## _cr15155 — Executive Summary of Cyprus EFF-supported Program (June 4, 2015) ## Source details **Canonical URL:** [_cr15155 — Executive Summary of Cyprus EFF-supported Program (June 4, 2015)](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15155.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15155.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15155.pdf.json) --- ### Background and program status - Recession and recent activity: - Output declined by 2.3 percent in 2014 (versus a 4.2 percent decline envisaged during the fourth review and 3.2 percent projected at the time of the 2014 Article IV Consultation). - Preliminary Q1 2015 estimate: expansion by 0.2 percent year-on-year (1.6 percent quarter-on-quarter). - Program reviews and financing: - Reviews delayed by late adoption of a modernized private debt restructuring framework; insolvency package adopted in April; implementing regulations for the foreclosure law adopted in mid-May. - Completion of the reviews would make available SDR 222.75 million (about €280 million). - Total access under the arrangement is SDR 891 million (563 percent of quota, about €1 billion). - The European Stability Mechanism released €5.7 billion (of €9 billion committed); an additional €100 million will be disbursed upon completion of this review cycle. - Date of document: June 4, 2015. ### Recent economic developments and outlook - Growth and labor market (real GDP percent change unless otherwise indicated): - 2013: -5.4; 2014: -2.3; 2015 (projection): 0.2; 2016: 1.4; 2017: 2.0; 2018: 2.2; 2019: 2.1; 2020: 1.8. - Unemployment (EU standard; percent): - 2013: 15.9; 2014: 16.1; 2015: 16.1; 2016: 15.1; 2017: 13.8; 2018: 12.5; 2019: 11.2; 2020: 10.2. - Latest observation: Unemployment was 15.6 percent in April 2015. - Prices: - Deflation accelerated to 1.7 percent in April 2015; core inflation at -0.8 percent. - HICP (period average): 2013: 0.4; 2014: -0.3; 2015: -0.8; 2016: 0.9; 2017: 1.3; 2018: 1.5; 2019: 1.8; 2020: 1.9. - Deflation expected to moderate, averaging 0.8 in 2015; positive inflation projected from 2016 onwards. - External and market developments: - External current account deficit widened in 2014 due mainly to a recovery of imports. - Cyprus issued a 7-year bond of €1 billion at a yield of 4 percent in late April 2015. - T-Bill market reactivated; domestic short-term yields declined to 2.5 percent in the latest auction (compared to an average of over 4 percent in 2014). - Baseline outlook and risks: - Modest growth of 0.2 percent in 2015; pick-up to around 2 percent in the medium term (below pre-crisis rates). - Recovery expected to be credit-less and led by tourism and non-financial business services. - Domestic risks: slow implementation of private debt restructuring and persistence of deflation. - External risks: protracted turmoil related to Greece; deeper recession in Russia and ruble depreciation. - Upside risks: stronger external demand, greater compression of yields (e.g., ECB QE), or milder Russian downturn. ### Financial sector developments and vulnerabilities - Non-performing loans and provisioning: - NPL ratio for core domestic banks: 59 percent of gross loans at end-2014 (equivalent to 134 percent of GDP). - Provision coverage of NPLs for core domestic banks: 37 percent (compared with a European average of 46 percent). - Capitalization and liquidity: - Average core tier 1 (CET1) ratio of the system at end-2014: 14.2 percent (compared to 12.1 percent at end-2013). - Capital injections: €1 billion and €0.2 billion from private sources into Bank of Cyprus (BoC) and Hellenic Bank, respectively. - Buffers of domestic banks at end-March 2015 were €0.9 billion higher (10 percent higher) than at end-2014. - BoC reliance on Emergency Liquidity Assistance (ELA) declined by €4.9 billion (about 28 percent of GDP) relative to its peak in 2013Q1, but ELA remains high at 37 percent of GDP. - Deposits and credit: - Subsidiaries of Greek banks represent about 14 percent of total deposits and experienced moderate outflows. - Credit to the domestic nonfinancial private sector: -0.5 percent year-on-year in April 2015. - Interest rates on loans and deposits declined markedly following liquidity improvements and monetary measures, including a one percentage point decrease in the maximum deposit rate by the CBC. ### Program performance, conditionality, and structural reforms - Compliance and conditionality: - All end-September 2014 PCs and continuous PCs met except the PC on accumulation of general government debt (missed due to delay in finalizing asset swap with CBC); swap expected to be finalized in Q3 of 2015. - Most structural benchmarks implemented, though with some delays. - New conditionality proposed: quarterly quantitative PCs through end-December 2015 and six new structural benchmarks. - Key structural and legal reforms: - New insolvency and foreclosure legislation adopted (package of five laws enacted April 18, 2015); remaining administrative acts and regulations for insolvency regime to be adopted by end-August 2015 (new SB). - Insolvency Service to be established; insolvency practitioners (IPs) to be recruited and licensed. - Review of civil procedure and court rules: by end-July for foreclosures and end-September for insolvencies. - Authorities committed to review the legal framework by end-September 2015 (new SB) and a comprehensive review in early 2016. - Title deeds: - Draft law to be prepared and approved by the Council of Ministers (COM) by end-June 2015 (new SB) to establish a rules-based procedure to transfer title to buyers who have paid in full. - Program completion: - Staff supports completion of the combined fifth, sixth, and seventh reviews; request for waiver of the nonobservance of one PC; establishment of PCs through end-December 2015; rephasing of purchases under the arrangement. ### Public debt profile, stress tests, and vulnerabilities - Debt levels and drivers: - Public debt at end-2014: 107 percent of GDP (compared to the fourth review forecast of 120 percent). - Improvement driven by a 10 percent upward revision of nominal GDP from ESA 2010 methodology and deferred ESM disbursements due to strong fiscal outturn and lower bank recapitalization needs. - Debt projected to