-assessment and increase collection enforcement powers (adopted in early June). - Cyprus informal economy estimated at 26 percent of GDP compared to 18 percent for EU27. ### Implementation Monitoring and Reporting - Extensive reporting requirements to IMF by Ministry of Finance, Cystat, and Central Bank of Cyprus with specified frequencies and maximum time lags (monthly, quarterly, daily items detailed). - Program monitored through quarterly reviews and checkpoints; conditionality includes continuous PCs, indicative targets, and structural benchmarks as defined in the TMU. - Authorization for publication: IMF authorized to publish Letter of Intent and attachments and related staff report. *Italic: Source — IMF staff report excerpt (content unit _cr14180).* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Extended Arrangement and Financing - A three-year Extended Arrangement under the Extended Fund Facility was approved on May 15, 2013, in the amount of SDR 891 million (563 percent of quota; about €1 billion). - Four purchases of amounts equivalent to SDR 74.25 million (about €84 million) each have been made so far; another purchase of the same amount is proposed to be released upon completion of the fourth review. - The European Stability Mechanism has released €4.75 billion (of €9 billion committed), and an additional €600 million is expected to be disbursed in early July. ### Program Status and Implementation - The program remains on track: all end-March and continuous performance criteria (PCs) were met. - Compliance with structural benchmarks (SBs) was mixed: - Two SBs related to the cooperative credit sector were met. - Two bank supervision SBs: one fulfilled partially and one with delay. - The SB related to legacy Laiki is expected to be achieved partially with a delay. - The fiscal structural SB on revenue administration was fulfilled with a slight delay; the SB related to welfare reform is yet to be achieved. - Key policy challenges going forward: - Addressing the high level of non-performing loans (NPLs). - Maintaining fiscal sustainability. - Strengthening institutions to support fiscal consolidation efforts and long-run growth. - Risks to the program remain significant, particularly those related to still strong macro-financial linkages. ### Recent Economic Developments — Overview - The recession continued to moderate in Q1 2014: - Output contracted by 4.1 percent year-on-year (y-o-y) and 0.7 percent quarter-on-quarter (q-o-q) in Q1 2014. - This performance is somewhat better than expected under the program. - Demand and supply contributions: - On the demand side, declines in private consumption and investment moderated relative to a year ago; exports were flat; the contraction in imports declined relative to last year. - On the supply side, construction and financial services contributed most to the contraction. - Economic sentiment improved in May, reaching levels last observed in 2010. ### Labor Market and Inflation - Unemployment and youth unemployment: - Unemployment rate fell slightly to 16.4 percent in April from a revised 16.7 percent at end-2013. - Youth unemployment was 42.3 percent in March. - Inflation: - The rate of deflation slowed to 0.1 percent in May. - Core inflation edged up to 0.2 percent in May. - Unit labor costs declined more than those of most euro-area countries. ### External Sector - Current account: - The current account deficit narrowed to 1.9 percent of GDP at end-2013, compared with a deficit of 6.9 percent of GDP in 2012. - The adjustment was largely due to a turnaround in the trade balance, which recorded a surplus of 1.9 percent of GDP. - The income balance remained negative, with both foreign assets and liabilities falling. - Competitiveness: - The real effective exchange rate (unit labor cost based) declined by about 9 percent since its peak in mid-2011. - Tourism: - Tourism receipts for the first quarter were down by 5.3 percent relative to a year ago, in part due to the different timing of Easter; tourist arrivals recovered in April and May. ### Fiscal Developments - End-March cumulative primary fiscal surplus: - Reached 0.6 percent of GDP, better than the target by 0.7 percent of GDP. - Outperformance largely due to higher-than-expected tax revenues (by 0.3 percent of GDP) and some one-off factors. - Primary spending was slightly lower than the target (by 0.2 percent of GDP), driven by lower compensation of employees and under-execution of intermediate consumption and capital expenditure, offsetting slightly higher social transfers and other current expenditures. - April fiscal developments: - Cumulative primary surplus reached 1.5 percent of GDP in April, on account of CBC dividends transferred to the state (1.1 percent of GDP) and continuation of positive tax revenue trends. - Fiscal composition notes: - Revenues increased primarily due to improved direct and indirect tax revenue. - The increase in primary spending was mainly due to higher social security payments because of accelerated processing of unemployment and redundancy benefit applications. ### Financial Sector and Structural Context - Banking sector: - Conditions are normalizing, but non-performing loans remain very high, constraining banks’ ability to provide credit to the economy. - Transition to the Single Supervisory Mechanism (SSM) and preparations for the comprehensive assessment are straining capacity in the short run, although the SSM and the Single Resolution Mechanism (SRM) are expected to improve confidence over the long run. - Overall macro-financial environment: - The economy remains weighed down by large private sector deleveraging needs. - External developments (EU Parliamentary election reaffirmation of political support; ECB interest rate cut and lending measures) are broadly supportive. *IMF staff report: Executive Summary, Cyprus — June 17, 2014.* ### 6. Conditions in the financial sector are gradually normalizing, although vulnerabilities ### 6. Conditions in the financial sector are gradually normalizing, although vulnerabilities remain ### Financial sector conditions and deposit flows - System-wide deposits have remained broadly stable despite abolition of all domestic payment restrictions. - Aggregate deposits declined by about 2 percent in the first five months of 2014, compared to a 20 percent fall during end March–December, 2013 (excluding bailed-in amounts). - During April and May 2014, the system experienced net inflows for the first time since 2012, reflecting inflows of non-resident deposits into foreign banks, which more than offset mild outflows from domestic banks. - The freeing of domestic payment flows, together with the release of €1.3 billion of Bank of Cyprus’ (BoC) frozen deposits in February–April, led to a shortening of maturity profiles (deposits maturing in less than 3 months now represent about half of total deposits). - BoC will release another €0.6 billion in equal tranches in July and September and decide on the release or extension of the last €1 billion in frozen deposits at end-July. ### Nonperforming loans (NPLs) and provisions - NPLs of the core domestic banking sector represented 52 percent of gross loans (close to 140 percent of GDP) at end-March, only marginally higher than their end-2013 level, and broadly in line with PIMCO’s projections. - Corporate NPLs stood at 55 percent and are highly concentrated (the largest 30 exposures represent a fifth of corporate NPLs). - NPLs for owner-occupied housing loans are around 36 percent. - Banks booked new provisions of about €5 billion in 2013, helping to stabilize provision coverage of NPLs at about 36 percent at end-February (in line with restructuring plans), albeit lower than the European average of 50 percent. ### Credit trends and lending conditions - Non-financial private sector credit fell 8.4 percent y-o-y in the first four months of 2014 (5.2 percent for residents) compared to 10 percent at end-2013. - Both corporate and household credit continued to decline. - Lending survey indicates credit demand remains weak and supply conditions are tightening, reflected in relatively high lending rates; the pace of credit contraction has slightly moderated. ### Progress on bank restructuring and capitalization - Following recapitalization at an aggregate level in March, the cooperative credit sector was consolidated into 18 institutions (meeting the end-March structural benchmark) and were recapitalized to meet regulatory minima. - BoC divested operations in Ukraine, Romania, and Serbia ahead of schedule, reducing risk exposure and boosting liquidity; Hellenic Bank sold its Russian subsidiary in early June. - CET1 capital of the core domestic sector stands at close to 11 percent and remains in line with the program. ### Macroeconomic outlook (selected projections and indicators) - The 2014 growth projection was revised up to -4.2 percent, more than ½ percentage point better than at the time of the third review. - Growth in 2015 is expected to reach 0.4 percent, half the rate projected during the last review. - Medium-term recovery is expected to be gradual; by 2020 private consumption and investment are projected to remain some 10 and 45 percent below their 2008 peaks, respectively. - Unemployment is expected to peak at 18.6 percent in 2014, ½ percentage point less than previously projected. - Inflation forecasts were slightly lowered in 2014 and 2015, reflecting permanent cuts in electricity prices in early 2014 and a more gradual recovery. ### Risks to the outlook - Downside external risks: potential re-intensification of geopolitical tensions in the CIS region, a sharper slowdown in Russia and further depreciation of the ruble (about a fifth of service exports go to Russia), and a weaker Euro area recovery. - Domestic risks: delays in addressing high NPLs could lead to a more extended deleveraging process and continued tightening of liquidity conditions, possibly prolonging the recession. - Deflation risk: the risk of a deflationary spiral remains, which could further weigh on private sector balance sheets even as it boosts competitiveness. - Upside scenario: continuation of positive trends since mid-2013 could lead to higher growth prospects. ### Public and external debt vulnerabilities - Projected public debt was revised down slightly due to a slightly higher nominal GDP and a somewhat lower expected cost of official financing, but remains high. - Sizeable contingent liabilities associated with government guarantees amount to 20 percent of GDP. - Large implicit liabilities associated with the banking sector, including ELA exposure of close to 60 percent of GDP, increase public debt vulnerability. - External debt fell to just under 350 percent of GDP at end-2013 from 450 percent of GDP a year earlier, reflecting the decline in banking sector deposits. - Net international investment position (IIP) deteriorated slightly to -86 percent of GDP at end-2013 compared with -82 percent in 2012. ### Policy discussions — Financial sector policy: tackling NPLs and safeguarding stability - Addressing high NPLs is critical to restoring credit and growth; NPLs at just above half of total loans are among the highest in Europe. - Large aggregate net financial asset position of households (close to 140 percent of GDP at end-2013) suggests scope to address some household NPLs (household NPLs amount to 46 percent of total loans and 70 percent of GDP). - High NPLs prevent resumption of credit, weakening activity and worsening repayment capacity; staff and authorities agreed that lowering NPLs is essential to support recovery. Policy measures and supervisory actions agreed or underway - Enhancing banks’ operational capacity: - Banks need to build capacity to manage high NPLs by reassigning and training staff and improving processes and IT systems. - BoC shifted 500 staff to its specialized NPL unit; the cooperative sector has 173 dedicated staff. - External audit assessments of BoC’s and the coops’ operational capacity were completed in May; audits identified needs to: (i) further enhance staff training; (ii) establish clear separation between front-line, restructuring, and recovery functions; (iii) improve IT systems to cope with large NPL caseloads; and (iv) strengthen monitoring of restructurings. - The CBC has required BoC and the coops to submit action plans to address shortcomings. - Strengthening implementation of the arrears management framework: - The CBC is reviewing banks’ and coops’ compliance with the existing framework to ensure necessary steps are taken to restructure loans of viable borrowers fairly. - Completion of the CBC review was extended to end-July due to workload from the ECB comprehensive assessment; banks will be required to develop action plans to address potential shortcomings. - The CBC will reassess implementation of these plans and issue recommendations, including on updating the arrears management framework as needed, by end-November (new SB). - Monitoring progress toward restructuring targets: - In April and May, BoC and the coops submitted first progress reports on restructuring performance against targets (e.g., NPLs, number of restructured loans, collection rates, re-defaults, early arrears). - Preliminary findings indicate banks find it difficult to deal with high inflow of NPLs, creating backlogs of restructuring and recovery cases. - CBC supervisory units presented assessments and recommendations for BoC to the CBC board at end-May, partially meeting their SB; coops are expected to do so with a delay (modified end-July SB). - Auditing past lending and restructuring decisions: - Discussions emphasized conducting a special internal audit of unduly favorable past treatment of former or current managers and major shareholders. - The CBC will evaluate this audit by end-January 2015 (new SB). - Where applicable, banks will be required to take civil action to recover damages. ### Context on feedback loops and policy constraints (Box highlights) - The banking sector remains large relative to the economy: about 470 percent of GDP overall, with domestic banks accounting for about 300 percent of GDP. - Reliance on central bank emergency liquidity support is the largest in the Eurozone, at over 30 percent of total deposits (close to 60 percent of GDP). - Households and SMEs face very high indebtedness (close to 300 percent of GDP), contributing to weakness in consumption and domestic demand. - Given high NPLs, constrained funding environment, tight capital buffers, and lack of fiscal space, Cyprus’s strategy focuses on developing bank internal capacity and targeted policies, alongside reforming the legal framework for foreclosure and in- and out-of-court debt restructuring. - Deleveraging needs are estimated at around 50–90 percent of GDP, although the positive net asset position provides a cushion. *Source: IMF staff report excerpt — "Conditions in the financial sector are gradually normalizing, although vulnerabilities remain" (content unit _cr14180).* ### 13. Reforming the debt-restructuring legal framework is another key policy action needed ### 13. Reforming the debt-restructuring legal framework is another key policy action needed ### Debt-restructuring legal framework and NPL resolution - Even with improved in-house bank systems for NPLs, progress critically depends on an adequate insolvency and foreclosure framework with balanced incentives to promote voluntary debt renegotiations. - Authorities agreed to reform the existing framework but needed additional time to finalize the overall strategy because of complexity and domestic issues, including: - the pervasive use of personal guarantees and title deeds; and - the need to design specific procedures for restructuring SMEs. - Commitments and timelines: - Finalize the reform strategy, to be approved by the government by end-July (new SB), after completing an impact assessment of debt restructuring options. - Amend the foreclosure law by end-June to facilitate private auctions without government interference to deter strategic behavior and facilitate collections. - New foreclosure legislation for primary residences will enter into effect at end-2014, together with the adoption (rather than submission) of the new insolvency framework (end-December modified SBs). ### External controls, payment flows, and liquidity - Domestic payment flows have been fully liberalized; external controls remain in place to preserve financial stability (MEFP ¶5, 6). - Authorities completed the last step of domestic restrictions related to opening of new accounts at end May. - Further progress under the program and on banks’ restructuring and funding plans is required before removing restrictions on external capital account transactions. - Monitoring of the effectiveness of external restrictions will need to be enhanced. - Liquidity and Eurosystem interaction: - Bank of Cyprus (BoC) faces a challenging liquidity situation with large ELA exposure amounting to close to 60 percent of GDP and limited collateral buffers. - Staff called for a relaxation of collateral rules to facilitate longer-term ECB refinancing rather than short-term ELA. - Authorities indicated approved but unused government guarantees would remain available for BoC to obtain additional liquidity if necessary to safeguard financial stability. ### Bank supervision, regulation, and resolution (pre-SSM) - CBC has taken steps to increase supervisory resources and enhanced supervisory monitoring of banks and coops. - Three focus areas: - Capital requirements: - Regulatory minimum of CET1 capital agreed at 8 percent to achieve consistency with pan-European requirements and the capital benchmark of the comprehensive assessment. - Average CET1 ratio for the core domestic sector stands close to 11 percent. - Staff called on CBC to request banks to maintain conservative capital buffers and proactively strengthen capital bases; the program buffer (10 percent of GDP) provides a cushion against shortfalls identified at the comprehensive assessment. - Bank resolution: - Importance of finalizing the resolution process for Laiki stressed; process has taken more than a year. - Authorities initiated selection of a firm to manage asset disposal and voting rights in BoC; interest has been limited. - An advisor is expected to be appointed for the disposal process by end-June, which would achieve partly and with delay the SB requirement in this area. - Timeframe related to entrusting the voting rights in BoC extended to end-September to allow concluding negotiations with the EBRD (modified SB). - Authorities submitted to parliament amendments of the resolution law to ensure independence of the Resolution Authority. - Credit register: - Operationalizing a country-wide credit register is ongoing and expected to be completed by end-September. - More comprehensive borrower information will allow banks to make better informed lending decisions and improve supervision (monitoring loan origination practices and credit risk). ### AML/CFT framework strengthening - Expected to bolster financial sector credibility and foster sustainable growth of the business service sector. - Three key areas of progress: - Supervision of financial institutions: - CBC resumed inspections of banks; one bank inspected, and CBC plans to complete an additional ten inspections by end-year. - Risk-based supervisory tools are being tested and should improve supervision effectiveness once rolled out. - Three letters requesting corrective actions have been issued following Deloitte’s audit; no sanctions yet but CBC is considering appropriate supervisory measures. - Supervision of professions: - Risk-based tools being developed to improve monitoring of professions (lawyers, accountants, administrative services providers) involved in company formation and management. - Company transparency: - Council of Ministers adopted an action plan to address recommendations of a third-party assessment of the Registrar of Companies and to remedy weaknesses identified by the Global Forum Report related to corporate transparency and exchange of information for tax purposes. - Plan includes amending legislation to streamline procedures for company registration and de-registration, strengthen enforcement powers of the Registrar, and update corporate