decline gradually to close to 80 percent of GDP by 2020 (compared to an initial program forecast of 105 percent of GDP). - Potential contingent liability risks (percent of GDP): - Government guarantees on bank loans: 17 percent of GDP. - Implicit contingent liabilities associated with banks’ reliance on central bank financing: 48 percent of GDP. - Non-materialization of privatization proceeds and the debt-to-asset swap: 12 percent of GDP. - External debt and net IIP: - External debt: around 300 percent of GDP at end-2014 (down from 327 percent of GDP the year before and a peak of 447 percent of GDP in 2010). - Net IIP: deteriorated to -84 percent of GDP in 2014 from -78 percent of GDP in 2013. - Stress test scenarios (selected results): - Growth risk (decline by about 7 percentage points for 2016–2017): debt ratio would increase to 114 percent of GDP by 2016 and 120 percent by 2020. - Primary balance shock (reducing planned fiscal adjustment in 2016–18 by 80 percent): debt ratio would increase to 100 percent of GDP in 2016 and to 83 percent of GDP by 2020. - Interest rate shock (real interest rate +3 percentage points each year 2016–20): debt would reach 99 percent of GDP in 2016 and slightly above 79 percent of GDP in 2020. - Combination of growth, interest rate, and primary balance shocks: debt ratio of 114 percent of GDP in 2016 and 124 percent of GDP in 2020. - Full materialization of government loan guarantees (€3 billion called): debt would reach 116 percent of GDP in 2016 and 101 percent of GDP in 2020. ### Fiscal outcomes, targets, and composition - 2014 fiscal outturn: - Cash primary surplus of 2.8 percent of GDP (significantly stronger than the fourth review target of a 1.6 percent of GDP deficit); represents a 4½ percent of GDP improvement relative to 2013. - Explanation drivers (percent of GDP): higher revenues from shallower recession (2.6), discretionary spending lower by 1.2, favorable wage bill developments (0.6), ESA 2010 nominal GDP revision reducing balance by 0.5. - Composition of additional revenue (percent of GDP): Taxes on Production and Imports: 0.7; Social Security Contributions: 1.1; Current Taxes on Income and Wealth: 0.3; Other Revenue: 0.5. - 2015 target: - Cash primary balance target for 2015: 1 percent of GDP (reflecting one-off factors and broadly neutral fiscal stance). - One-off factors include high CBC dividends in 2014; payment of remaining compensation to pension funds for losses arising from the deposit bail-in; retroactive contribution to the EU budget due to GDP revision; upfront costs related to closure of Cyprus Airways. - Medium-term fiscal anchor: - Authorities will target a long-term primary surplus in a range of 3 to 4 percent of GDP to bring debt below 80 percent of GDP in 2020. - For macro framework purposes, the primary surplus from 2018 onwards is assumed to be 3½ percent of GDP. - Primary balance targets for 2016–17 set at 2.4 and 3 percent of GDP, respectively, subject to revision if needed. ### Financial-sector policies to address NPLs and reforms to supervision - Urgent priority: address high NPLs (59 percent of loans) to prevent erosion of banks’ balance sheets and enable renewed credit growth. - Legal and operational reforms: - Mortgage law: streamlines foreclosure allowing sale of collateral by mortgage creditors without government agencies. - Personal insolvency law: tools to restructure viable individual debtors while, where possible, keeping primary residence. - Amended bankruptcy law: potential “fresh start” after three years under conditions. - Corporate examinership law: designed to facilitate restructuring of viable businesses. - Guaranteed minimum income scheme introduced as safety net. - Implementation actions and timing: - Administrative acts and regulations for insolvency regime to be adopted by end-August 2015 (new SB). - Insolvency Service to be established and staffed; IPs recruited and licensed. - Roll-out expectations: foreclosures and debt relief orders may be implemented relatively quickly; personal repayment plans and corporate examinerships expected not until end of the year at the earliest. - Supervisory measures and targets: - CBC framework to incentivize restructuring, monitor, and require corrective action. - CBC and banks to agree forward-looking performance targets; targets and banks’ performance to be published quarterly, first by end-July (new SB). - CBC to perform semi-annual bank audits analyzing sustainability of restructuring cases; results to be made available to the ECB’s SSM by end-June for corrective action. - Legislation to enable sale of loans to non-banks while retaining borrower protections: COM to approve by end-June 2015. - Secondary market and asset sales: - Sale of NPLs to other investors to speed balance sheet clean-up; legal modernization needed to allow sale and securitization with adequate oversight and borrower protection. ### Annex I — NPL problem and impact assessment of the new framework - Scale of the problem: - Private sector debt described as "over 400 percent of GDP." - NPL ratio in the domestic banking sector: "59 percent." - Credit to the private sector contracted by "about 8 percent" in the last two years. - Insolvency-driven restructuring scenarios and impacts: - NPLs eligible for insolvency as assessed by banks: "€1–3 billion (6–7 percent of GDP)." - Scenario portfolio at risk: "€1 billion" or "€3 billion." - Strategic default ratio: "15 or 30 percent." - Additional write-downs beyond existing provision coverage ratio of "33 percent": "10 or 20 percent." - Estimated private sector debt reduction from insolvency: "about €0.5–2.1 billion or 3–12 percent of GDP." - Corresponding impact on bank capital due to additional provisioning: "€0.2–1.1 billion." - Estimated effect on credit growth (using cross-country elasticity 2000–14): "a 1 percentage point decline in private sector debt is associated with a 0.2 percentage point increase in credit growth." - Applying elasticity implies credit growth could rise "between 0.6–2.4 percentage points" over the medium term from the estimated debt reductions. - Caveats: - Estimates assume banks adequately capitalized per comprehensive assessment and that additional capital impact ("€0.2–1.1 billion") will not