information to allow timely access to accurate and current beneficial ownership information. ### Fiscal policy: maintaining sustainability - 2014 primary deficit target tightened to 1.6 percent of GDP (MEFP ¶9). - The 0.4 percent of GDP revision largely reflects the impact of higher growth. - Primary balance will improve modestly in nominal terms as higher nominal tax revenues are expected to more than offset a small increase in nominal spending (about 0.2 percent of GDP on a cash basis) due to restructuring of about 1.5 percent of GDP of called government guarantees that will be repaid over several years. - Staff and authorities agreed continued prudent budget execution is warranted given risks from the large stock of government guarantees and potential additional costs related to welfare reform. - If macroeconomic conditions deteriorate beyond expectations, staff called for allowing automatic stabilizers to operate. - Medium-term projections and adjustments: - Primary balance projected to strengthen gradually toward the target of 4 percent of GDP in 2018. - Medium-term primary balance targets were revised to include CBC dividends of about 0.6 percent of GDP per year in 2015–16, expected to be distributed in line with Eurosystem Treaties and the Statute. - Fiscal adjustment path modified to balance reaching the long-run primary surplus target with minimizing negative fiscal impulse during initial recovery stages. - Primary balance expected to turn positive in 2016, reflecting in part the pickup in growth. - Authorities set medium-term budget ceilings consistent with the revised path; implementation details to be finalized in the 2015 budget. ### Fiscal structural reforms and social safety net - Social safety net reform: - Authorities committed to implementing social safety net reform in July (MEFP ¶10) introducing a guaranteed minimum income scheme (GMI) covering all vulnerable groups. - Reform expected to increase coverage and reduce poverty while remaining budget neutral. - Financing in the 2014 budget expected to cover reform costs in the second half of the year (about 0.2 percent of GDP). - Authorities expect to achieve with a delay the SB requirement for government approval of the budget-neutral reform once social dialogue is completed in mid-June; passage of the new law and start of implementation expected shortly thereafter (end-June existing SB). - Staff called for identifying additional non-GMI benefits that could be streamlined, preparing contingency measures, and setting up a monitoring unit to assess GMI outcomes (applications and costs, targeting accuracy, coverage, impact on poverty). - Tax collections and revenue administration reform: - Short-term measures: - Legislative amendments submitted to parliament (adopted in early June) to establish self-assessment and increase collection enforcement powers by allowing tax authority to go after debtors’ assets (prior action). - Joint audits of large and high-risk taxpayers started; four audits completed and another six planned by end-June (MEFP Table 2). - Cyprus’s informal economy estimated at 26 percent of GDP compared to 18 percent for EU27. - Long-term reform: - Enabling law consolidating two tax authorities submitted to parliament in early May and adopted in early June (slight delay to related SB). - Next step: appoint management team to lead transitional structure; operational integration starts with integrated unit for large taxpayers (end-December 2014 existing SB). - Staff stressed transparent recruitment, prompt resolution of data reconciliation issues, and intensified monitoring of monthly performance indicators (registration, filing, payment, auditing, debt collection). ### Budget and fiscal risk management - Following adoption of fiscal responsibility and budget system law (FRBSL), focus on implementation with priority on medium-term budget formulation ahead of next year’s budget. - Plan to finalize and update a database of government guarantees and an associated risk assessment report. - Need to improve management of guarantees by clarifying ministerial responsibilities and developing common procedures for issuance, monitoring, restructuring, and recovery. ### Debt management and privatization - Medium-term debt strategy needed to enable sustainable return to capital markets (MEFP ¶13). - Significant maturities due after program period: 37 percent of GDP in 2017–20, of which 14 percent of GDP in 2017 alone. - Authorities committed to developing a strategy to minimize risks, including diversifying debt structure, improving domestic T-bill market functioning, and strengthening management of government guarantees (end-October new SB). - Authorities considered scope to probe markets early given decline in yields and favorable market conditions to partly address post-program refinancing concerns and reduce the outstanding Laiki recapitalization bond held by BoC; staff emphasized safeguarding objective of minimizing risks and securing adequate terms. - Privatization steps for state-owned enterprises: - Privatization expected to reduce public debt by about 8 percent of GDP by 2018 and increase economic efficiency. - Head of new privatization unit appointed; unit expected to be fully operational by end-June. - Preparations focused on commercial activities of the ports authority (CPA) and state-owned telecom (Cyta), expected to be privatized during the program period. - Authorities plan to update port regulatory framework and pass legislation to convert Cyta into a limited liability company by end-year. - Cyta has embarked on restructuring and reached agreements to reduce staff by ¼ through a voluntary retirement scheme. ### Program modalities, conditionality, and financing - All end-March and continuous quantitative performance criteria (PCs) met; compliance with structural conditionality mixed. - Out of seven SBs for this review: - Two were met; - Requirements of three were achieved (one partially and two with a delay); - Requirements for another two SBs expected to be achieved in full or in part in June. - Prior action and proposed modifications: - Prior action: Authorities will adopt legislation to fight non-compliance and tax evasion (submission of legislation was a prior action for the third review). - Quantitative PC modifications proposed for end-June: - Raise the floor on the primary balance given over-performance through March and improved growth outlook for 2014. - Raise the ceiling on primary expenditure to reflect restructuring of called government guarantees (expected cash payments of about 0.3 percent of GDP booked under other capital transfers). - Increase the ceiling on government debt to account for effect of called guarantees to entities outside general government (about 0.5 percent of GDP) and accommodate slight delay of asset swap with the CBC to the third quarter. - End-September PCs are being established. - Structural benchmarks (seven new or modified SBs proposed): - Government approval of the debt-restructuring reform strategy (new SB, end-July). - CBC assessment of coops’ performance against operational and financial targets (modified SB, end-July). - Appointment of a third party to manage Laiki’s voting rights in BoC (modified SB, end-September). - Government approval of a debt management strategy (new SB, end-October 2014). - CBC assessment of banks’ and coops’ implementation of action plans to address arrears management deficiencies (new SB, end-November 2014). - Adoption of legislation to modernize personal and corporate insolvency procedures and regulate insolvency practitioners (modified SB, end-December 2014). - CBC assessment of preferential bank lending practices (new SB, end-January 2015). *Source: _cr14180 - 13. Reforming the debt-restructuring legal framework is another key policy action needed (IMF).* ### 26. Risks to program implementation remain significant, but there are mitigating factors: ### _cr14180 - 26. Risks to program implementation remain significant, but there are mitigating factors: ### Risks to program implementation - The large and still vulnerable banking sector continues to pose a large implicit liability on the sovereign and remains intrinsically linked with the economy. - Inability to make progress with reducing NPLs—including due to opposition to the foreclosure and insolvency reforms from vested interests—could reignite negative bank-sovereign-real sector feedback loops. - Uncertainty regarding the implications of the comprehensive assessment for bank capital needs may dent confidence. - Shocks to confidence could also lead to a renewal of liquidity pressures. - Reform fatigue could compromise the authorities’ ambitious structural reform agenda. ### Mitigating factors - The program’s enhanced bank supervisory measures and the authorities’ decision to accelerate the passage of the new insolvency framework are expected to help with facilitating the workout of NPLs. - Recent successful capital-raising initiatives by other European banks and indications of investor interest in the Cypriot banking system (already evidenced by the early investment in Hellenic Bank last year) may help to boost bank capital buffers; the sizeable program buffer also provides a cushion. - Stabilizing deposit trends, continued prudence with respect to capital controls, and the availability of government guarantees help to guard financial stability. - The authorities have stepped up efforts to overcome delays and increased and reorganized resources, which, together with their public commitment to structural reforms and renewed support following the European parliamentary elections, provide reassurance about program implementation going forward. ### Financing assurances for the program - The program is expected to be fully financed over the next 12 months. - Available government deposits of about €1.3 billion in early May (including €0.2 billion of CBC profits transferred to the government). - Expected proceeds of €0.1 billion from the transfer of the coinage function from the CBC to the Treasury in June. - Planned cash disbursements from the ESM/IMF of €2.3 billion. - Projected financing needs of €2.6 billion over the next year. - Adequate financing for the remainder of the program remains in place, including: - remaining ESM/IMF disbursements, - the expected transfer of €0.2 billion central bank dividends in 2015–16, - expected privatization proceeds. - The program buffer (about 10 percent of GDP) could help provide a cushion against contingent risks, such as those related to government guarantees or potential additional capital needs in the banking sector. ### Capacity to repay the Fund - The medium-term macroeconomic and debt outlook are slightly better than at the time of the third review. - Peak exposure to the Fund occurs in 2016 at 563 percent of quota or 6 percent of GDP. - Debt service to the Fund, assessed relative to GDP and exports, remains manageable. - Risks remain, given large post-program financing needs and still high macroeconomic uncertainty. - External and public debt sustainability and the capacity to repay the Fund are dependent on: - the recovery taking hold next year, - a continued external and fiscal adjustment, - full and timely program implementation. ### Program progress in the first year - Growth has been better than projected under the program’s macroeconomic framework. - The authorities have made substantial progress in resolving problems in the banking sector by taking upfront decisions to address the root of the problems. - Fiscal targets have been consistently met, and important fiscal structural reforms have been set in motion. ### Remaining challenges - Economic conditions continue to be difficult; the recession is expected to continue this year, to be followed by a very modest and gradual recovery. - Implementation of structural conditionality is becoming more challenging as efforts shift from crisis management to restructuring and from reform legislation to implementation and follow up. ### Financial sector stabilization - The stabilization of the financial sector is a major achievement. - Domestic banks and coops have been recapitalized. - The coop sector was significantly consolidated. - All financial institutions made progress in setting up restructuring units, cutting costs, and deleveraging operations abroad. - One year after the crisis, the authorities have fully normalized payment flows within the country. ### Nonperforming loans (NPLs) - NPLs remain very high, requiring resolute policy action. - Reducing NPLs is essential to facilitate the provision of credit needed to support employment and growth. - Implementation as soon as possible of the insolvency and foreclosure reform is needed to give incentives to borrowers and lenders to restructure NPLs. - The authorities also need to intensify the supervisory monitoring of banks’ effective action to collect and restructure debt. ### External controls and liquidity - External controls are still needed to safeguard financial stability. - Bank liquidity and funding conditions have not fully normalized. - Restrictions on the capital account need to be maintained until further progress is made under the program and with respect to banks’ restructuring and funding plans. - Careful monitoring of the effectiveness of the restrictions and adequate provision of liquidity by the Eurosystem remain key. ### Financial supervision, regulation, and AML/CFT - Financial supervision and regulation need to be further strengthened, as does the implementation of the AML/CFT framework. - Ahead of the completion of the pan-European comprehensive assessment, the supervisory authorities need to ensure that banks maintain conservative capital buffers and, if possible, strengthen their capital base. - Governance arrangements for legacy Laiki should be completed to facilitate its orderly wind-down. - The authorities will need to further enhance the AML supervision of banks and professions and company transparency. ### Fiscal performance and outlook - The authorities met fiscal targets with comfortable margins. - Implementation of ambitious fiscal measures and additional discretionary tightening allowed for a larger-than expected reduction in the budget deficit, despite the sharp output contraction. - The authorities have locked in the permanent savings achieved so far. - Looking forward, fiscal policy needs to remain prudent. - Careful budget execution is called for, given still high uncertainty. - Automatic stabilizers should be allowed to operate if downside risks materialize. - Over the medium term, the authorities need to target a smooth fiscal adjustment balancing the long-run need to reduce public debt with short-run cyclical considerations. - A debt management strategy and privatization of state assets will help ensure a sustainable exit from official financing in due course. ### Structural reforms and social protection - As the program enters its second year, greater emphasis is needed on structural reforms. - To ensure adequate protection of vulnerable groups during the downturn, the authorities need to implement the reform of the social safety net without delay, while safeguarding fiscal targets. - Further progress is required to fight tax evasion, reform the revenue administration, improve budget processes, and strengthen the management of fiscal risks. ### Overall assessment and policy imperative - Given still significant risks, full and timely policy implementation remains essential to the program’s success. - Strong links between the banking sector and the macro-economy highlight the criticality of measures to deal with NPLs and protect financial stability. - The still high and vulnerable public debt points to the importance of continued fiscal prudence and complementary fiscal structural reforms. - The authorities will need to maintain the reform momentum and overcome resistance and fatigue to implement identified policies to pave the way for sustainable growth and an eventual exit from official financing. *IMF staff appraisal extract.* ### 39. On the basis of progress to date and policy commitments going forward, staff ### _cr14180 - 39. On the basis of progress to date and policy commitments going forward, staff ### Staff recommendation - On the basis of progress to date and policy commitments going forward, staff supports the completion of the fourth review and the proposed modifications to performance criteria. ### External debt sustainability — baseline and stress tests - Figure 6 indicates external debt trajectories (Percent of GDP) with baseline and historical scenarios; baseline gross external debt values shown include 507, 297, and plotted series across 2009–2021. - Individual shocks are permanent one-half standard deviation shocks; permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance (footnote 3). - Specific scenario box averages (baseline and scenario and five-year historical averages) are reported in the figure captions (values presented in figure panels). ### Public debt sustainability — risk assessment (Heat Map, Figure 7) - Risk-assessment benchmarks: - Debt burden benchmark: 85 percent (upper/lower coloring rules described). - Gross financing needs benchmark: 20 percent (coloring rules described). - Bond spread benchmarks: 400 and 600 basis points. - External financing requirement benchmarks: 17 and 25 percent of GDP. - Change in share of short-term debt: 1 and 1.5 percent. - Public debt held by non-residents: 30 and 45 percent. - Reported indicators (2013, indicators vis-à-vis risk assessment benchmarks): - Bond spread: 695 bp (noted in figure). - External Financing Requirement: 12 (in percent of GDP) and other tabulated values include 17 and 25 used as benchmarks. - Annual change in short-term public debt: 1 (percent) and 1.5 (percent) benchmarks. - Public debt in foreign currency and public debt held by non-residents: 49% public debt held by non-residents noted in figure. ### Realism of baseline assumptions and forecast track record (Figure 8) - Cyprus median forecast errors and percentile ranks (2005–2013): - Real GDP growth median forecast error: -0.96 (percent), has a percentile rank of 22%. - Primary balance median forecast error: -2.00 (percent of GDP), has a percentile rank of 14%. - Inflation (GDP deflator) median forecast error: -0.18 (percent), has a percentile rank of 18%. - 3-year CAPB adjustment percentile rank: 16%. - 3-year average CAPB level percentile rank: 21%. ### Baseline projections and key debt/fiscal/market indicators (tables and figures) - Sovereign spreads and debt indicators (select series, as of projections table): - Nominal gross public debt series: 64.0, 86.6, 111.5, 119.9, 124.4, 121.9, 115.2, 110.2, 106.1, 102.8, 99.5 (percent of GDP across years shown). - EMBIG (bp): 363. - Y CDS (bp): 381. - Real GDP growth (in percent) series: 2.5, -2.4, -5.4, -4.2, 0.4, 1.6, 2.0, 2.2, 2.1, 1.8, 1.8. - Inflation (GDP deflator, in percent) series: 3.1, 1.6, -1.5, 0.2, 1.3, 1.7, 2.1, 2.2, 2.0, 2.1, 2.1. - Effective interest rate (in percent): 5.0, 4.4, 3.3, 3.0, 2.4, 2.4, 3.1, 3.5, 4.1, 4.6, 4.7. - Contribution to change in gross public sector debt (cumulative change, selected years): - Cumulative change in gross public sector debt: 0.5, 15.1, 24.9, 8.4, 4.5, -2.5, -6.7, -5.0, -4.1, -3.3, -3.3, -5.4 (by year as listed). - Identified debt-creating flows total and components (primary deficit, automatic debt dynamics, other identified flows) as detailed in the debt decomposition table. - Table 1 (Selected Economic Indicators, 2008–20) key series (percent change / percent of GDP): - Real GDP (selected years): 3.6, -1.9, 1.3, 0.4, -2.4, -5.4, -4.2, 0.4, 1.6, 2.0, 2.2, 2.1, 1.8. - Unemployment rate EU standard (percent): 3.6, 5.4, 6.3, 7.9, 11.9, 15.9, 18.6, 18.0, 16.8, 15.2, 13.8, 12.2, 10.9. - General government debt (percent of GDP): 48.9, 58.5, 61.3, 71.5, 86.6, 111.5, 119.9, 124.4, 121.9, 115.2, 110.2, 106.1, 102.8. - Current account balance (percent of GDP): -15.6, -10.7, -9.8, -3.4, -6.9, -1.9, -0.1, 0.2, 0.6, 0.4, -0.1, -0.3, -0.4. ### Public gross financing needs and sources (Table 3 and Figures) - Table 3 (Calculation of Gross Financing Requirements and Sources, 2013–17, Millions of euros): - Gross financing requirement including a buffer (2013 May-December): 