significantly tighten credit supply. - Estimates are speculative and rest on strong assumptions. - Voluntary restructuring and dampening factors: - Voluntary restructuring could add upside; in first three quarters of 2014, credit facilities restructured amounted to "12 percent of NPLs (19 percent of GDP)" though many at risk of re-default. - Dampening factors include reduced pool of good-quality borrowers, sensitivity of bank capital to writedowns, and potential regressive impacts on credit allocation and lending rates. ### Cooperative credit sector, supervision, AML/CFT, and other institutional priorities - Cooperative sector transformation: - 93 CCIs merged into 18 entities; CCB became sector head office. - CCB to prepare time-bound action plans by end-June to address governance and arrears management; implementation strategy by end-July for financial management, risk and control functions. - Banking supervision and Laiki resolution: - SSM supervisory agenda for 2015 focuses on credit risk, NPLs, and financial control functions; CBC to review capacity needs by end-June. - Laiki under resolution for more than two years; liquidation to commence as soon as possible; advisor appointed and a plan covering liquidation of all assets to be presented by end-June. - CBC governance and other supervisory gaps: - CBC governance framework to be updated; external advisor hired for reorganization. - Pension funds and insurance supervision: report under preparation; implementing legislation to be submitted to Parliament by end of year. - AML/CFT: - On-site inspections of 11 banks in 2014. - Amendments to Company Law adopted to simplify registration/de-registration and strengthen registrar enforcement powers. - Further work required in supervising banks and professions and enhancing company transparency; supervisors to bolster institutional and staff capacity. - CBC to continue appropriate actions regarding the FBME branch operating in Cyprus. ### Labor market, external spillovers, and near-term baseline (selected points) - Labor market: - Employment in 2014Q4 picked up by 1.2 percent year-on-year. - Unemployment rate stabilized at 16 percent; youth unemployment at 33 percent. - Long-term unemployment rose to almost 8 percent from below one percent prior to the crisis. - Unit labor costs in the last quarter of 2014 were 13 percent below their peak in 2011. - External spillovers: - Exports to Russia in 2013: about 17 percent of exports (9 percent of GDP). - Tourism dependence on Russian arrivals: increased to about 25 percent in 2013–14 (about 4 percent of GDP). - Stock of Russian FDI in Cyprus in 2013: 150 percent of GDP (90 percent via SPEs). - A reduction of tourism in 2015 by 20 percent estimated to reduce growth by about ½ppt. - Exports to Greece in 2013: about 6½ percent of exports (3½ percent of GDP). - A weaker euro and stronger EU recovery expected to raise growth in 2015 by ¼–½ppt. - Oil price effects: - Cypriots spend €8 out of every €100 of disposable income on fuel. - A €10 decline in global oil prices frees up disposable income equivalent to 0.3 percent of GDP (assuming 50 percent pass-through). - A €25 decline in baseline oil prices for 2015 relative to Article IV Staff Report would boost GDP by 0.4 percent, with total impact after import leakage estimated at 0.2 percent; inflation reduction estimated at about 1ppt. ### Program financing, monitoring, and capacity to repay - Financing assurances and flows: - Government deposits of about €0.8 billion at end-April. - Expected proceeds: €0.1 billion from transfer of the coinage function from the CBC to the Treasury by year-end; €0.1 billion central bank dividends in 2016. - Expected privatization proceeds: €0.5 billion during the program period. - Undisbursed funds from the ESM/IMF. - These sources more than cover €2.7 billion in projected financing needs through May 2016. - Capacity to repay: - Peak exposure to the Fund occurs in 2016 at 563 percent of quota or 6 percent of GDP. - Staff conclusion: capacity to repay the Fund is comfortable, contingent on maintaining the reform path. ### Key policy priorities and recommendations (staff appraisal) - Financial sector: - Prioritize effective implementation of the new private debt restructuring framework (insolvency and foreclosure regimes) to reduce NPLs and support bank balance-sheet repair. - Strengthen supervisory measures and support bank restructuring where needed. - Ease asset sales restrictions and address backlog of un-issued and un-transferred title deeds to facilitate NPL management. - Fiscal policy: - Maintain prudent public finances given still-high public debt and contingent liabilities. - Lock in fiscal savings from better-than-expected macro developments and execute public investment allocations to support recovery. - Structural reforms: - Continue reforms in tax administration, public financial management, privatization, and public administration to support medium-term growth and fiscal sustainability. - Implement welfare reform (GMI) and build a national benefit registry to detect and prevent abuse. - Program implementation: - Complete pending reviews to secure IMF and ESM disbursements and reinforce confidence and financial support mechanisms. *International Monetary Fund — Executive Summary and staff report excerpts for Cyprus EFF-supported program (content provided).