5,839.7; 2014: 3,383.1; 2015: 3,433.1; 2016: 1,987.4; 2017: 3,344.0. - Government portion of gross financing requirement: 3,406.0 (2013 May-December); 2,729.0 (2014); 2,577.7 (2015); 1,611.6 (2016); 3,344.0 (2017). - Fiscal deficit values: 833.7 (2013 May-December); 847.4 (2014); 610.6 (2015); 179.5 (2016); 108.0 (2017). - Debt maturities: 2,572.3 (2013 May-December); 1,881.6 (2014); 1,967.1 (2015); 1,432.2 (2016); 3,236.0 (2017). - Market financing (government): 776.2 (2013); 950.3 (2014); 750.3 (2015); 904.2 (2016); 2,944.0 (2017). - Net financing requirement: 5,063.6 (2013 May-December); 2,432.7 (2014); 2,682.7 (2015); 1,083.2 (2016); 400.0 (2017). - Official financing sources and buffers total equal net financing requirement each year (e.g., Official financing sources: 4,837.8 (2013 May-December); 2,332.7 (2014); 2,182.7 (2015); 583.2 (2016); 0.0 (2017)). - IMF financing indicated: 252.8 (2013 May-December); 332.7 (2014); 332.7 (2015); 83.2 (2016); 0.0 (2017). - ESM financing indicated: 4,585.0 (2013 May-December); 2,000.0 (2014); 1,850.0 (2015); 500.0 (2016); 0.0 (2017). ### External financing requirements and rollover dynamics (Table 5 and Table 9) - Table 5 (External Financing Requirements and Sources, 2012–20, Millions of Euros): - Gross financing requirements: 60,086 (2012), 61,881 (2013), 34,862 (2014), 32,595 (2015), 30,551 (2016), 29,416 (2017), 29,734 (2018), 29,388 (2019), 29,477 (2020). - Short-term debt amortization: 53,069 (2012), 48,982 (2013), 31,337 (2014), 29,261 (2015), 27,520 (2016), 26,557 (2017), 26,022 (2018), 25,466 (2019), 24,689 (2020). - Financing gap and program financing lines: Financing gap entries include 0 (2012), 4,838 (2013), 2,333 (2014), 2,183 (2015), 583 (2016), 0 (2017 onward). ESM provision listed as 0, 4,585, 2,000, 1,850, 500, 0, 0, 0, 0. IMF entries: 0, 0, 25, 33, 33, 33, 38, 3, 0 (by year columns). - Table 9 (External Debt Sustainability Framework, 2009–2021): - Baseline external debt (percent of GDP) series includes 544.1, 491.9, 468.2, 448.5, 348.0, 364.7, 360.7, 351.1, 337.3, 323.9, 310.2, 302.0, 296.6, -5.3 (change noted). - Change in external debt series: 223.9, -52.3, -23.6, -19.8, -100.5, 16.7, -4.0, -9.6, -13.8, -13.5, -13.6, -8.2, -5.4. - Identified external debt-creating flows (sum) and components (current account deficit excluding interest payments, deficit in goods and services, net non-debt creating capital inflows, automatic debt dynamics) are presented with exact values (e.g., current account deficit excluding interest payments: 2.5, 1.4, -5.8, -3.4, -7.8, -8.2, -8.8, -9.7, -10.2, -10.4, -10.1, -10.0, -9.6). ### Monetary and financial sector aggregates (Table 6 and related) - Aggregated MFI balance sheet (Billions of Euros, end of period, selected series): - Assets: 118.1 (2008), 139.4 (2009), 135.0 (2010), 131.4 (2011), 128.1 (2012), 90.2 (2013), 89.7 (2014), 88.3 (2015), 87.7 (2016), 88.0 (2017), 88.8 (2018), 89.9 (2019), 91.2 (2020). - Claims on non-residents: 63.4 (2008), 76.9 (2009), 69.3 (2010), 61.3 (2011), 55.9 (2012), 25.4 (2013), 25.2 (2014), 25.1 (2015), 25.4 (2016), 25.9 (2017), 26.6 (2018), 27.4 (2019), 28.0 (2020). - Deposits of non-residents: 51.7 (2008), 66.6 (2009), 60.6 (2010), 56.5 (2011), 51.3 (2012), 24.7 (2013), 22.7 (2014), 22.0 (2015), 22.0 (2016), 22.4 (2017), 22.7 (2018), 23.0 (2019), 23.4 (2020). - Money and credit aggregates: - Private sector credit excluding brass plates: 39.5 (2008), 42.7 (2009), 46.5 (2010), 48.6 (2011), 49.3 (2012), 46.5 (2013), 44.6 (2014), 43.0 (2015), 41.9 (2016), 41.5 (2017), 41.3 (2018), 41.5 (2019), 41.8 (2020) (units correspond to table headings). ### IMF financing schedule and program reviews (Table 8) - Schedule of reviews and purchases (Amount of Purchase, Millions of SDR, Percent of Quota): - Each listed date (May 15, 2013; September 15, 2013; December 15, 2013; March 15, 2014; June 15, 2014; September 15, 2014; December 15, 2014; March 15, 2015; June 15, 2015; September 15, 2015; December 15, 2015; March 15, 2016; June 15, 2016) shows Amount of Purchase 74.254, Percent of Quota 46.93% for each line. - Total: 891.00 (Millions of SDR), 563.21% (Percent of Quota). ### Selected reforms completed (Table 11) - Macrofinancial and fiscal reforms completed (dates and objectives): - Reform of COLA wage indexation mechanism in public sector (December 2012) — limit application to 50 percent of price index thereafter. - Adopted 2013 and medium-term budget with consolidation measures of about 4.5 percent of GDP (December 2012). - Reformed General Social Insurance Scheme and government pension scheme, and freeze public sector pensions (January 2013). - Rolled over and extended maturity of €1 billion domestic debt via voluntary debt exchange and rolled over €1.9 billion Laiki recapitalization bond (June 2013). - Adopted the 2014 budget with consolidation measures of about 2.3 percent of GDP (December 2013). - Adopted law on Fiscal Responsibility and Budget Systems (February 2014). - Independently assessed banking sector capital needs (February 2013). - Adopted a modern bank resolution law (March 2013). - Resolved Laiki bank and disposed of Greek operations (March 2013). - Completed BoC recapitalization and exit from resolution (July 2013). - Recapitalized Hellenic Bank from private sources (October 2013). - Recapitalized and consolidated the coop sector (March 2014). - 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 (September 2013). - Finalized a code of conduct for banks and an arrears management framework (September 2013). - Established legal framework for a credit register (November 2013). - Amended AML legislation and conducted AML-related audits and assessments (December 2012; August–September 2013). ### MEFP commitments and timelines (Tables 12 and 13) - Financial sector policy and restructuring commitments (selected deadlines and rationales): - CBC to set minimum bank capital requirement at 8 percent CET1 under Pillar 1 — End-June 2014. - Authorities to adopt amendments to the resolution law — Mid-July 2014. - Authorities to operationalize the credit register — End-September 2014. - Authorities to adopt legislation for rehabilitation of viable companies and insolvency practitioner licensing — End-December 2014. - Authorities to privatize CyTA and CPA commercial activity by end of program; privatize EAC by Mid-2018. - Authorities to complete debt-to-asset swap to reduce public debt by approximately €1 billion — End-July 2014. - CBC to transfer an additional €0.2 billion to the budget — End of program. - Conditionality for the Fourth Review (Table 13) — status as reported: - CBC in-situ assessment of banks’ loan workout units operational capacity: End-March 2014 — Not met. Requirement achieved in May. - Government approval of final design of reformed social welfare system: End-March 2014 — Not met. Requirement expected mid-June. - Merger of credit cooperative sector into maximum of 18 institutions: End-March 2014 — Met. - Appoint independent firm/institution for legacy Laiki voting rights and manage disposal of Laiki's assets abroad: End-April 2014 — Not met. Expected partially achieved by end-June. - Submission to Parliament of new Cyprus Tax Department enabling law: End-April 2014 — Not met. Requirement achieved on May 8. - Completion of assessment of operational capacity of cooperative credit institutions’ loan workout units: End-May 2014 — Met. - CBC supervisory units to submit first quarterly report on BoC/coops performance against targets: End-May 2014 — Not met (BoC achieved on time; coop sector not achieved). *Italic: Source — IMF staff estimates and program documents as presented in the supplied content.* ### Appendix I. Cyprus: Letter of Intent ### Appendix I. Cyprus: Letter of Intent ### Program status and requests - Progress: Fiscal performance through end-March exceeded expectations; all end-March and continuous performance criteria (PCs) met. - Structural benchmarks (SBs): Two SBs related to consolidation of the coop sector and assessment of its operational capacity met; a third SB achieved partially; two SBs achieved with delay; two additional SBs expected to be completed fully or partially in June. - Financing request: Completion of the fourth review under the EFF arrangement and the fifth purchase under this arrangement in the amount of SDR 74.25 million. - Conditionality requests: - Modification of the end-June 2014 PCs on: (i) the general government primary balance, general government primary expenditure; and the stock of general government debt. - Establishment of new quantitative PCs for end-September 2014. - Establishment of new or modified SBs: - strategy to reform the debt restructuring legal framework (end-July); - quarterly CBC report on coops’ progress with restructuring targets (end-July); - entrusting the management of Laiki’s voting rights in BoC to an independent third party (end-September); - CBC assessment of banks’ and coops’ action plans to address deficiencies in debt management capacity and practices (end-November); - approval of a new debt management strategy (end-October); - adoption of legislation to modernize personal and corporate insolvency procedures and regulate insolvency practitioners (end-December 2014); - assessment of governance issues related to bank preferential lending practices (end January-2015). *We are fully committed to the policies set forth in the attached MEFP and will consult with the Fund on any revisions.* ### A. Recent developments and outlook - Recent contraction: GDP contracted by 5.4 percent in the prior year. - Sectoral drivers: Significant declines in financial and construction sectors; tourism and services helped cushion the adjustment. - Social impact: Unemployment rose to very high levels; disposable incomes fell. - NPLs: Non-performing loans now close to 140 percent of GDP for the core domestic banking sector. - Revised growth projections: - 2014: -4.2 percent (revised from -4.8 percent). - 2015: 0.4 percent. - 2016: 1.6 percent. - Risks: Geopolitical tensions related to the Ukraine conflict; domestic delays in addressing large NPLs. ### B. Financial sector policies Restructuring private sector debt - Priority: Ensuring banks effectively address high NPLs (about half of total loans). - CBC supervisory focus areas: - Assessment of debt restructuring capacity, policies and compliance with the Code of Conduct: - CBC completed in-situ assessment of operational capacity of banks’ and coops’ units (one SB achieved with delay, the other on time). - Identified deficiencies in banks: capacity and training, IT systems, independence of arrears management units, and performance monitoring against quantitative targets. - Verification of banks’ compliance with the code of conduct and assessment of arrears management policies and practices of banks and coops to be finalized by end-July. - Banks and coops required to submit action plans to the CBC: - address operational deficiencies (by end-June); - address shortcomings related to compliance with the code of conduct and arrears management policies and practices (by end-September). - CBC supervisory units to examine implementation and submit main findings and recommendations to the CBC Board by end-November (new SB). - Monitoring progress toward restructuring targets: - BoC submitted first quarterly reports in April; coops submitted in May. - CBC supervisory units assessing quarterly reports; findings on BoC reported to CBC Board; coops’ findings to be reported by end-July (modified SB). - Governance assessment: - Internal audit departments of BoC (including transferred Laiki operations) and of coops to submit by end-September a special examination report on lending and debt restructuring practices concerning loans related to former and/or current managers, directors, members of committees and major shareholders. - CBC to complete assessment of internal auditors’ main findings and take appropriate action, including requiring civil action where applicable, by end-January 2015 (new SB). - Debt restructuring legal framework: - Project group established and stakeholder consultations conducted. - Reform strategy to be approved by the Council of Ministers by end-July (new SB). - Impact assessment of insolvency law options on lenders to be conducted by end-June. - Foreclosure legislation: committed to amend by end-June, with immediate effect for all mortgaged properties except primary residences; provisions for primary residences to enter into effect by end-December in line with adoption of the insolvency law. - New foreclosure legislation to allow sale of loan collateral through private auctions by mortgage creditors without interference from government agencies. - Legislation on household and corporate insolvency and procedures for licensing and regulation of insolvency practitioners to be adopted by end-December (modified SB). Normalizing financial flows - Payment restrictions: Substantially relaxed in line with August 2013 roadmap; domestic transfers fully liberalized; restrictions on term deposits and cash withdrawals abolished. - Capital account: Further relaxations to be considered only after additional program progress. - Liquidity assurances: - CBC stands ready to take measures per Eurosystem procedures and rules. - Government guarantees up to €2.9 billion may be provided, in line with state aid rules, for issuance of bank bonds usable as collateral against liquidity if necessary. Strengthening supervision and regulation - Preparations for the Single Supervisory Mechanism (SSM) and ECB Comprehensive Assessment: - Capital: - CBC to set minimum bank capital requirement at 8 percent CET1 under Pillar I by end-June. - CBC will request significant banks to maintain capital buffers in excess of minimum Pillar I requirements and take prompt action if needed. - Banks instructed to submit by end-June estimates of the potential impact of upcoming NPL and provisioning EU rules on banks’ profitability and coverage ratios. - Bank resolution: - Legacy Laiki remains under resolution and will need to be wound down. - Transfer management of Laiki’s voting rights in BoC to independent reputable firms or international institutions by end-September (modified SB). - Appoint reputable advisory firm to manage disposal of Laiki assets by end-June (existing SB); firm to finalize action plan for disposal by end-July. - Amend resolution law by mid-July to strengthen independence and effectiveness of the Resolution Authority. - Bank internal audit and credit register: - CBC to revise governance directive on interaction between banks’ internal audit units and CBC bank supervisors by end-July. - Operationalize the credit register, develop options for supervisory use, and finalize additional data content by end-September. Strengthening the AML/CFT framework - AML bank supervision: - CBC resumed inspections; one onsite inspection completed. - CBC will inspect three additional banks by end-June, and another seven by end-December. - CBC committed to apply supervisory and enforcement measures for deficiencies and non-compliance. - Registrar of Companies: - Free basic information on all companies registered in Cyprus to be made available by end-June. - Company law amendments to modernize registration and strengthen enforcement powers of Registrar to be completed by end-October. - By end-January 2015, competent authorities to be able to access adequate, accurate and current beneficial ownership information on all types of legal persons registered in Cyprus based on the Registrar’s information. ### C. Fiscal policy - 2014 primary fiscal deficit target: adjusted to 1.6 percent of GDP on a cash basis. - Implies a modest tightening of 0.4 percent of GDP, reflecting upward revision in 2014 growth projection and improved revenue performance. - End-March fiscal targets met with a comfortable margin of 0.6 percent of GDP. - Fiscal forecast remains conservative and accounts for potential contingent liabilities associated with called loan guarantees. - Medium-term fiscal strategy targets: - Reduce primary deficit to 1 percent of GDP in 2015. - Primary surplus of 1.8 percent of GDP in 2016. - Primary surplus of 4 percent of GDP by 2018 to place public debt on a sustained downward path. - Fiscal-strategy statement finalized in May, guiding budget ceilings. ### D. Structural fiscal reforms Guaranteed Minimum Income (GMI) reform - Objective: Strengthen social safety net, cover those in need, reduce poverty, preserve work incentives. - Implementation milestones: - Approved by the Council of Ministers at mid-June (existing end-March SB). - Completion of IT testing phase and adoption of the welfare law by end-June (existing SB). - Budget neutrality approach: - 2014 financing: 2014 budget estimated to fully cover GMI costs in second half of 2014 as public assistance and other benefits are incorporated into the GMI. - Contingency planning: By mid-July, identify: - a list of social benefits outside the GMI for review of beneficiary profiles and eligibility; - other contingency measures to ensure budget neutrality in 2014. - Monitoring: By end-June, establish a monitoring unit to assess GMI outcomes (number of applications and costs, targeting accuracy, coverage, impact on poverty) and to evaluate costing. - 2015 and beyond: By end-September, update GMI costing as part of the 2015 budgetary process and, if needed, rationalize other benefits outside the GMI to ensure consistency with 2015 and medium-term fiscal targets. *Attachment I. Cyprus: Memorandum of Economic and Financial Policies (excerpt) contained in the Letter of Intent dated June 16, 2014.* ### 11. We are also taking steps to strengthen our revenue administration. This is key to ### _cr14180 - 11. We are also taking steps to strengthen our revenue administration. This is key to ### Revenue administration: short-term measures and legal changes - Taxes owed but not paid are high, amounting to an estimated 6 percent of GDP. - Prior action for the review: adoption of new legislative amendments by Parliament and finalization of regulations to: - establish self-assessment; - provide the revenue administration authority to prohibit the alienation of immovable assets, seize movable assets, and garnish bank accounts. - Garnishment powers: - Would not require a court order but could allow a short appeal period to safeguard taxpayer interest. - Such enforcement actions to be taken after other procedures have been exhausted and the tax debt is undisputable. ### Revenue administration reform: consolidation and implementation timetable - Enabling law consolidating two tax authorities into a single Department of Taxation: - Submitted to Parliament on May 8 (existing end-April structural benchmark; slight delay). - Adopted on June 5. - Next steps and deadlines: - Appoint the new management team of the new department by end-July. - Implement a common taxpayer database by end-September. - Complete the single registration process by end-December. - Establish an integrated unit for large taxpayers in the new department by end-December (existing structural benchmark). ### Monitoring, audits, and collection procedures - To mitigate revenue loss risk during integration, monitoring of monthly performance indicators (registration, filing and payment, auditing and debt collection) will be intensified. - Revenue administration reform project team actions: - Prepare by end-June an assessment of performance for the first 5 months of the year with remedial actions as needed. - Field audits: - Two joint pilot field audits for large taxpayers are being conducted and will be completed by end-June. - Planned eight field audits for high-risk taxpayers: four finalized and the remainder to be completed by end-June. - Collection procedures will be initiated following these assessments, as needed. ### Fiscal risks from government guarantees and PDMO actions - Stock of government guarantees: €3 billion (20 percent of GDP); not systematically monitored. - Public Debt Management Office (PDMO) measures: - Increased resources to complete, by mid-July, a comprehensive database of guarantees crosschecked with financial institutions and purged of called guarantees. - Concluded agreement with a foreign bank for restructured payment of one set of called guarantees equal to 1 percent of GDP. - Working to finalize restructuring for payment to a domestic bank of an additional set of called guarantees equal to 0.5 percent of GDP by mid-July. - Will prepare quarterly risk-assessment reports on the stock of guarantees; first report to be finalized by end-September and included in the fiscal risk statement in the 2015 budget. - Institutional arrangements and procedures to manage guarantees, deal with debt restructuring and recovery of costs associated with called guarantees will be put in place by end-September; procedures will be described in a manual and/or guidelines to be prepared by end-January 2015. ### Medium-term debt strategy and market re-access plans - Significant official financing: €10 billion at favorable conditions meets most financing needs during the program period. - Debt maturity concentration: relatively high concentration of debt repayment obligations amounting to €8 billion following the end of the program in May 2016 and until end-2020, of which €2.7 billion is in 2017 alone. - Actions: - Establish an investor relations function within the PDMO by end-July. - PDMO will develop a comprehensive medium-term debt-management strategy aimed at: - smoothing debt redemption profile and reducing refinancing risk; - diversifying across instruments and types of investors; - ensuring smooth functioning of the domestic Treasury bill market; - enhancing monitoring and risk assessment of contingent liabilities from government guarantees. - Council of Ministers to adopt the updated strategy by end-October (new structural benchmark). ### Privatization program and timelines - Objectives: improve economic efficiency, reduce public debt, and encourage foreign direct investment. - Privatization unit: - Head appointed; additional staff hiring underway to have a fully operational unit by end-June. - By end-September: - Complete selection process for strategic and financial advisors for the commercial activities of the ports administration (CPA), the telecommunications company (CyTA), and the electricity company (EAC). - Commitments and deadlines: - Privatize CyTA and the commercial activities of CPA before the end of the program. - Update regulatory framework for CPA by end-December via parliamentary approval of respective legislation. - Legislation to convert CyTA into a limited liability company to be adopted by end-December. - Complete privatization process for EAC by mid-2018, after unbundling activities and preparatory steps. ### Program financing measures and asset transfers - Central Bank of Cyprus (CBC) profit transfers: - CBC transferred €180 million of central bank profits to the government in April. - An additional €200 million is expected to be transferred during 2015-16, in line with CBC duties under the Treaties and the Statute. - Coin issuance rights transfer: - Plan to transfer rights and liabilities associated with issuing coins from the CBC to the Treasury, expected to contribute €100 million in additional financing. - Amend the Central Bank Bill, expected to be approved by Parliament by end-June; a MoU between the CBC and Ministry of Finance will also be signed then. - Debt-to-asset swap: - Commitment to finalize a debt-to-asset swap that will reduce public debt by €1 billion (about 6 percent of GDP), to be conducted in accordance with CBC rules and the Treaties by end-July. - Government has completed a valuation of the assets; a second valuation on behalf of the CBC will be completed before end-July. ### Program monitoring and conditionality - Implementation monitored through quarterly program checkpoints (PCs) and reviews. - Program includes continuous performance criteria, indicative targets, and structural benchmarks, as defined in the Technical Memorandum of Understanding (TMU). - Continuous performance criteria highlighted: - Non-accumulation of external payment arrears. - Non-intensification of restrictions of payments and transfers for current international transactions or introduction of multiple currency practices. - Authorization for publication: - The IMF is authorized to publish the Letter of Intent and its attachments, and the related staff report. *Source: _cr14180 - 11. We are also taking steps to strengthen our revenue administration. This is key to* ### 9. The ceiling on new general government sector guarantees shall include domestic and ### _cr14180 - 9. The ceiling on new general government sector guarantees shall include domestic and ### Guarantees ceiling and adjustments - The ceiling on new general government sector guarantees shall include domestic and external guarantees granted during the test period, as well as guarantees for which the maturity is being extended beyond the initial contractual provisions. - The ceiling shall exclude guarantees granted under a risk sharing instrument of the EU structural funds (see COM (2011) 655 final) that do not create contingent liabilities for the Cypriot State. - Government entities outside of the general government but within the non financial public sector are not permitted to grant guarantees. - Stock of guarantees at end March 2013: €3.1 billion. - For reporting purposes, the stock of guarantees within the year will be derived on the basis of material fluctuations. - Adjustments to the ceiling on the accumulation of new general government guarantees: - Upwards for the issuance of government guaranteed bonds to be used in monetary policy operations to boost BoC’s liquidity up to €2.9 billion. - Upwards (downwards) by the amount of any increase (decrease) of the disbursement of EIB and/or Council of Europe Development Fund loans to be guaranteed by the government in 2014 relative to the amounts presented in Table 1 of the MEFP. The annual provision of guarantees cannot exceed €312 million. ### Arrears ceilings (performance criteria) - Ceiling on the Accumulation of External Arrears (continuous performance criterion): - External payment arrears are defined as payments on debt to non-residents contracted or guaranteed by the general government, which have not been made within seven days after falling due. - Stock of external payment arrears as of end-March 2013: €0. - Ceiling on the Accumulation of Domestic Arrears (performance criterion): - Domestic expenditure arrears are defined as unpaid invoices that have past the due date by 90 days. If no due date is specified, an unpaid commitment is considered to be in arrears 90 days after the initiation of the invoice. - Stock of domestic expenditure arrears as of end March 2013: €0 million. - Ceiling on the Accumulation of VAT Refund Arrears by the General Government (performance criterion): - VAT refund arrears consist of unpaid VAT refunds that have past the due date for payment established in the tax legislation and/or the corresponding regulations. - Stock of VAT refund arrears as of end March 2013: €140 million. ### Monitoring of prior actions, structural benchmarks and MEFP commitments - Prior action: Adoption of measures to fight tax evasion. Specifications include: - Amendments of relevant legislation to establish self-assessment for all income taxpayers. - Legislation and regulations to harmonize and increase collection enforcement powers of the revenue administration, including authority to prohibit the alienation of immovable, seize movable assets and garnish bank accounts. Powers related to garnishing bank accounts would not require a court order but could allow a short appeal period. - AML supervision’s implementation: - On a quarterly basis, in the context of the program review starting in the fourth quarter of 2013, the supervisory competent authorities will, on a confidential and anonymized basis grant Fund staff access to supervisory assessments and information about enforcement actions applied for non-compliance and/or violations of laws and regulations. - With regard to the CBC, in line with the 2014 annual inspection program, onsite supervision missions will start in the first quarter and step-up during the year, as capacity builds and resources are expanded. The total number and quarterly profile of these inspections, as well as staffing objectives and levels will be subject to periodic review by the CBC and the Fund in light of experience. - Exchange of financial intelligence: - The Financial Intelligence Unit (FIU) will 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. ### Reporting requirements (summary of key items and timing) - 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. - Selected reporting items, frequency, responsible institution, and maximum time lags: - Detailed execution of revenues, expenditure and financing provided in EDP reporting format — Monthly — MOF. Budget Department/Cystat. Maximum time lag: 27 days after the end of the month, except end-December data which will be provided 30 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 — Monthly — 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 — Monthly — 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 — Monthly — 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 — Monthly — 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 — Quarterly — MOF. Treasury Department. Maximum time lag: 27 days after the end of the month. - Stock of external arrears — Monthly — MOF. Treasury Department. Maximum time lag: 15 days after the end of the month. - Assets and liabilities of the central bank — Monthly — 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 — Monthly — 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 — Quarterly — 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 — Monthly — 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 — Daily — Central Bank of Cyprus. Maximum time lag: Next working day. - Deposits by institution, currency, and residency and end-of-day liquidity buffers — Daily — Central Bank of Cyprus. Maximum time lag: Next working day. - Financial soundness indicators—core set, deposits, NPLs, capital adequacy ratios — Quarterly — Central Bank of Cyprus. Maximum time lag: 60 days after the end of the month. - Note: Reporting requirements for cooperative banks will be revisited after the CBC becomes their supervisor. ### Financial sector reform — objectives, progress, and key commitments - Key programme objectives (financial sector and broader): - 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 fiscal consolidation to correct the excessive general government deficit by 2016, reduce current primary expenditure, increase efficiency of public spending within a medium-term budgetary framework, enhance revenue collection and improve public sector functioning. - Implement structural reforms to support competitiveness and sustainable and balanced growth, including reforming the wage indexation system and removing obstacles in services markets. - Progress since February (selected items and dates): - Operational integration for the supervision of cooperative credit institutions by the Central Bank of Cyprus was completed. - Directives on loan origination and on provisioning were implemented; banks submitted action plans for complying with the provisioning and disclosures directive. - Assessment of operational capacity of financial institutions to work-out non-performing loans was carried out. - Publication of the first Financial Stability Report was rescheduled for end-December 2014 due to internal resource constraints. - Restructuring progress: - The Cooperative Central Bank was effectively recapitalised by the State with the ESM notes on 10 March 2014. - Merger of the individual coops into 18 institutions was completed by end-March and capital injections in the individual institutions were completed in April. - Bank of Cyprus is implementing its restructuring plan and agreed key performance indicators; Hellenic Bank submitted its business plan in March. - Significant banks are participating in the on-going Comprehensive Assessment of the ECB, due to be completed by the end of October 2014. - Liberalisation of restrictive measures progressed. - Maintaining liquidity in the banking sector: - Authorities commit to continue implementing the roadmap for the gradual relaxation of restrictive measures published on 8 August 2013, with milestones taking into account investor confidence and financial stability indicators, including liquidity. - CBC, in consultation with the ECB, will monitor liquidity closely and stand ready to take appropriate measures in line with Eurosystem rules. - Additional government guarantees for issuance of bank bonds of up to EUR 2.9 billion in nominal value could be used as collateral against liquidity, if necessary, in line with State aid rules. - Bank of Cyprus and the Cooperative Central Bank submitted capital and funding plans in April 2014. CBC will receive updated plans quarterly and transmit them to the ECB, the EC, the ESM and the IMF. - Regulation and supervision commitments and timelines: - Central credit register to be operational by end-September for credit assessment purposes; CBC to develop supervisory-use options by end-September. Harmonisation at euro area level due to be completed in 2016. - New loan origination directive adopted in October 2013; full implementation of the new provisioning and disclosure directive by the time of publication of the 2014 annual accounts. For co-operative credit institutions, requirements will be fully applied in their 2013 annual accounts. - Banks to report on potential impact of newly introduced and upcoming EU rules on profitability and coverage ratios by end-June. - Authorities to present an action plan to improve enforcement of corporate financial statements preparation by end-September, with legal amendments by end-November. - BoC and the coops submitted quarterly restructuring implementation reports in April and May 2014; CBC supervisory units will assess these and submit conclusions and proposed actions to the CBC Board within four weeks of receipt. - Governance directive to be revised by end-July, specifying interaction between banks’ internal audit units and bank supervisors. - CBC to request by end-May the internal audit department of BoC (including transferred Laiki operations) and of coops to submit by end-September a special examination report on lending and debt restructuring practices related to former and current managers, directors, members of Committee and major shareholders, aiming to identify decisions that led to disproportionate losses in net present value terms. CBC to complete assessment and take appropriate action, including requiring civil action where applicable, by end-January 2015. - Independently audited consolidated accounts of the cooperative credit institutions for the year 2013 will be published by end-June. - CBC staffing and governance: - The CBC will have sufficient staff to carry out its functions in full independence as stipulated by the Treaties. Current recruitment of experienced staff should be finalised by end-June. - CBC will assess need to increase staff by end-October taking into account new tasks and the Single Supervisory Mechanism, and address identified needs by end-December. - Review of CBC governance by end-June and adoption of necessary legislative amendments by end-September. - Authorities, in consultation with EC, ECB and IMF and informing the ESM, reviewed the effectiveness of the Resolution Authority, including its composition and governance, in March. *Document: _cr14180 - 9. The ceiling on new general government sector guarantees shall include domestic and* ### 2014. The amendments to the Resolution Law are to be adopted by mid-July. ### _cr14180 - 2014. The amendments to the Resolution Law are to be adopted by mid-July. ### Monitoring of corporate and household indebtedness - The Cypriot authorities will step up monitoring of corporate and household indebtedness and prepare quarterly reports, including information on the 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 becomes fully operational. - The annual Financial Stability Report, to be published at year-end, will include an extended analysis on corporate and household indebtedness. - Quarterly monitoring reports will continue to be submitted and their scope and content will be further enhanced. - Measures will be taken to strengthen management of non-performing loans (NPLs) and to deal with troubled borrowers. A framework for targeted private-sector debt restructuring is being established. Key operational actions and deadlines: - Following completion of the merger process for the cooperative credit institutions, an assessment of the operational capacity of the CCB's loan workout unit will be completed by end-May. - Banks will be required to report quarterly on restructuring progress and management of NPLs. The first report, with reference date end-March, will be submitted by end-June, using specific performance indicators and targets (e.g. number of loans restructured, cash collections, etc.), which were approved by the CBC in consultation with EC, ECB and IMF and informing ESM. - Banks will report monthly on early arrears (e.g. number and amount of past due loans within 1-90 days, type of actions taken, and number and amount of cured or uncured loans). - The CBC will, with assistance of an external expert, review banks’ arrears management policies and practices, taking into account international best practices. The preliminary findings of this review will be presented to the EC, ECB and IMF, and informing the ESM, by mid-July. The review will be completed by end-July and serve as a basis for further policy recommendations on arrears management processes in credit institutions. - Following the review, revisions of the Arrears Management Directive and of the Code of Conduct will be introduced as needed, taking into account developments and timelines in the Single Supervisory Mechanism, by end-September. - The responsible CBC supervisory units will examine implementation of banks' action plans to correct deficiencies identified by the external expert and submit main findings and recommendations to the CBC Board by end-November. - By end-June, the CBC will introduce requirements for banks and coops to submit agreed-upon procedure reports prepared by their external auditors on banks’ effectiveness of debt restructuring arrangements and strategies for the periods ending in December 2014, June 2015, December 2015, and June 2016. - The role of the Financial Ombudsman with regard to handling complaints on compliance with the arrears management process was clarified by end-March. The necessary legal amendments to the Law on the Financial Ombudsman are to be adopted, in consultation with the EC, ECB and IMF and informing the ESM, by end-June. - The Cypriot 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 would be introduced. - The Cypriot authorities will prepare, by mid-July, an action plan for removing impediments for lenders to obtain adequate updated information on the financial situation of delinquent borrowers, under sufficient safeguards. These impediments will be fully removed by end-December. - To encourage a market for distressed assets, the Cypriot authorities will prepare, by end-June, a report identifying impediments to transfer individual loans to third parties. ### Increasing financial transparency - Actions follow findings of the April 2013 MONEYVAL audit and an independent auditor; authorities have progressed in enhancing the anti-money laundering (AML) framework in line with best practices and commit to implementation under the timetable set out in the agreed AML Action Plan. Key AML measures: - Strengthen preventive measures of obliged entities with regard to 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). The programme partners take note of the establishment by the Cypriot authorities of trust registers with the supervisory authorities (Action Plan – section 4.3.1). - Supervisory competent authorities are reviewing 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). In carrying out its onsite supervisory program, the CBC will build on its follow-up work on the April 2013 audit regarding individual financial institutions. - On a quarterly basis, in the context of the programme review starting Q4-2013, the supervisory competent authorities 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. - 