* ### EXECUTIVE SUMMARY ### _cr15155 - EXECUTIVE SUMMARY ### Background and program status - The recession in 2014 was milder than expected: output declined by 2.3 percent in 2014 (compared to a 4.2 percent decline envisaged during the fourth review and 3.2 percent projected at the time of the 2014 Article IV Consultation). - GDP growth was positive in the first quarter of 2015 for the first time in almost four years: preliminary Q1 2015 estimate indicates expansion by 0.2 percent year-on-year (1.6 percent quarter-on-quarter). - Reviews under the EFF-supported program were delayed by the late adoption of a modernized private debt restructuring framework; insolvency and foreclosure legislation has now been adopted (insolvency package adopted in April; implementing regulations for the foreclosure law adopted in mid-May). - Completion of the reviews would make available SDR 222.75 million (about €280 million). Total access under the arrangement is SDR 891 million (563 percent of quota, about €1 billion). - The European Stability Mechanism has released €5.7 billion (of €9 billion committed); an additional €100 million will be disbursed upon completion of this review cycle. - Date of document: June 4, 2015. ### Recent economic developments - Growth and labor market: - Real GDP: 2013: -5.4; 2014: -2.3; 2015 (projection): 0.2; 2016: 1.4; 2017: 2.0; 2018: 2.2; 2019: 2.1; 2020: 1.8 (percent change, unless otherwise indicated). - Unemployment rate (EU standard; percent): 2013: 15.9; 2014: 16.1; 2015: 16.1; 2016: 15.1; 2017: 13.8; 2018: 12.5; 2019: 11.2; 2020: 10.2. - Unemployment was 15.6 percent in April (latest observation). - Prices: - Deflation accelerated to 1.7 percent in April 2015; core inflation at -0.8 percent. - HICP (period average): 2013: 0.4; 2014: -0.3; 2015: -0.8; 2016: 0.9; 2017: 1.3; 2018: 1.5; 2019: 1.8; 2020: 1.9. - External sector: - External current account deficit widened in 2014 reflecting a deteriorating trade balance, due mainly to a recovery of imports. - Sovereign market access: - In late April 2015 Cyprus issued a 7-year bond of €1 billion at a yield of 4 percent. - T-Bill market reactivated; domestic short-term yields declined to 2.5 percent in the latest auction compared to an average of over 4 percent in 2014. ### Financial sector developments and vulnerabilities - Non-performing loans (NPLs): - NPL ratio for core domestic banks: 59 percent of gross loans at end-2014 (equivalent to 134 percent of GDP). - Provision coverage of NPLs for core domestic banks: 37 percent (compared with a European average of 46 percent). - Capitalization and liquidity: - Average core tier 1 (CET1) ratio of the system at end-2014: 14.2 percent (compared to 12.1 percent at end-2013). - Capital injections: €1 billion and €0.2 billion from private sources into Bank of Cyprus (BoC) and Hellenic Bank, respectively. - Buffers of domestic banks at end-March 2015 were €0.9 billion higher (10 percent higher) than at end-2014. - Reliance by BoC on Emergency Liquidity Assistance (ELA) has declined by €4.9 billion (about 28 percent of GDP) relative to its peak in 2013Q1, but ELA remains high at 37 percent of GDP. - Deposits and credit: - Subsidiaries of Greek banks represent about 14 percent of total deposits and experienced moderate outflows in recent months. - Credit to the domestic nonfinancial private sector continued to fall: -0.5 percent year-on-year in April 2015. - Interest rates on loans and deposits declined markedly following improvements in liquidity and monetary measures (including a one percentage point decrease in the maximum deposit rate by the CBC). ### Program performance and structural reforms - Program compliance: - Compliance with quantitative conditionality has been good; all but one performance criterion for end-September 2014 were comfortably met. - Most structural benchmarks have been implemented, though with some delays. - Legal framework to address NPLs: - New insolvency and foreclosure legislation adopted; some parliamentary amendments may weaken effectiveness and implementation will need adjustments over time based on experience. - Effective implementation of the new private debt restructuring framework is essential to reduce the extremely high level of NPLs and to consolidate financial stability and boost growth. - Political economy: - A difficult political environment—governing party in a minority and May 2016 legislative elections looming—could complicate passage of pending reforms (privatization, public administration, and further balance-sheet cleanup measures). ### Macroeconomic outlook and risks - Baseline outlook: - A gradual recovery is expected in 2015 with modest growth of 0.2 percent; growth is projected to pick up in 2016 and then to stay around 2 percent in the medium term—below pre-crisis rates. - The recovery is expected to be credit-less and led by service sectors less reliant on credit (tourism and non-financial business services). - Inflation and unemployment projections: - Deflation is expected to moderate as the impact of lower oil prices subsides, averaging 0.8 in 2015. - Positive inflation is projected from 2016 onwards as domestic demand and wages gradually recover. - Unemployment path has been shifted down relative to previous projections, with a gradual decline projected as employment picks up. - Risks: - Domestic risks: Slow progress in implementing the private debt restructuring framework and addressing NPLs could delay balance sheet repair and credit expansion, constraining the recovery and medium-term growth; persistence of deflation could further weigh on stressed private sector balance sheets. - External risks: Protracted turmoil related to Greece could affect Cyprus through financial spillovers, confidence effects, or lower EU external demand; a deeper recession in Russia and/or further depreciation of the ruble could affect Cyprus’s business and tourism sectors beyond baseline assumptions. - Upside risks: Stronger-than-expected external demand, greater compression of yields (for example due to ECB QE), or a milder downturn in Russia could boost growth. ### Key policy priorities and recommendations - Financial sector: - Prioritize effective implementation of the new private debt restructuring framework (insolvency and foreclosure regimes) to address high NPLs and support bank balance-sheet repair. - Strengthen supervisory measures and support bank restructuring where needed. - Fiscal policy: - Maintain prudent public finances given still-high public debt; fiscal consolidation remains important to ensure sustainability. - Structural reforms: - Continue structural reforms to support the sustainability of public finances and to foster medium-term growth, including privatization and public administration reforms—recognizing political constraints. - Program completion: - Complete pending reviews to secure available IMF and ESM disbursements and to reinforce confidence and financial support mechanisms. *International Monetary Fund — Executive Summary of Cyprus EFF-supported program (June 4, 2015).* ### 12. The public debt profile has improved significantly, although risks remain (Annex 2). At ### 12. The public debt profile has improved significantly, although risks remain (Annex 2). ### Public debt profile and risks - At end-2014, public debt stood at 107 percent of GDP, compared to the fourth review forecast of 120 percent. - The bulk of the improvement derives from: - a 10 percent upward revision of nominal GDP due to the adoption of the ESA 2010 methodology for national accounts; - deferred ESM disbursements in light of the strong fiscal outturn and lower bank recapitalization needs. - Going forward, debt is projected to decline gradually to close to 80 percent of GDP by 2020 (compared to an initial program forecast of 105 percent of GDP), reflecting no further bank recapitalization needs. - Potential contingent liability risks: - government guarantees on bank loans: 17 percent of GDP; - implicit contingent liabilities associated with the banks’ reliance on central bank financing: 48 percent of GDP; - non-materialization of privatization proceeds and the debt-to-asset swap: 12 percent of GDP. ### External debt and net IIP - External debt: - Dropped to around 300 percent of GDP at end-2014 from 327 percent of GDP the year before (and a peak of 447 percent of GDP in 2010), largely reflecting the decline in ECB financing to the banking sector. - Remains sensitive to shocks, in particular to interest rates and growth. - Net international investment position (IIP): - Deteriorated to -84 percent of GDP in 2014 from -78 percent of GDP in the previous year, reflecting mainly a decline in holdings of foreign assets. - IIP data estimated from CBC BPM6 data excluding special purpose vehicles. ### Financial sector policy — NPLs and restructuring (Annex I; MEFP ¶3–9) - Urgent priority: Addressing the high level of NPLs to prevent erosion of banks’ balance sheets and enable renewed credit growth. - Causes of slow restructuring progress: - Lack of incentives for borrowers and lenders to negotiate (including a foreclosure process taking years, resulting in almost no foreclosures to date); - Banks’ capacity constraints; - Outdated corporate restructuring and personal bankruptcy procedures. - New debt-restructuring framework (major steps forward; requires effective implementation): - Mortgage law: streamlines foreclosure by allowing sale of loan collateral to be conducted by mortgage creditors without government agencies. - Personal insolvency law: provides tools for viable individual debtors to restructure while keeping, where possible, their primary residence. - Amended bankruptcy law: would provide a “fresh start” to debtors after three years, under certain conditions. - Corporate examinership law: should be conducive to restructuring of viable businesses. - Guaranteed minimum income scheme provides a safety net for vulnerable groups. - Implementation actions and timing: - Remaining administrative acts and regulations for insolvency regime to be adopted by end-August 2015 (new SB). - Insolvency Service to be established and staffed; insolvency practitioners (IPs) to be recruited and licensed. - Review of civil procedure and court rules: by end-July for foreclosures and end-September for insolvencies. - Voluntary mediation process established under the financial ombudsman. - Roll-out expectations: some procedures (foreclosures, debt relief orders) may be implemented relatively quickly; personal repayment plans and corporate examinerships expected not until end of the year at the earliest. - Review and monitoring concerns: - Some Parliamentary-introduced provisions may deviate from international norms and risk weakening effectiveness (e.g., allowing nonviable debtors to suspend enforcement and limiting guarantor liability). - Last-minute amendments giving mortgage debtors a preferential right to buy back mortgaged property at foreclosure auction may weaken payment discipline. - Authorities committed to review the legal framework by end-September (new SB) and conduct a comprehensive review in early 2016 based on implementation experience. - Title deeds (property titles) problem and remedies: - Procedural impediments and high costs have led to discrepancies between economic ownership and formal title possession, increasing legal uncertainty and risks for lenders, complicating loan restructuring and collateral assessment. - Remedies: - Draft law to be prepared and approved by the Council of Ministers (COM) by end-June 2015 (new SB) to establish a rules-based procedure to transfer title to buyers who have paid in full; - Develop statutory and contractual standards to incentivize and facilitate swift transfer of titles; - Review procedures to streamline issuance of titles. ### Supervisory tools and bank operational measures (MEFP ¶4–7) - Program strategy: strengthen banks’ capacity to address problem loans on a case-by-case basis. - Progress achieved: establishment of large-scale internal workout units at banks; sector-wide standards via the Arrears Management Framework and the “Code of Conduct”. - Key areas for further progress: - Loan restructuring targets: - CBC has designed a framework to incentivize restructuring, enable prompt monitoring, and require corrective action. - CBC and banks to agree forward-looking performance targets; targets and banks’ performance to be published quarterly, for the first time by end-July (new SB). - Banks required to update quarterly capital budgets and adjust provisioning commensurate with restructuring performance. - Sustainability of restructuring solutions: - CBC to perform semi-annual bank audits analyzing sustainability of concrete restructuring cases. - Results to be made available to the ECB’s Single Supervisory Mechanism (SSM) for the first time by end-June, to implement corrective actions if needed. - Instruments to facilitate bank asset sales: - Sale of NPLs to other investors would speed balance sheet clean-up. - Legal framework modernization needed to allow sale and securitization of assets and servicing by third-parties with adequate risk oversight and borrower protection. - By end-June 2015, COM to approve legislation to enable sale of loans to non-banks while retaining protections under the Code of Conduct. ### Cooperative credit sector (MEFP ¶5) - Transformation since 2013: - 93 individual cooperative credit