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. - Authorities committed to reform the Department of Registrar of Companies as foreseen in section 3.10 to ensure adequate, accurate and current basic information on all types of legal persons registered in Cyprus can be obtained and be accessible to the public in a timely manner. - Cypriot authorities commit to maintain efforts for the widest possible exchange of information with other FIUs, either spontaneously or in response to requests. The 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 the end of the quarter), starting with Q4 2013, and publish this information on the FIU website on an annual basis. ### B. Recapitalisation and restructuring of financial institutions Restoring adequate capital buffers: - Authorities will finalise transposition of CRD IV and national discretions under the CRR by end-June. - As part of this process, authorities will fix the Common Equity Tier 1 ratio at 8% under Pillar 1 in line with the harmonised benchmark applied under the baseline scenario of the ECB Comprehensive Assessment. - Implementation of CRD IV and CRR will not lead to any distribution of capital by banks found in the PIMCO exercise to face a capital shortfall. - In line with CRD IV, the CBC will request significant banks to maintain capital buffers in excess of the minimum Pillar 1 requirement based on conservative assumptions and to take prompt action if needed. Management of legacy Laiki: - The Resolution Authority instructed the Special Administrator to appoint a well-recognised and independent consulting or auditing firm(s) or international institution(s) to be entrusted with the voting rights associated with Laiki’s shares participation in BoC. This appointment will be completed by end-September. - Finalisation of appointment of an advisor to provide services associated with management of the disposal process shall be completed by end-June. - As part of the terms of reference for the appointment of the advisor agreed in consultation with the EC, ECB and IMF and informing the ESM, an action plan for the full disposal of the assets will be developed by end-July, with a view to maximize value for creditors. Restructuring of Bank of Cyprus (BoC): - BoC has progressed with implementing the restructuring plan and has divested operations and stakes abroad ahead of schedule. - CBC agreed with BoC on operational and financial indicators on progress with implementing the restructuring plan that will be communicated quarterly to the public, together with the financial accounts. - CBC will complete by end-February 2015 a comprehensive technical assessment of BoC’s restructuring plan to identify areas requiring further strengthening and review, with due consideration to establishment of the Single Supervisory Mechanism. Restructuring and recapitalisation of cooperative credit institutions: - Final restructuring plan for the cooperative sector was submitted to the EC in January 2014. - Based on that plan and commitments by Cypriot authorities, the Commission approved restructuring aid for the cooperative credit institutions as compatible with the internal market on 24 February 2014. - Cooperative credit institutions that benefited from public capital injections are subject to specific management rules, restrictions and a restructuring process scrutinised by an external monitoring trustee. - The monitoring trustee will submit quarterly reports on governance and operations, as well as ad-hoc reports as needed, and will verify proper governance and use of commercial-basis criteria in key policy decisions and assess soundness of strategies to deal with loan arrears. - The monitoring trustee shall have access to Board meeting minutes, and be observer at the executive committees and other critical committees, including risk management and internal audit functions. - The merger of individual cooperative credit institutions into 18 entities was completed in March. - Cooperative credit institutions that subsequently become unviable will be required to merge with viable ones. - Following completion of the merger process and establishment of the final governance structure of the sector, the CBC will review its affiliation directive by end-July. - A relationship framework between the State and the Cooperative Central Bank (CCB) was established based on the new legal framework for management of the State stake in the cooperative sector; compliance will be reviewed on a quarterly basis by the monitoring trustee, who will report any breaches to the EC. Authorities will inform the ECB, the ESM, and the IMF of conclusions of that report. - CCB has utilised external expertise to develop and implement policies and practices in arrears management and corporate restructuring; recommendations deemed necessary by the authorities will be implemented. - Recruitment of executive and senior management of the CCB and CCIs will take place in line with international best practices and established selection criteria, and will be completed by end-May. - CBC agreed with the CCB and the Ministry of Finance Management unit on operational and financial indicators on progress with implementing the restructuring plan that will be communicated quarterly to the public. - By end-January 2015, the CBC will complete an assessment of the CCB’s implementation of effective local and risk management programs for the CCIs on the basis of common policies and tools as well as a consolidated management program at the CCB level in line with the restructuring plan, taking into account the competences of the Single Supervisory Mechanism. ### C. Legal framework for private debt restructuring - All legal, administrative or other hurdles currently constraining seizure and sale of loan collateral shall be removed so assets pledged as collateral can be recovered within a reasonable period deemed to be a maximum time-span of 1.5 years from initiation of relevant proceedings. - In the case of primary residences, this time-span could be extended to 2.5 years. - Authorities commit not to introduce any further impediments to the seizure of assets pledged as collateral. - A Task Force was established to prepare a study assessing the magnitude of registered, but untitled, land sales contracts and underlying mortgages and to develop recommendations by end-June. - Authorities will, in consultation with EC and IMF and informing the ECB and ESM, prepare a comprehensive reform framework to be endorsed by the Council of Ministers by end-July, establishing appropriate corporate and personal insolvency procedures. - A draft of the reform framework as well as an impact assessment of various options on lenders will be completed by end-June and shared with the EC, ECB, IMF and the ESM. - On the basis of that framework, corporate and personal insolvency legislation will be adopted, which will include licensing and regulation of insolvency practitioners by end-December. - Legal framework in relation to foreclosures and forced sales of mortgaged property will be amended in consultation with the EC and the IMF and informing the ECB and the ESM, and adopted by end-June, with immediate effect for all mortgaged properties except primary residences (for which provisions will enter into effect by end-December, in line with adoption of the insolvency legislation), to allow private auctions to be conducted by mortgage creditors, without interference from government agencies. - Authorities will initiate a review by end-June and, by end-December, will formulate recommendations on the Civil Procedure Code and Court Rules to ensure smooth and effective functioning of revised foreclosure and insolvency frameworks. - Authorities will review the private sector debt restructuring legal framework in the second half of 2015 to assess results and define additional measures as needed. ### II. FISCAL POLICY Key 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 set out in this Memorandum of Understanding (MoU) through high-quality permanent measures, and additional measures in the outer years, particularly to reduce growth in expenditure on the public sector wage bill, social benefits and discretionary spending, while minimising impact on vulnerable groups. - Fully implement fiscal consolidation measures for 2014, listed in Annex 1. - Correct the excessive general government deficit by 2016. - Maintain fiscal consolidation over the medium term, converging towards Cyprus' medium-term budgetary objective of a balanced budget in structural terms, by containing expenditure growth, improving the structure of taxation and undertaking fiscal-structural measures, including implementation of a Medium-Term Budgetary Framework designed in accordance with EU specifications. Implementation and monitoring: - Authorities adopted a number of fiscal measures for 2012-2014 and progressed on fiscal-structural reforms; they commit to full implementation of these measures and to regularly monitor the budgetary effect. - Any deviation from projected budgetary effect will be evaluated and addressed in quarterly programme reviews, taking into account macroeconomic developments. - In event of underperformance of revenues or higher social spending needs, the government should be ready to take additional measures to preserve programme objectives, including by reducing discretionary spending, taking into account adverse macroeconomic effects. - Over the programme period, cash revenues above programme projections, including any windfall gains, will be saved or used to reduce debt. To the extent over-performance is deemed permanent, this can reduce need for additional measures in outer years. - Measures, such as tax amnesties, that could have an adverse impact on tax compliance and foster tax fraud and evasion, thereby counteracting efforts, are cautioned against. *Source: _cr14180 - 2014. The amendments to the Resolution Law are to be adopted by mid-July.* ### 3.5 of this Memorandum, will not be undertaken over the course of the programme period. The ### 3.5 of this Memorandum, will not be undertaken over the course of the programme period. The ### EU funds and implementation capacity - The government will modify by mid-June 2014 the bill amending the road vehicles and traffic law so that it will not include the provision for a tax amnesty for the payment of annual road tax. - Sound fiscal policy and expenditure prioritisation should contribute to preserving the good implementation of Structural and other EU funds, in respect with the programme's budgetary targets. - EU funds will be targeted to those areas that deliver the most important economic and social impact, in accordance with the priorities to be set in the relevant EU regulatory framework. - The Government will ensure that the necessary national funds remain available to cover national contributions, including non-eligible expenditure, under the European Structural and Investment Funds (ERDF, ESF, Cohesion Fund, EAFRD and EFF/EMFF) in the framework of the 2007-2013 and 2014-2020 programming periods, while taking into account available EIB funding. - The authorities will ensure that the institutional capacity to implement current and future programmes is improved and the appropriate human resources of Managing Authorities and implementing bodies are available. - In accordance with Regulation 472/2013, Cyprus shall provide all the information that the programme partners consider to be necessary for the monitoring of the implementation of the economic adjustment programme. - The Cypriot authorities will consult ex-ante with the European Commission, the ECB and the IMF on the adoption of policies that are not included in this Memorandum but that could have a material impact on the achievement of programme objectives. - In line with State aid rules, the Government shall not implement any measures involving State aid towards Cyprus Airways until the approval of a restructuring plan by the European Commission. ### Fiscal policy in 2014 - Based on the programme's current macroeconomic and fiscal projection and reflecting the 2014 Budget, the Cypriot authorities will achieve a deficit of the general government primary balance of EUR 275 million (1.7% of GDP) in 2014 corresponding to a headline deficit of 5.3% of GDP (respecting the 16 May 2013 Council Recommendation with a view to bringing an end to the situation of an excessive government deficit in Cyprus). - Cyprus will fully implement the permanent measures included in the 2014 Budget, amounting to at least EUR 270 million in 2014 (Annex 1). ### Fiscal policy in 2015-16 - Based on the programme's updated budgetary projection, the Cypriot authorities will achieve a deficit of the general government primary balance of no more than EUR 258 million (1.6% of GDP) in 2015, corresponding to a headline deficit of 5.1% of GDP (respecting the 16 May 2013 Council Recommendation on correction of the excessive deficit in Cyprus). - In 2016 the Cypriot authorities will achieve a general government primary balance surplus of at least EUR 201 million (1.2% of GDP), corresponding to a headline deficit of 2.4% of GDP (respecting the 16 May 2013 Council Recommendation on correction of the excessive deficit in Cyprus). - These targets and the underlying updated budgetary projection will be embedded in the 2015-2017 Fiscal Strategy Statement, which will be adopted by the Council of Ministers by Q2-2014. - After review by and consultation with the programme partners the 2015 and 2016 Budget Laws will be adopted, respectively, by December 2014 and December 2015. - The 2014-2016 expenditure ceilings will be updated for the period 2015-2017 and will accompany the 2015 Budget Law document. - Any deviation from the budgetary objectives contained in the 2014-2016 framework will be properly documented and reasons for such deviations will be provided to the programme partners. - In Q2-2016, the Cypriot authorities will present the programme partners with a provisional list of measures to attain a primary surplus of 3% of GDP in 2017 and 4% of GDP in 2018. The measures required will be included in the draft 2017 Budget Law. ### Fiscal-structural measures — key objectives - Objectives: - (1) to improve the efficiency of public spending and the budgetary process by means of an effective Medium-Term Budgetary Framework (MTBF) that is fully compliant with the Directive on requirements for budgetary frameworks and the Treaty on Stability, Coordination and Governance (TSCG); - (2) take further steps to control the growth of health expenditure; - (3) enhance tax revenues by improving tax compliance and collection; - (4) undertake reforms of the public administration to improve its functioning and cost-effectiveness, notably by reviewing the size, employment conditions and functional organisation of public services; - (5) undertake reforms of the overall benefit structure with the aim of producing an efficient use of resources and ensuring an appropriate balance between welfare assistance and incentives to take up work; and - (6) elaborate a programme for improving the efficiency of state-owned and semi-public enterprises and initiate a privatisation programme. ### Pension reform - While acknowledging that the Cypriot authorities have recently introduced substantial reforms (as noted in Annex 1), which, according to the results of the actuarial study which were peer reviewed in the Ageing Working Group of the Economic Policy Committee in September 2013, have adequately addressed the issue of the high projected increase in pension spending and secured the long-term financial viability of the pension system through 2060, it remains important to monitor the long term financial sustainability of the system and consider further reform steps, if needed. ### Health care reform — measures and timetable - To strengthen the sustainability of the funding structure and the efficiency of public healthcare provision, the following measures will be adopted: 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 the programme partners and all co-payments for using public health care services; b) taking into account the findings of the functional review of the Ministry of Health, carry out health sector reforms, including restructuring all public hospitals/public health facilities, the Ministry of Health, the HIO, and other associated facilities/organisations based on a Reform Plan to be approved by the Council of Ministers by Q2-2014. The reform plan will provide for the autonomization of all public hospitals/public health facilities. All necessary legislative changes to be approved by the House of Representatives by end-November 2014 aiming at full implementation by Q2-2015; - Public hospitals complete the shadow-budgeting for all inpatient cases on diagnoses-related groups by Q3-2014 and for all in- and outpatient activities by Q4-2014; c) taking into account the economic conditions, the implementation of the necessary complementary reforms, the results of the updated actuarial study, and after consultation with the programme partners, implement a National Health System (NHS), to be fully in place by mid-2016. - NHS design and implementation details: 1. The NHS will be developed and implemented based on the fundamental principles of free choice of provider, social equality and solidarity, financial sustainability and universal coverage of a minimum benefit basket. 2. Implementation will be carried out in three stages. By mid-2015, in the first stage of NHS, primary care consultation services will be covered. By 1 January 2016, outpatient specialist care and outpatient pharmaceuticals will be added to the benefits covered. Full implementation of NHS will be achieved by mid-2016. 3. NHS will be initially based on a single payer agency. The system may evolve into a multiple insurance system provided that the necessary preconditions for achieving efficiency and affordability gains (i.e. consumer information and transparency, contestable markets, freedom to contract, fiscal viability of insurance agencies, competition regulation and risk-adjustment) can be ensured. 4. The detailed road map for the implementation of the NHS will be agreed with programme partners by Q2-2014. The amended bill of NHS will also determine and clarify the respective role, governance and responsibilities (notably concerning the strategic policy, budget control, monitoring, audit and regulation) of the Ministry of Health and the HIO and will be approved by the House of Representatives by Q4 2014. 5. The policies of the Ministry of Health on pricing and reimbursement of medical goods and services, including those related to pharmaceutical expenditure, will be revised in agreement with programme partners to contain projected spending levels under NHS. *IMF — Cyprus memorandum excerpt* ### 6. An Implementation Advisory Team will be established by end-June 2014, ### _cr14180 - 6. An Implementation Advisory Team will be established by end-June 2014, ### Health sector reform and NHS implementation - Establish an Implementation Advisory Team by end-June 2014, drawing on national and international expertise, to assist the Ministry of Health with implementation of NHS and health sector reforms. - Commission an independent consultant (chosen in consultation with programme partners) to undertake a study to: - evaluate the functional and financial sustainability of the NHS operated by single or multi payer agencies; - assess how and when the precondition mentioned in paragraph c)3 (consumer information and transparency, contestable markets, freedom to contract, fiscal viability of insurance agencies, competition regulation and risk-adjustment) can be achieved. - Adopt by Q4-2014 a binding set of contingency measures (Council of Ministers) to ensure agreed budget limits of public health expenditure are not exceeded. 