institutions (CCI) merged into 18 entities. - Cooperative Central Bank (CCB) became the sector’s head office. - Remaining needs and actions: - Improve governance and ensure the CCB can fulfill its expanded role. - Strengthen the sector’s arrears management capacity. - Upgrade the sector’s financial management, risk and control functions (now under the CCB). - CCB to prepare time-bound action plans by end-June to address governance and arrears management; prepare an implementation strategy by end-July to address financial management, risk and control functions. ### Banking supervision and Laiki Bank resolution (MEFP ¶7) - Banking supervision: - SSM prepared an ambitious supervisory agenda for 2015 focusing on credit risk, NPLs, and financial control functions. - CBC retains important responsibilities; has hired additional staff and will further review capacity needs by end-June. - Laiki Bank: - Under resolution for more than two years; liquidation should commence as soon as possible to allow payout of creditors. - Need to preserve value in Laiki’s bank holdings abroad and prudently manage Laiki’s large stake in BoC has delayed liquidation. - An advisor appointed to support sale of Laiki’s foreign operations; by end-June a plan will be presented covering liquidation of all assets. ### Central Bank of Cyprus (CBC) governance and other supervisory gaps - CBC governance: - Current governance framework has not undergone significant revisions since inception and warrants updating. - CBC has hired an external advisor to assist in reorganization including high-level governance arrangements. - Pension funds and insurance companies supervision (MEFP ¶8): - Authorities identified significant deficiencies. - A report under preparation will outline future oversight landscape and provide an inventory of the fragmented pension fund system. - Necessary legislation to implement the report’s findings will be submitted to Parliament by the end of the year. - AML/CFT framework (MEFP ¶9): - On-site inspections of 11 banks in 2014. - Parliament adopted amendments to the Company Law to simplify registration/de-registration of non-compliant companies and strengthen the registrar’s enforcement powers. - Registrar to update corporate data and fully implement the governmental action plan. - Further work required in supervising banks and professions and enhancing company transparency via registrar reform. - Banks and professions supervisors to bolster institutional and staff capacity and coordinate with prudential bank supervisors. - For the branch of FBME operating in Cyprus, the CBC needs to continue appropriate actions based on inspection results to minimize reputational and financial risks. ### Fiscal policy outcomes and targets (MEFP ¶10–11) - 2014 fiscal outturn: - Cash primary surplus of 2.8 percent of GDP, significantly stronger than anticipated. - This outcome compares with the fourth review target of a 1.6 percent of GDP deficit. - Represents a 4½ percent of GDP improvement relative to 2013, achieved despite contraction of economic activity. - 2015 target: - Cash primary balance target for 2015: 1 percent of GDP, reflecting several one-off factors and a broadly neutral fiscal stance. - One-off factors include: - high CBC dividends in 2014; - payment of remaining compensation to pension funds for losses arising from the deposit bail-in; - a retroactive contribution to the EU budget due to the upward revision of the GDP series; - upfront costs related to the closure of Cyprus Airways. - Other impacts: entry into force of an EU directive changing taxation of certain services to a consumption-place basis and banks’ contribution to the European National Resolution Fund rather than into the budget. - Given limited fiscal measures and negligible automatic stabilizer effects, the targeted balance represents a broadly neutral fiscal stance for 2015. - Automatic stabilizers would be allowed to operate if the economy underperformed relative to the forecast. - Medium-term fiscal anchor: - Authorities will target a long-term primary surplus in a range of 3 to 4 percent of GDP, which will bring debt below 80 percent of GDP in 2020 (MEFP ¶11). - Program’s original anchor required sustaining a primary surplus of 4 percent of GDP from 2018 onwards to reduce debt-to-GDP to close to 100 percent by 2020. - With the revised debt path, a long-term primary surplus of between 3 and 4 percent of GDP is deemed consistent with ensuring public debt converges to a prudent level. - With this primary surplus target, debt would reach 80 percent of GDP in 2020 and continue declining thereafter. - Recognizing the upward revision of nominal GDP does not alter repayment capacity, debt would remain within the range deemed sustainable at program start (70–100 percent of GDP) for Cyprus. - Primary balance targets for 2016–17 were set at 2.4 and 3 percent of GDP, respectively, but could be revised if future events jeopardize the medium-term target. - For macroeconomic framework purposes, the primary surplus from 2018 onwards is assumed to be 3½ percent of GDP. ### Structural reforms (MEFP ¶12–16; Tables 12 and 13) - Social safety net: - A guaranteed minimum income scheme (GMI) introduced in July (end-June 2014 SB). - Authorities will monitor implementation, assess targeting accuracy and coverage, and build a national benefit registry to detect and prevent abuse. - Public debt management and guarantees: - New public debt management strategy approved by the COM (end-October 2014 SB). - Database of government guarantees completed; initial quarterly risk assessment reports prepared. - Institutional framework to manage guarantees designed; adoption of the new government guarantee management framework intended (new end-June 2015 SB). - Revenue administration: - Senior officials appointed to head new unified tax department; large taxpayer office established (end-December 2014 SB). - New tax debt recovery plan being implemented, including pilot exercise of new collection enforcement powers. - Authorities will complete merger of tax departments, strengthen large taxpayers office, and develop a new tax procedure code while protecting revenue collections during integration. - Public administration reform: - Reform to ensure affordability of the public wage bill once transitory freeze of wages and hiring limits expire, and to address distortions in compensation and staffing (new end-December 2015 SB). - Privatization preparations: - Preparations advanced for privatization of state-owned enterprises, including appointment of advisors for privatization of the telecommunications company and commercial activities of the Limassol port. - Business environment and growth: - Action plan adopted by COM to improve business environment and promote growth, with two pillars: - improving overall business environment by streamlining regulations and cutting red tape; - addressing bottlenecks impeding growth of the tradable sector. *Source: IMF staff report (text as provided).* ### 26. All but one of the performance criteria were met and compliance with structural ### _cr15155 - 26. All but one of the performance criteria were met and compliance with structural ### Program implementation and conditionality - All end-September 2014 PCs and continuous PCs have been met, except for the PC on accumulation of general government debt which was missed due to a delay in finalizing the asset swap between the government and the CBC associated with the valuation of the properties involved (MEFP Table 1). - The swap is now in its final stages and is expected to be finalized in Q3 of 2015. - Most SBs have been implemented, albeit with some delays (Table 10). The SB related to legacy Laiki was missed; a new plan is being designed (¶18). - New conditionality and rephasing of remaining purchases under the arrangement proposed (Table 9 and MEFP Tables 1 and 3): - Prior action: The amended foreclosure law was adopted in September 2014 (Technical Memorandum of Understanding, “TMU”, ¶15). Its suspension was lifted in April 2015. - Quantitative PCs: Quarterly PCs through end-December 2015 are proposed. - Structural benchmarks: Six new SBs are proposed. - Rephasing of arrangement: The availability date for the purchase under the eighth review would be set for September 15, 2015, with two more reviews following on a quarterly basis. ### Risks to program implementation and mitigation - Risks: - Opposition to program policies from political parties and vested interests could obstruct pending reforms, particularly as legislative elections approach. - In the financial sector, implementation of the new and untested debt restructuring framework could be hampered by legal obstacles and limited capacity, delaying balance sheet repair. - Mitigating factors: - Authorities’ strong commitment to the program and Cyprus’s track record of implementation. - Authorities are building capacity of actors involved in private sector debt restructuring and plan a full review of the framework to ensure effectiveness in early next year. ### Financing assurances and capacity to repay the Fund - Financing assurances: - Available government deposits of about €0.8 billion at end-April. - Expected proceeds of €0.1 billion from the transfer of the coinage function from the CBC to the Treasury by year-end. - Expected transfer of €0.1 billion central bank dividends in 2016. - Expected privatization proceeds (€0.5 billion) during the program period. - Undisbursed funds from the ESM/IMF. - These more than cover the €2.7 billion in projected financing needs through May 2016. - Capacity to repay: - Macro outlook, public finances and debt outlook are stronger relative to the fourth review. - Return to capital markets, if sustained, would facilitate repayment to the Fund. - Recent debt management operations have reduced immediate post-program financing needs. - Peak exposure to the Fund occurs in 2016 at 563 percent of quota or 6 percent of GDP. - Staff conclusion: Capacity to repay the Fund is comfortable, contingent on maintaining the reform path (Table 8). ### Staff appraisal — progress and policy recommendations - Progress: - Liquidity and solvency in the banking system have improved. - Public finances are on a stronger footing. - Important structural reforms are being implemented. - Growth turned positive in Q1 of 2015 for the first time since mid-2011. - Complete removal of external payment restrictions due to normalization of the banking system. - Key recommendations and observations: - Maintain reform momentum amid a difficult political environment; political obstacles were overcome for private debt restructuring legislation, but some deviations from international norms occurred. - Solve the NPL problem to ensure financial stability and boost growth: - Effective implementation of the new insolvency and foreclosure legislation is critical. - Make necessary adjustments to correct identified deficiencies and other issues arising in practice. - Ease asset sales restrictions and address backlog of un-issued and un-transferred title deeds to facilitate NPL management. - Strengthen banking supervision and continue bank restructuring: - Banks and coops should continue implementing restructuring plans and arrears management frameworks with well defined indicators and address deviations. - The CBC should continue to strengthen supervisory capacity, in partnership with the SSM. - Fiscal prudence warranted despite strong outturns: - Fiscal outturns significantly exceeded expectations in 2014, but public debt and contingent liabilities remain high. - Continue prudent budget execution and lock in fiscal savings from better-than-expected macro developments. - Thorough implementation of the new welfare system to protect vulnerable groups. - Execute public investment allocations to support recovery. - Continue structural reforms critical for public finances and growth: - Tax administration and public financial management reforms to increase tax base and support allocation of public resources. - Privatization reform to boost efficiency and attract investment. - Public administration reform to ensure sustainability of the wage bill after program expiration and enhance government efficiency. - Address weaknesses in the business environment to support growth prospects. - Staff supports: - (i) completion of the combined fifth, sixth, and seventh reviews; - (ii) request for a waiver of the nonobservance of a performance criterion as the deviation was temporary and