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; - capacity planning. - Initiate tendering of the IT-infrastructure necessary for implementing the NHS by Q2-2014. - Review income thresholds for free public health care in comparison to eligibility criteria for social assistance, ensuring co-payments protect from catastrophic health expenditures, by Q2-2014. - Continue to publish clinical and prescription guidelines and to audit their implementation; continue to establish the system for health-technology assessment. - Conduct periodic reviews of the basket of publicly-reimbursable medical services 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. - Consider establishing a system of family doctors acting as gate-keepers for access to further levels of care. ### Public financial management - Provide for establishment of a Fiscal Council with a statutory regime, functions, nomination procedures for its governing body and funding arrangements grounded in the Fiscal Responsibility and Budget System Law (FRBSL), including: - an implementing text pertaining to Fiscal Council staff; - a draft MoU on exchange of information between the Fiscal Council and the Ministry of Finance prior to the granting of the fifth disbursement of financial assistance. - Improve risk-assessment analysis associated with government guarantees: - Submit for consultation with programme partners by mid-July 2014 an advanced draft of the risk assessment report prepared by the Public Debt Management Office, with a view to a final version by Q3-2014. - The report shall identify guarantees expected to result in calls in the current and following year. - Adopt a comprehensive medium-term debt-management strategy by end-October 2014 aimed at: - smoothing the debt redemption profile and reducing refinancing risk; - diversifying across instruments and types of investors; - ensuring a smooth functioning of the domestic Treasury bill market; - enhancing risk-assessment of contingent liabilities from government guarantees. - Implement guidelines for public investment management, including project appraisals in line with FRBSL provisions by Q2-2014. - Authorities commit not to enter into any new tendering process and not to sign any public private partnership (PPP) contract before implementation of the guidelines for public investment management. - Regularly update the PPPs inventory, including contingent liabilities, and include it both in the annual budget law and in the annual financial report. ### State-owned enterprises and privatisation - Adopt the law regulating creation and functioning of SOEs at central and local levels by the HoR by mid-June 2014; the law will enhance monitoring powers and include reporting on SOEs in the annual budgetary procedure. No additional SOEs will be created until the law is adopted. - Submit for consultation with programme partners a plan with detailed timelines for review of SOEs under internal review by Q2-2014. - Each SOE to submit a strategic plan to the competent minister for approval, in consultation with programme partners, and in line with FRBSL and SOEs Law provisions by Q4-2014. - Implement the privatisation plan submitted to programme partners to improve economic efficiency and restore debt sustainability; the plan includes privatisation of, inter alia, CyTA (telecoms), EAC (electricity), CPA (commercial activities of ports), and real estate and land assets. - CyTA and CPA will be privatised within the programme period and EAC by mid-2018. - Establish regulatory framework to safeguard provision of basic public goods and services in line with national policy goals and EU Treaty/secondary legislation. - Actions to pursue privatisation: - Establish the Privatisation Unit through appointment of its Head and experts; the Unit will be fully operational by June 2014. - Appoint independent advisors for CPA privatisation by Q2-2014. - Appoint independent advisors for privatisation of CyTA and EAC by Q3-2014. - Approve, through the Council of Ministers and based on advisors' recommendations, a detailed plan for privatisation of CyTA (including main characteristics of the transaction) by Q4-2014. - Convert CyTA into a Limited Liability company by December 2014. - Appoint independent advisors and develop a plan with detailed intermediate steps and timings for disposing identified real estate assets by Q3-2014. - The privatisation plan identified after consultation with 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, to be used for public debt reduction. ### Revenue administration, tax compliance, and international tax cooperation - Continue reforming revenue administration to reinforce efficiency and effectiveness of revenue collection and fight against tax fraud and evasion. - Short-term measures to be completed without delay and in no case later than by Q2-2014: - Attribute personal responsibility for payment of company taxes to those who (in case of non-listed companies) truly and effectively control a company and to the responsible manager for fraudulent filing of company taxes. - Harmonise legislation among tax types so that not paying withholding taxes is a criminal offence. - Strengthen tax authorities' powers to ensure payment of outstanding tax obligations, including authority to garnish assets or prohibit alienation/use of assets (including property and bank accounts). Garnishing of bank accounts will not require prior court approval but may allow a short appeal period during which the relevant amount remains frozen. - Enact legislation to establish self-assessment for all income taxpayers by changing from pre-assessment verification to post assessment audits selected on the basis of risk. - Long-term reform measures: - Put in place a comprehensive compliance strategy by Q2-2015, based on analytical work on risk identification and analysis and evaluation of risk treatment strategies. - Make IRD data available to selected tax administration staff via one platform for integral risk identification and analysis by Q2-2014. - Cleanse income tax registers by Q2-2014 and VAT registers by Q4-2014 by removing inactive cases and establish process to maintain registers up-to-date. - Improve joint work programme for large and high risk taxpayers; provide a progress report by Q2-2014 and finalise compliance risk management module for large taxpayers by Q3-2014, with a view to setting up the integrated large taxpayer unit of the new tax department by Q4-2014. - By Q3-2014, elaborate an integral strategy for prosecution of tax fraud as a criminal offence, including evaluation of required investigative and legal resources for the new tax department. - Establish a new integrated function-based tax administration integrating Inland Revenue Department and VAT Service; prior to the fifth disbursement enact enabling legislation for establishment of the new tax agency by 1 July 2014, including provisions for a fixed term of office for the new Commissioner of Taxation and sound principles for rotation. - Reinforce the tax unit in the Ministry of Finance responsible for tax policy formulation and monitoring revenue performance (including measuring the VAT gap) by Q2-2014. ### International tax cooperation and exchange of information - Safeguard timely and effective exchange of information on tax matters; fully ensure applicability of laws and standards governing international exchange of tax information. - Actions: - Fully transpose and implement Council Directive 2011/16/EU on administrative cooperation in 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 VAT, which prescribe specific timeframes for Member States to 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 by entities and legal arrangements (e.g. trusts) under Cyprus law, notably entities and legal arrangements whose beneficial owners are resident in other EU Member States. - Improve Inland Revenue Department capacity to follow-up on tax information received from other countries, e.g. by permitting department access to databases of other public entities to facilitate taxpayer identification. - Prior to the fifth disbursement of financial assistance, submit to the OECD Global Forum the follow-up report detailing actions to address shortcomings identified, with a view to achieve full compliance. - Continue swift implementation of commitments to reverse the negative opinion by the OECD Global Forum and provide a progress report to programme partners by Q2-2014. - Monitor progress in responding timely to tax information requests by EU and third countries; submit quarterly performance updates to programme partners (within 14 days of the end of the quarter). - In context of Council Directive 2003/48/EC (EUSD) on taxation of savings income: - Continue to provide to the EC necessary and available information/statistics extracted from data exchanged under the FISC153. - On an annual basis starting from tax year ending on 31 December 2013, provide to the EC a breakdown of information under the EUSD by sector of activity of paying agents, including possible sanctions actually claimed of paying agents for application of the EUSD. - In 2015, provide to the European Commission a report on 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. ### Immovable property tax reform - Reform immovable property tax to improve fairness and increase tax administration efficiency: - Implement a General Valuation (GV) for all immovable properties; new values determined on basis of tangible building- and plot-related characteristics by Q2-2014. - Implement the recurrent immovable property tax based on updated valuations for tax year 2015, at the latest. Design shall ensure progressivity and proceeds consistent with measure I.27 of Annex 1. - Legislative timeline: - Necessary legislative changes should be adopted by the House of Representatives by early July 2014, following consultation with programme partners. - Legislation specifying frequency of mandatory update of values should be enacted by Q1-2015, following consultation with programme partners. - To ensure smooth implementation, present to programme partners by end-June 2014: - a communication strategy informing of goals, implications for citizens and procedures of the property tax reform; - a comprehensive objections' management strategy to effectively and timely deal with valuation complaints. - Additional actions and assessments: - By Q4-2014, conduct assessment of relevance of parameters used in the Computer Assisted Mass Appraisal (CAMA) model for the GV and identify possible missing parameters; refine CAMA if needed by Q2-2015. - Conduct assessment of variance between GV assessed values and market price by Q4-2014. - Implement by Q2-2015 recommendations of a study on scope for consolidating collection and administration of municipal recurrent property tax and sewage tax; study to review existing exemptions and derogations, report on scope for shifting revenues from transaction fees/taxes to recurrent taxation, and provide initial review of tax regulations relevant for foreclosure process by Q2-2014. ### Public administration reform - Commission independent external review of possible further public administration reforms with horizontal and sectoral elements. - Horizontal element (World Bank and UK public administration) to include reviews of: - appropriate system of remuneration and working conditions/conditions of employment in public sector (e.g. annual vacation leave, sick leave, maternity leave, working time) in relation to private sector and other EU countries and based on best practices; - introduction of a new performance based appraisal system in public sector linking performance with remuneration system/increments for development and promotion purposes. - Results of the horizontal review will be presented by Q3-2014; based on findings, authorities will agree on a reform after consultation with programme partners, submit to HoR for approval and implement by Q4-2014. - Sectoral element to examine: - role, competences, organisational structure, size and staffing of relevant ministries, services and independent authorities; - possibility of abolishing, merging or consolidating non-profit organisations or companies and SOEs; - possibilities for re-organisation and re-structuring of local government. - Sectoral batches: - First batch (World Bank and UK public administration) covers Ministries of Agriculture, Education and Health, local government and Department of Registrar of Companies. - Based on findings, agree on reform plan after consultation with programme partners; plan to be approved by Council of Ministers by Q2-2014. - Relevant legislation for reforms in Agriculture, Education, local government indicated as high priority adopted by HoR by Q3-2014. - Relevant legislation indicated as high priority on Companies Registrar adopted by October-2014. - Reform will start to be implemented by Q4-2014 in accordance with the reform plan. - Second batch covers remaining Ministries (Labour, Welfare and Social Insurance, Communications and Works, Energy, Commerce, Industry and Tourism, Interior, Defence, Justice and Public Order, Foreign Affairs) and Ministry of Finance (including Treasury and Directorate General for European Programmes, Coordination and Development). It will also include all SOEs (subject to decisions under provisions of 3.4 and 3.5 regarding privatisation, restructuring or liquidation), the President’s Office and the Council of Ministers, and the Constitutional and Independent Services. *Source: _cr14180 - 6. An Implementation Advisory Team will be established by end-June 2014,* ### Annex 3 for a detailed list). The results of the second batch will be presented by Q4- ### _cr14180 - Annex 3 for a detailed list). The results of the second batch will be presented by Q4- ### Reform sequencing and timelines - Second batch results: presented by Q4-2015; will include cost estimates and implementation timelines with detailed intermediate steps. - Based on the review findings, Cypriot authorities to agree on a reform plan after consultation with programme partners, to be approved by the Council of Ministers by Q1-2016. - Relevant legislation for reforms indicated as high priority: adopted by the House of Representatives by Q2-2016. - Reform implementation start: by Q3-2016, in accordance with the reform plan. - Authorities will review the impact of changes to public sector working hours and present findings to programme partners by Q4 2014. ### Welfare system (Guarantee Minimum Income — GMI) - Reform effective date: implement the reform plan of the welfare system as of 1 July 2014. - Reform objectives: - consolidating existing social benefits by streamlining, merging some benefits, phasing out others, integrating under the Ministry of Labour, Welfare and Social Insurance; - improving targeting of benefits; - providing work incentives to avoid welfare dependency. - Required steps and deadlines: - adopt final design of reformed welfare system by the Council of Ministers by mid-June 2014 after consultation with social partners, followed by consultation and review by programme partners; the adopted reform to define all benefits, respective levels, eligibility criteria, overall costing, and provisions on mandatory participation of beneficiaries to active labour market programmes; - establish a monitoring unit to assess GMI outcomes (number of applications and costs, targeting accuracy, coverage and impact on poverty) by end-June 2014; - by end-June 2014 provide programme partners with a list of social benefits outside the GMI whose beneficiary profiles and eligibility will be examined; by mid-July 2014 provide contingency measures to ensure fiscal neutrality of the reform in 2014; - By Q3-2014, update the costing of the GMI as part of the budgetary process for 2015 on the basis of an assessment of possible fiscal impact and identify possible additional rationalization of social benefits outside the GMI to achieve fiscal neutrality; - ensure a comprehensive database and necessary IT requirements, including all required interfaces with different databases to allow comprehensive verification of eligibility criteria, are in place by end-June 2014 to support administration of reformed welfare system; - transfer all relevant competences and responsibilities related to administration and provision of all social benefits to the Ministry of Labour, Welfare and Social Insurance, appropriately equipped in financial and human resources, with the latter being reassigned from other departments by Q2-2014, except education benefits (Ministry of Education and Culture) and benefits to displaced people (Ministry of Interior). - Consistency requirement: reformed welfare system must be consistent with fiscal targets defined in this MoU. - Draft legislation for new GMI: submitted for review to programme partners before submission to the House of Representatives; law to be adopted by Q2-2014. ### Labour market — key objectives - Objectives: 1. Implement reform of wage indexation to ensure sustainable competitiveness improvements and allow wage formation to better reflect productivity developments; 2. Prepare and implement comprehensive reform of public assistance to balance public assistance and work incentives, target income support to most vulnerable, strengthen activation policies and contain public finance impact of rising unemployment; 3. Link any change in the minimum wage to economic conditions to attenuate adverse competitiveness and employment effects. ### Cost of living adjustment (COLA) of wages and salaries - Tripartite agreement to be pursued with social partners by Q4-2014 for: - suspension of wage indexation in the private sector until 2016; - application thereafter of the reformed wage indexation system (COLA) applicable to the public sector (lower frequency of adjustment, suspension at times of recession and partial indexation). ### Minimum wage - Commitment: 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 - Overall approach: reform public assistance to serve as safety net while safeguarding incentives to work; ensure consistency with welfare reform (section 3.10). - Specific actions: - develop a coherent methodology for continuous monitoring and evaluation of activation measures across ALMP; a comprehensive report to be presented by Q3-2014; apply new methodology as of then; - enhance administrative capacity of public employment services via increased staff mobility and/or outsourcing of specific tasks by Q3-2014; - ensure effective cooperation between public employment services, social welfare services and benefit-paying institutions for activation of unemployed recipients of social assistance, including clear procedures for automatic exchange of information and a transparent system linking benefit receipt with job-search efforts. - Youth employment measures: - submit National Action Plan for Youth Employment by end-May 2014, including measures envisaged for support under the Youth Employment Initiative and implementation of the Youth Guarantee, in line with European Council conclusions of June 2013; - ensure design, management and implementation of youth-targeted measures are integrated within broader activation system and coherent with welfare reform and agreed budgetary targets; - submit by end-May 2014 a comprehensive note summarising the full list of all active labour market policies (existing and envisaged) with intended aims, recipients and budgetary allocations. ### Goods and services markets — key objectives - Structural reforms aim to: - remove unjustified obstacles in services markets to boost growth in services-intensive economy; - improve quality and reduce cost of regulated professional services; - reinvigorate tourism competitiveness; - improve administration regulation for real estate to foster foreign demand; - plan for exploitation of domestic offshore natural gas to reduce energy import dependency and improve current account and public debt sustainability, noting financing and planning challenges. ### Services Directive and regulated professions - Authorities to adopt necessary amendments for full implementation of the Services Directive. - Rules referring to calculation of fees for professional services need assessment for compliance with internal market and competition principles; opinion of the Commission for the Protection of the Competition (CPC) and programme partners required. - Comprehensive review of requirements affecting access and exercise of regulated professions (lawyers, engineers, architects): eliminate by law requirements that are not justified or proportional by Q3-2014. ### Competition, transparency and sectoral regulatory authorities - Strengthen CPC independence and effectiveness: - continue to provide sufficient and stable financial means and qualified personnel to enhance operation by Q2-2014; - adopt necessary amendments to mergers legislation; amended law to be adopted by the HoR by June 2014 at the latest; - promote a more active advocacy role for the CPC to safeguard and promote competition by Q2-2014; CPC may seek technical assistance. - Ensure by Q2-2014 that the General Auditor's Office has sufficient financial means and personnel to carry out functions and increased tasks as stipulated by EC Monitoring Report (Chapter 28) and 2014 EU Anti-Corruption Report. - Ensure powers and independence of National Regulatory Authorities (NRAs) are effective in accordance with the EU Regulatory Framework by Q2-2014. ### Housing market and immovable property regulation - Objectives: ensure property market clearing, efficient seizure of collateral, restore demand; address legal disputes from incomplete documentation and slow judicial procedures. - Required actions and deadlines: - define binding administrative deadlines for issuance of title deeds upon receipt of certificate of final approval by Q2-2014; submit amending bill concerning the Street and Building Permit Law to HoR by Q3-2014 after consultation with programme partners to enforce deadlines for supervisor engineers issuing certificates of completion; - prepare joint action plan to streamline processes within the DLS and between DLS, Local and District Authorities and Ministry of Interior Technical Services by Q2-2014; plan to detail resources required, streamlined processes, clear deadlines for consultations for issuing certificate of final approval, and means to enforce deadlines; - 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 eligible for "ex-officio" issuance of title deeds, required certificates and permits). Ex-officio cases counted in backlog from date certificate of final approval is issued by respective Local or District Authority. By mid-July provide programme partners granular data on stock of backlogs of permits, deeds, and certificates and a strategy identifying ways to reduce backlog and continue publishing quarterly progress reviews starting Q3-2014; - implement electronic access to registries of title deeds, mortgages, sales contracts and cadastre for monetary financial institutions and all government services by Q4-2014; - improve pace of court case handling to eliminate court backlogs by Q1-2016; provide detailed statistics on court backlogs and duration of court proceedings to programme partners quarterly starting Q4-2014; submit draft action plan for elimination of court backlogs, including electronic filing of new documents by end-October 2014; enact legislation to establish an Administrative Court by Q4-2014. ### Tourism - Actions and timelines: - present a progress report on implementation of the tourism action plan twice per year, including assessment based on performance indicators, by Q1 and Q3 every year starting 2014; update of first progress report to programme partners by Q2-2014; - present a plan enhancing coordination of tourism stakeholders and relevant authorities by Q2-2014, including concrete actions and roadmap for an effective coordination mechanism; - start implementing an aeropolitical strategy to adapt Cyprus' external aviation policy in line with EU external aviation policy and EU aviation agreements while ensuring sufficient air connectivity. Action plan approved by Council of Ministers in May 2014 to be implemented as of Q3-2014 and reviewed annually by Cypriot authorities in consultation with programme partners. ### Energy - Commitments: - ensure the Third Energy Package is fully and correctly implemented without delay; - formulate a comprehensive strategy for rearrangement of the Cypriot energy sector; strategy to be developed and updated under full authority of the Government and include at least three key elements to be presented to programme partners per timeline specified. - Key element 1 (detailed): - a roll-out plan for infrastructure required for exploitation of natural gas covering required investments, associated costs, financing sources and methods, ownership structure; major planning risks and bottlenecks; projection of revenue streams over time; and an appropriate sales framework for off-shore gas supply for both exports and domestic markets aimed at maximising revenues. Next update by Q2-2014. - Prior to finalisation of forthcoming Government Agreement (GA) and supplementary agreements between the Republic of Cyprus and Contracting Parties to a Production Sharing Contract, authorities will undertake a financial and budgetary impact analysis of GA and supplementary agreements. Impact assessment to evaluate potential financial and budgetary impacts on general government position of envisaged LNG project and financing arrangements, with particular focus on budgetary commitments that may arise before or at time of taking the final investment decision. GA and supplementary agreements to be consistent with fiscal targets until 2016 and thereafter as defined in this MoU. *CYPRUS — INTERNATIONAL MONETARY FUND (excerpt)* ### 2. a comprehensive outline of the regulatory regime and market organisation for the ### _cr14180 - 2. a comprehensive outline of the regulatory regime and market organisation for the ### Regulatory regime and market organisation for the restructured energy and gas sector - Objective: introduce open, transparent, competitive energy markets taking into account: - the size of the Cypriot economy; - integration of Cyprus' energy system into regional markets; - the principle of independent regulatory oversight; - prospects of privatisation of SOEs in the energy sector; - EU targets for energy efficiency, renewable energy and carbon emissions. - Required content of the outline: - description of the sequence and timing of major changes envisaged, including: - the institutional framework; - the type and scope of the regulatory instruments; - the different forms of government ownership and involvement; - the setting-up of wholesale markets for gas and electricity; - the customer's free choice of supplier; - the full unbundling of gas suppliers and customers. - consideration of intended use and duration of 'isolated market' and 'emergent market' derogations. - Deliverables and timing: - an advanced intermediate draft will be provided by Q2-2014; - a final outline by Q4-2014. ### Institutional framework for management of hydrocarbon resources and resource fund - Objective: establish an institutional framework, including a resource fund, to receive and manage public revenues from offshore gas exploitation and sales. - Governance and legal requirements: - resource fund should benefit from a solid legal base and governance structure drawing on internationally-recognized best practices; - fund should be established in the FRBSL (see 3.3); - clear rules required governing inflows and outflows, dividends, fees and costs of government entities and stakes in the energy sector; - these rules should be provided for in the FRBSL and the specific law on the resource fund and detailed in implementing legislation of FRBSL. - Deliverables and timing: - an advanced draft of the specific law will be submitted to programme partners for consultation by Q2-2014, before its submission to the House of Representatives. ### Interdependence and technical assistance - The three key elements (regulatory outline, institutional framework, resource fund) are strongly interdependent and need to be developed in parallel and collated in one summary document. - Technical assistance: for some technical aspects, technical assistance will be provided where requested. ### Technical assistance (general) - By end-June 2014 the Cypriot authorities will provide an updated request for technical assistance needs during the programme period, including on-going technical assistance projects. - Coordination: - all technical assistance provided by the European Commission, other than that directly under Structural and other EU funds, will be coordinated by the Support Group for Cyprus. ### Growth strategy - Objective: develop a comprehensive and coherent growth strategy to move the economy to a sustainable growth path taking into account: - on-going public administration reform; - public financial management reform; - commitments in the Cyprus Economic Adjustment Programme; - relevant Union initiatives and the Partnership Agreement for implementation of the European Structural and Investment Funds. - Aims include: - creating a more attractive business environment; - addressing administrative complexity; - implementing more streamlined and simpler procedures. - Deliverables and timing: - By Q3-2014, assign a single body to develop, coordinate, and enforce the growth strategy. - By Q3-2014, provide, in consultation with programme partners, an action plan for development and implementation of the growth strategy. - The Cypriot authorities may request technical assistance to further develop this strategy. ### Budgetary measures adopted by Cyprus in or after December 2012 — overview of key measures and exact parameters - 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 hiring on first entry posts in the broader public sector for three additional years until 31 December 2016; ii) recruiting one person for every four retirees (horizontal); iii) measures to increase mobility of civil servants; iv) implementing a four-year plan aimed at the abolition of at least 1880 permanent posts (see I.16). - I.5 Freeze hiring of new hourly paid employees and enforce immediate application of mobility within and across ministries and other government entities. For health and security posts, recruitment of one person for every five retirees will be possible. - 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 (non-recurring; not an automatic indexation). - 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) abolition of redundant/overlapping schemes (mothers allowance, other family allowances and educational allowances); and (b) abolition of supplementary allowances under public assistance, abolition of the special grant and streamlining of the Easter allowance for pensioners. - I.10 Ensure a reduction of at least EUR 29 million in 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); - ii. reducing 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%; - iii. reducing the daily overseas subsistence allowance for business trips by 15% and ensure a further reduction 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 (business class preserved 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; - 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 taxable income calculation; 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 various employee categories; increase the minimum age for entitlement to an unreduced pension (by 6 months per year) to be in line with the statutory retirement age; preserve acquired rights; introduce an early retirement penalty of 0.5% per month of early retirement; - iii. reduce preferential treatment of specific groups (army, police) concerning contribution to 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 entitled to a pension and gratuity but not covered by the government's pension scheme or any similar plan; - v. amend Article 37 of the Pensions Law to abolish the provision that a second spouse is considered a widow/widower for pension entitlement; - 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%; - vii. 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; - 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. increasing the minimum age for entitlement to an unreduced pension by 6 months per year to align with the statutory retirement age; - v. introducing an early retirement penalty of 0.5% per month of early retirement to make early retirement actuarially neutral; - vi. introducing 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 from 10 years to at least 15 years over 2013-17 (in place since December 2012); - viii. ensure pension entitlements that will accrue after 1 January 2013 are considered as personal income and become fully taxable also if received as a lump-sum payment; employees granted option to convert all or part of 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 aimed at the abolition of at least 1880 permanent posts over 2013-2016. - I.17 Introduce measures to control healthcare expenditure including: - a. abolish beneficiary class "B" and all exemptions for free public health care based on non-income related categories except for persons with certain chronic diseases depending on illness severity; introduce a compulsory health care contribution for public servants and public servant pensioners of 1.5% of gross salaries and pensions (measure to be reviewed by Q2-2014); participation voluntary for families with three or more dependent children; - b. increase fees for medical services for non-beneficiaries by 30% and create a co-payment formula with zero or low admission fees for visiting general practitioners; increase fees for higher levels of care for all patients irrespective of age; - c. introduce financial disincentives for using emergency care services in non-urgent situations; - d. introduce financial disincentives (co-payment) to minimise medically unnecessary laboratory tests and pharmaceuticals; - e. adopt a Council of Ministers decision concerning a restructuring plan for public hospitals implementing recommendations from the 2009 "Public Hospital Roadmap". - I.18 Reduce expenditure on various housing schemes by at least EUR 36 million by consolidating and streamlining schemes for the displaced and the Comprehensive Housing Scheme, discontinuing the special grant for acquiring a first residence and ceasing loans and loan guarantees related to house construction and acquisition under government-administered housing schemes. - I.19 Further streamline the Easter allowance to pensioners by limiting the benefit to pensioners with a monthly per household income of at most EUR 500. - I.20 Implement a scaled reduction in emoluments of public and broader public sector pensioners and employees as follows: EUR 0-2.000: 0.8%; EUR 2.001-3.000: 1%; EUR 3.001-4.000: 1.5%; above EUR 4001: 2.0 %. - Revenue measures - I.21 Increase excise duties on tobacco products, in particular on fine-cut smoking tobacco, from EUR 60/kg to EUR 150/kg. Increase excise duties on cigarettes by EUR 0.20/per packet of 20 cigarettes. - I.22 Increase excise duties on beer by 25% from EUR 4.78 per hl to EUR 6.00 per hl per degree of pure alcohol of final product. Increase excise duties on ethyl alcohol from EUR 598.01 to EUR 956.82 per hl of pure alcohol. - I.23 Increase excise duties on energy (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 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 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 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 structural reform measures in the educational system in budget year 2014, including reduction of the number of teachers seconded to the Ministry of Education and Culture, removal of 1:1.5 teaching time ratio from evening schools, elimination of teaching time concession for being placed in two or more educational districts, elimination of mentoring components for newly appointed teachers and reduction of costs of afternoon and evening programmes. - I.36 Ensure additional expenditure savings by further reduction of public sector allowances and streamlining of overtime compensation, including revising the formula for calculating overtime compensation on weekdays and weekends for state officers and apply revision pro rata to hourly paid employees. - I.37 Further targeting of social pensions. - I.38 Abolition of income tax exemption for certain pension schemes. - I.39 Reduction in the tax-free threshold for lottery gains. - Revenue measures - I.40 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.41 Increase the standard VAT rate from 18% in 2013 to 19% in 2014. - I.42 Increase the reduced VAT rate from 8% to 9%. - I.42 Increase excise duties on energy (oil products) by increasing the tax rate on motor fuels (petrol and gasoil) by EUR 0.05. - I.43 Increase, as of 1.1.2014, contributions 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.44 Reform of the tax system for motor vehicles with effect from budget year 2014, based on environmentally-friendly principles, to raise additional revenues in the medium-term through annual road tax, registration fee and excise duties including motor fuel duties; reform will take into account study of the University of Cyprus. - I.45 Introduce 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. *International Monetary Fund — Cyprus: selected sections on energy sector reform, hydrocarbon resource management, technical assistance, growth strategy, and budgetary measures (sections and numbered measures as provided in the source).* ### Annex 2 ### Annex 2 ### 1. Customer Due Diligence (CDD) - Heading/Deficiency: Business profile not always properly established. - Action 1.1.1: CBC to provide guidance to ensure that obliged entities engage in adequate training of all staff involved in establishing customer business relationships and opening accounts, so that business profiles are properly determined and assigned. - Status: Compliant - Heading/Deficiency: Lack of understanding of cumulative risks in complex ownership structures / introduced business. - Action 1.2.1: CBC to provide sufficient guidance to ensure that obliged entities have sound and effective risk management systems in place to identify and understand ML/TF risks within their customers, products and services, geographical locations/areas, and delivery channels. Risk management systems should include an overall policy for identifying and understanding, measuring, controlling, and monitoring ML/TF risks. The risk management policies, procedures and measures should be submitted to the board for approval on an annual basis, or as required by changes in the business model. - Status: Compliant; Ongoing; New legislative measures. - Action 1.2.2: CBC and other supervisory authorities to issue guidance to obliged entities in order to explain the new provisions on the introduction of tax crimes (including tax evasion) as predicate offences. - Status: Compliant - Action 1.2.3: CBC to issue additional guidance to obliged entities to adequately identify and establish the source of wealth for PEPs or for customers that become PEPs after the business relationship has been accepted. - Status: Compliant - Heading/Deficiency: Higher risk customers/changes in risk not dealt with appropriately on an ongoing basis. Particular issues relating to PEPs. - Action 1.3.1: CBC to issue additional guidance to ensure that financial institutions have sound and effective systems and measures in place to demonstrate enhanced ongoing monitoring for higher risk clients, including PEPs. - Action 1.3.2: CBC to ensure that financial institutions have sound and effective systems and measures including updated CDD measures. - Status: Compliant; Timeline: Q2-2014 ### 2. Reliance / Introduced Business - Deficiency: Use of introducers allowed by CY legislation and is widespread. - Action 2.1: CBC to review, strengthen, and amend as needed the regulatory framework and the relevant requirements relating to the use of introducers/third parties to ensure compliance by obliged entities establishing business relationships and/or opening accounts through third parties. - Status: Compliant - Deficiency: Training/awareness in institutions. - Action 2.2: CBC to reiterate and clarify the obligation under the CBC directive that obliged entities are required to establish adequate AML/CFT training programs for all staff responsible for establishing business relationships and/or opening customer accounts and updating customer information. CBC to ensure that training programs are implemented and include information on current ML and TF techniques, methods and trends, and clear explanations of all aspects of the AML/CFT laws, regulations. In particular, this should include requirements concerning CDD, suspicious transaction reporting and sanctions for non-compliance. - Status: Ongoing - Deficiency: Mechanisms for coordination with supervisors of introducers. - Action 2.3: CBC to establish co-operation mechanisms with CySEC, the Cyprus Bar Association and ICPAC (for accountants) for exchanging information and ensuring supervisory coordination. - Status: Compliant ### 3. Suspicious Transaction Reporting (STR) - Deficiency: 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. - Status: Partially compliant; Timeline: Q2 - 2014 ### 4. Transparency of Beneficial Ownership - Objective: Ensure that transparency and availability of beneficial ownership information is in line with international standards and best practice. - Access to information - Action 4.1.1: Revision of Trust and Company Services Providers Law as appropriate and AML Law to ensure that adequate, accurate and timely information on the beneficial ownership of Cypriot legal persons and arrangements can be provided to the domestic competent authorities and their foreign counterparts; and revise the directives and circulars issued by supervisory authorities (CBC, CySEC, Cyprus Bar Association, ICPAC). - Action 4.1.2: In the case of nominees, either a) require nominee directors and nominee shareholders to disclose the identity of their nominator to the company and to the company register; or b) require that all nominee directors and nominee shareholders be authorised or otherwise regulated (i.e. as lawyers, accountants or TCSPs) and maintain information on the identity of their nominator, which is to be made available to the competent authorities upon request. A record of director's or shareholder's nominee status will be accessible through the registers under the TCSP Law, which list all regulated persons (i.e. lawyers, accountant and TCSPs). - Status: Compliant; Compliant - Note: Under Cyprus law, there is no legal concept of “nominee director”, but it is used with reference to professionals who provide director services. - Company Registry - Action 4.2.1: Carry out a third party review of the functioning of the Companies’ Registrar and communicate results to the programme partners. - Action 4.2.2: Ensure the department of the registrar is appropriately resourced. - Status: Compliant; Ongoing - Register of Trusts - Action 4.3.1: CY to establish trust registries with the supervisory authorities for all express trusts established under CY law, where the name of the trust and the name and address of the trustee will be contained therein. The trust registers will be accessible by the supervisory authorities in order to facilitate them in their supervisory duties. - Status: Compliant ### 5. Supervision of Financial Institutions - 5.1 Revise the AML/CFT supervisory structure within the CBC, ensuring it is adequately resourced - Action 5.1.1: Revise and/or establish organisation structure and management within the CBC’s Banking Supervision and Regulation Department (BSRD) to address AML/CFT matters, in order to conduct adequate, timely and proactive risk-based AML/CFT supervision. - Status: Compliant - Action 5.1.2: CBC to ensure adequate human resources and technical capacity to undertake effective AML/CFT supervision. The level of resources should be commensurate with the size, complexity, and risk profiles of the financial institutions operating in the system. To meet this objective, if deemed necessary by the CBC, hire AML/CFT experts with the necessary professional skills and experience (e.g. foreign supervisors retired or on leave) – subject to necessary confidentiality restrictions. - Status: Ongoing - References in actions: BCP 2 and FATF 26-27; FATF Immediate Outcome (IO) 3; See BCP 2.6c - 5.2 Develop risk-based supervisory tool(s) for offsite surveillance/monitoring activities prior to implementation - Action 5.2.1: Design, develop, adopt and pilot, for a selected group of financial institutions, a risk assessment methodology and tool(s) that provides for: - a comprehensive analysis of inherent ML/TF risks within the following risk factors: customers, products & services, geographic locations/areas, and delivery channels; - an assessment of the internal control environment that should be in place to mitigate and/or control the inherent ML/TF risks, as identified and measured; - institutional risk profiles; - specific AML/CFT supervisory strategies (adapted to institutional risk profiles). - Status: Compliant - 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). - 5.3 Develop risk-based supervisory tool(s) for onsite inspections prior to implementation - Action 5.3.1: Design, develop, adopt and pilot, for a selected group of financial institutions, a methodology for onsite activities, including the necessary examination/verification procedures for onsite inspections. Examination procedures should include, at a minimum: Corporate Governance; Risk Assessment Systems; Policies & Procedures; Compliance Function; Internal & External Audit Functions; Training Program. - Status: Partially compliant; Timeline: Q2 – 2014 - 5.4 Establish Formal AML/CFT Training Program - Action 5.4.1: Establish a formal AML/CFT training program for CBC staff to ensure adequate implementation of the offsite and onsite tools. Develop and deliver customised AML/CFT training to supervisory staff in topics including, but not limited to: - newly developed offsite and onsite risk-based tools; - customer acceptance policies; - customer due diligence (CDD); - monitoring of transactions; - identification and reporting of STR; - funds transfers; - correspondent banking; - recordkeeping; - compliance function; - internal controls; - audit functions; - corporate governance; - risk assessment systems - Timeline: 2014 - Action 5.4.2: Provide CBC supervisory staff with ongoing training to ensure adequate knowledge of risks and supervisory techniques. - Status: Ongoing - 5.5 Implement adequate supervision - Action 5.5.1.a: CBC to establish corrective actions and follow-up on the cases revealed by Deloitte. - Action 5.5.1.b: Apply appropriate enforcement actions with regard to any breaches of compliance, and apply sanctions if applicable. - Status: Compliant; Partially compliant; Timeline: Q2 - 2014 - Action 5.5.2: On a quarterly basis, in the context of the programme review, starting Q4 2013 the CBC will on a confidential basis, share anonymised information with the programme partners, by granting access to supervisory assessments and information about enforcement actions applied for non-compliance and /or violations of laws and regulations. - Status: Ongoing - Subsequent steps (timelines generally Q2 -2014): - 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. - 5.5.4.1 CBC to start implementing the new examination/verification procedures in line with the inspection program for 2014, and to adjust/fine-tune the procedures using the results of the pilot inspections. - 5.5.4.2 CBC to update the institutional risk profile and supervisory strategy based on the results of the pilot inspection. - Timelines: Q2 -2014; Q2 -2014 for pilot implementation and adjustments ### 6. Supervision and Monitoring of Lawyers, Accountants and TCSPs - 6.1 Align resources with risks / Establish an effective monitoring structure for AML/CFT matters - Action 6.1.1: Ensure adequate human resources and technical capacity to undertake effective AML/CFT monitoring. The level of resources should be commensurate with the size, complexity, and risk profiles of each business and professional. To meet this objective, if deemed necessary by the supervisory authorities, hire AML/CFT experts with the necessary professional skills and experience (e.g. professionals having performed monitoring or supervision of these professions abroad) – subject to necessary confidentiality restrictions. - Status: Ongoing - 6.2 Develop risk-based tool(s) for Offsite surveillance/monitoring activities prior to implementation - Action 6.2.1: Design, develop, adopt, and pilot a risk assessment methodology and tool(s) that provides for: - a comprehensive analysis of inherent ML/TF risks within the following risk factors: customers, products & services, geographic locations/areas, and delivery channels; - an assessment of the internal control environment that should be in place to mitigate and/or control the inherent ML/TF risks, as identified and measured; - risk profiles; - specific AML/CFT monitoring strategies (adapted to institutional risk profiles). - Status/Timelines: Ongoing (CBA and ICPAC); Q3-2014 (CySEC) - Action 6.2.2.1–6.2.2.3: 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; assign ML/TF risk profiles to businesses and professionals reviewed under the pilot exercise; 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. - Timelines: Q2-2014 (CBA and ICPAC); Q3-2014 (CySEC) - 6.3 Develop risk-based tool(s) for Onsite inspections prior to implementation - Action 6.3.1: Design and develop a methodology for onsite activities, including the necessary examination/verification procedures for onsite inspections. Examination procedures should include, at a minimum: Risk Assessment Systems; Policies & Procedures; Compliance Function; Training Program. - Timelines: Q2 – 2014 (CBA and ICPAC); Q3-2014 (CySEC) - 6.4 Establish Formal AML/CFT Training Program - Action 6.4.1: Establish formal AML/CFT training program and develop and deliver customised AML/CFT training courses. Develop and deliver customised AML/CFT training to supervisory staff in topics including, but not limited to: - newly developed offsite and onsite risk-based tools; - customer acceptance policies; - customer due diligence (CDD); - monitoring of transactions; - identification and reporting of STR; - recordkeeping; - compliance function; - risk assessment systems etc. - Timelines: Q2–2014 (CBA and ICPAC); Q4-2014 (CySEC) - 6.5 Implement adequate supervision - Action 6.5.1: On a quarterly basis, in the context of the programme review, starting Q4-2013, the CySEC, CBA and ICPAC will, on a confidential basis, share anonymised information with the programme partners by granting access, to supervisory assessments and information about enforcement actions applied for non-compliance and /or violations of laws and regulations. - Status: Ongoing - Subsequent actions and timelines: - 6.5.2: Implement the new offsite analytical tool(s) through pilot reviews of a selected group of lawyers, accountants and TCSPs. Adjust/fine-tune the offsite analytical tool(s) using the results of the pilot reviews, and come-up with a supervisory program for 2014. - Timelines: Q3–2014 (CBA and ICPAC); Q4-2014 (CySEC) - 6.5.3: Implement the new examination/verification procedures through pilot onsite inspections of a selected group of lawyers, accountants and TCSPs. Adjust/fine-tune the procedures using the results of the pilot inspections. - Timelines: Q3–2014 (CBA and ICPAC); Q4-2014 (CySEC) *Source: _cr14180 - Annex 2* ### Introduction ### Introduction ### Program performance and political context - Significant progress toward the program’s objectives in its first year of implementation; the fourth review is described as another successful milestone. - All performance criteria observed with considerable margins. - Compliance with structural conditionality is being adhered to; all seven structural benchmarks were observed by the time of this review (two partially completed and very close to finalization). - Political ownership and commitment remain strong; authorities share international partners’ strategy to restore the Cypriot economy. - European elections outcome underlines broad support for the government’s adjustment efforts. - EBRD decision in May 2014 to complement Cyprus' international bailout: expects to invest between €500-€700 million in Cyprus through 2020 to strengthen the financial sector, support privatization, assist in corporate restructuring, and provide finance to small- and medium-sized enterprises. ### Recent positive developments and market access - Economic Sentiment Indicator recorded its twelfth consecutive increase in May, to 99.3 from 93.5 in March, highest since 2010. - Tourist arrivals showed recovery in April and May. - Banking system: deposits recorded the first net inflow in April since December 2012, triggering abolition of all domestic payment restrictions. - Sovereign bond yields reached their lowest level since May 2011 as rating agencies reversed successive downgrades. - On June 18, €750 million were raised in a sale of five-year notes; issuance was four times oversubscribed. - Objectives of issuance: reduce the Republic’s average interest cost, improve debt maturity profile (currently front loaded in the post program years), and improve BoC’s liquidity by reducing its exposure in Laiki’s recapitalization bond. - Authorities emphasize that positive developments will not lead to complacency and will encourage continued reform. ### Macroeconomic developments - GDP: recession moderated; GDP growth fell by 4 percent y-o-y in Q1 2014. - Program projection revision: 2014 outcome revised to -4.2 percent from -4.8 percent in the third review. - Authorities project a more favorable outcome than Fund staff for 2014 and beyond. - Unemployment: - Harmonized unemployment rate fell from a peak of 16.9 percent in 2013 to 16.4 percent in April, 2014. - Forecasted to edge upwards in 2014 despite nascent stabilization signs. - Contributing factors to moderation: sharp declines in nominal and real labor costs containing employment cuts; shrinking labor force from migration outflows and a shrinking public sector workforce via early retirements. - Public sector reductions to continue through retirement schemes in SOEs as they prepare for privatization; Telecoms company agreed to reduce staff by a quarter. - Labor market has proven more flexible than anticipated; recent data suggest employment is bottoming out. - Inflation: - Core inflation edged up to 0.2 percent in Q1 2014, after turning negative in Q4 2013. - These levels both help restore competitiveness and can counter efforts to resume growth and reduce debt overhang. - Current account: - Deficit narrowed to -1.9 percent of GDP in 2013 from -6.9 percent in 2012. - Improvement mainly due to a drop in goods’ imports; some improvement in exports of domestically produced goods; services balance improved as tourism revenues increased. - Deficit expected to further improve as competitiveness is reestablished. ### Fiscal developments - Fiscal performance through end March continued to outperform quarterly estimates. - Primary balance recorded a surplus of 0.6 percent of GDP in Q1, 2014, meeting the Quantitative Performance Criterion that suggested a small deficit. - Outperformance largely reflects better than projected revenue performance (tax and non-tax revenues), ending up 0.5 percent of GDP above the estimate. - Expenditure lower than original estimates, driven by lower intermediate consumption and capital expenditure. - 2014 primary deficit target was reduced to 1.6 percent of GDP, from 2 percent of GDP in the third review and 3.3 percent before that. - Revision reflects impact of higher growth and assumes some cash-basis improvement. - Authorities committed to meeting fiscal targets and keeping strong track record; note staff’s view that flexibility may be required to allow automatic stabilizers if downside risks materialize. - Adoption of legislation and regulations to fight tax evasion (a prior action for this review) strengthens future revenue protection. - Recent law enables consolidation of two tax authorities to improve collections efficiency. - Parliament approved legislation (prior action) giving increased powers to the tax authority: prohibit alienation of immovable assets, seize movable assets, and garnish bank accounts. ### Financial sector reforms and challenges - Financial sector reform is the cornerstone of the program; reforms to date are described as bold and numerous with adherence to an ambitious timetable. - Since the last review, requirements for another five financial sector structural benchmarks were observed (one partially). - Transition to the SSM and preparations for the comprehensive assessment test limited capacity. - Systemwide deposit outflows continued to normalize with net inflows recorded in April and May; inflows attributed to non-resident deposits into foreign banks, indicating a faint return of international clients' confidence. - Domestic depositor trust remains dispersed; evidence of substantial cash holdings outside the banking system. - Non-performing loans (NPLs): - NPLs in Cyprus are described as the highest in Europe. - NPL growth is stated to be at par with PIMCO’s projections and defined using a relatively more stringent definition, in line with the European Banking Authority’s expected definition by year-end. - Authorities and banks face the challenge of bringing NPLs down; substantial technical assistance provided from the Fund, third-party specialists, and other country experiences. - Measures taken or close to completion: - Banks have established specialized units for troubled borrowers; external consultants assist operational efficiency. - Central Bank’s Arrears Management Framework, Code of Conduct for borrowers and creditors, and loan origination directive in place. - Authorities revamping legal and operational framework to promote voluntary workouts. - Draft legislation to facilitate forced sales procedure by enabling mortgage creditors to conduct private auctions to create an efficient foreclosure procedure, discourage strategic defaults, and incentivize voluntary debt restructuring. - Insolvency framework reform being accelerated to assist in cleansing unrecoverable loans from banks’ balance sheets. - Deleveraging priority limits credit growth; staff flags concerns over access to credit, while demand weakness is also a factor. - Bank Lending Survey: further tightening of credit supply for households expected for Q2 2014; demand weakness likely to persist. - Liquidity: - Banking system’s liquidity position remains challenging; reliance on exceptional funding decreased in Q1 2014 but remains high. - Authorities and banks exploring ways to improve cost and amount of liquidity within limited toolkit. - Recent ECB policy initiatives are welcome but impact remains to be fully appreciated. - Liberalization of restrictive measures: - Gradual liberalization continued in line with the four-stage roadmap. - Restrictive measures relating to cash withdrawals, cashing of cheques, and limits on transfers within Cyprus were lifted in recent months. - Abolition of the last domestic restriction on opening new current accounts at end-May means payments within Cyprus are totally free, leaving only cross-border capital controls in place. ### Structural reforms - Authorities implementing structural reforms across the economy: regulated professions, public administration review, public financial management, housing market, health, pensions, tourism, and energy. - Social safety net reform: - Structural benchmark on government approval of Guaranteed Minimum Income reform achieved. - Reform expected to increase coverage by 20 percent over the existing scheme and reduce poverty by as much as 70 percent in absolute terms, while maintaining budget neutrality. - Scheme governed by a single administrative framework to yield efficiency gains and reduce benefit abuse. - Privatization and public administration: - Privatization plan approved in March; first SOEs prepared for sale: the port authority and the telecoms company. - Structures refined to increase value and appeal to private investors. - Head of the privatization unit appointed with significant M&A expertise; rest of unit’s staffing proceeding as envisaged and should be operational soon. ### Conclusion and request to the Board - Cyprus’ adjustment program continues positive momentum from the prior year: recession moderating, fiscal performance exceeding expectations, financial system stabilizing without domestic restrictions, and return to international debt markets. - Authorities recognize remaining challenges and the need for sustained improvements. - Authorities request the Board’s approval of the completion of the fourth review and associated modifications of performance criteria. *Source: Introduction (content unit _cr14180) — IMF staff report excerpt* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14180.pdf_