minor; - (iii) establishment of performance criteria through end-December 2015; - (iv) rephasing of purchases under the arrangement. ### Labor market developments (Box 1) - Labor market stabilizing, but remains fragile. - Employment and unemployment: - Employment in 2014Q4 picked up by 1.2 percent year-on-year with a slight increase in labor force participation. - Unemployment rate stabilized at 16 percent. - Unemployment rate remains three times pre-crisis long-run average of 4¼ percent (2000–08). - Youth unemployment rate at 33 percent (fourth highest in the euro area), though declined from 2013 peak. - Long-term unemployment rose to almost 8 percent from below one percent prior to the crisis. - Unit labor costs (ULCs): - ULCs in the last quarter of 2014 were 13 percent below their peak in 2011; decline more pronounced in the nontradable sector, driven mainly by public sector wage cuts. - Employment composition: - Almost all net jobs lost over 2012Q4–2014Q1 were held by other EU nationals. - Share of other EU nationals in employment declined from 13½ percent to 10 percent over this period. - As of 2014Q4, Cypriot employment had picked up by 4½ percent year-on-year, while employment of other EU nationals declined by 7½ percent. - Policy implication: Labor market fragility highlights risks for medium term growth despite recent stabilization. ### External spillovers and the near-term baseline (Box 2) - Net impact on growth in the baseline from countervailing external shocks is close to zero for the year. - Russia: - Exports to Russia in 2013 were about 17 percent of exports (9 percent of GDP), up from 6 percent in 2007. - Tourism dependence on Russian arrivals increased from 19 percent in 2012 to about 25 percent in 2013–14 (about 4 percent of GDP). - Stock of Russian FDI in Cyprus stood at 150 percent of GDP in 2013, of which 90 percent via SPEs registered in Cyprus. - Value-added of services to these SPEs amounted to 4 percent of GDP. - Recession in Russia and ruble depreciation led to a 20 percent decline of Russian tourist arrivals in September 2014–April 2015 (year-on-year). - A reduction of tourism in 2015 by 20 percent is estimated to reduce growth this year by about ½ppt. - Total non-resident non-MFI deposits stood at 83 percent of GDP at end-March. - Greece: - Exports to Greece in 2013 accounted for about 6½ percent of exports (3½ percent of GDP), down from 13 percent in 2007. - Expected growth slowdown in Greece in 2015 is estimated to reduce Cyprus growth by about 0.1–0.2ppt this year. - Deposits in Cypriot subsidiaries of Greek banks account for 14 percent of total deposits, of which about €2.5 billion (14 percent of GDP) are insured. - Lower oil prices: - Cypriots spend €8 out of every €100 of disposable income on fuel. - A €10 decline in global oil prices (sustained for a whole year and assuming that 50 percent of the decline is passed through to lower gasoline prices) frees up disposable income equivalent to 0.3 percent of GDP. - A €25 decline in the baseline oil prices for 2015 relative to the Article IV Staff Report would boost GDP by 0.4 percent, but after import leakage the total impact on GDP is estimated at 0.2 percent. - Energy imports account for 20 percent of imports (8 percent of GDP). - A €25 decline in oil prices is estimated to reduce inflation by about 1ppt relative to the Article IV staff report. - Weaker euro and stronger EU recovery: - Depreciation of the euro against the sterling following QE enhances attractiveness for UK tourists; arrivals from Britain increased by 16 percent in the first four months of 2015. - Stronger EU recovery would boost exports (half of exports shipped to the EU). - Combined, these effects are expected to raise growth this year by ¼–½ppt. ### New legal insolvency framework (Box 3) - New legislation adopted on April 18 2015 based on Reform Strategy of July 2014; consists of five pieces of legislation: - (i) amendments to the Company Law to allow for faster and more cost effective liquidation of insolvent, nonviable companies; - (ii) a Law on Examinership to facilitate restructuring and rehabilitation of viable companies; - (iii) a Law on Insolvency Practitioners establishing qualification, licensing and regulation framework; - (iv) amendments to modernize the Bankruptcy Law to allow for a “fresh start” for insolvent debtors; - (v) a Law on Personal Insolvency allowing restructuring of secured and unsecured debts of insolvent individuals and debt relief for individuals with virtually no income or assets. - Divergences and concerns: - Amendments during Parliamentary discussions introduced provisions that may heavily favor debtors (e.g., suspension of enforcement, foreclosure or bankruptcy proceedings for up to six months for certain individual debtors; definition of “debt to a financial institution” limiting default interest rate to 2 percent). - These provisions may undermine incentives for debt restructuring and effective implementation; authorities committed to closely monitor roll-out and review laws to address weaknesses. - Protections for guarantors: - Special provisions limit potential impact on guarantors (limited to guarantees outstanding at adoption and loans already non-performing), including: - 3-year prohibition on foreclosure against guarantor’s primary residence in recourse to guarantee liability; - enhanced disclosure obligations towards guarantor in repayment plan procedure; - allowing payment of guarantors’ obligations in monthly installments taking into account reasonable living expenses over a 3-year period or longer; - limiting recourse by creditor to guarantor to 2 years following approval of debtor’s repayment plan, and by guarantor to other guarantor(s) and/or the debtor to 3 years following payment by guarantor; - limiting liability of guarantors whose net worth does not exceed a certain threshold for mortgages over primary residences not exceeding a certain threshold. - Obligations of guarantors who are natural persons are limited in the Examinership regime as long as guaranteed obligations do not exceed a certain threshold. - Way forward: - Establish Insolvency Service, train and license first insolvency practitioners, educate stakeholders and public, and adopt remaining acts and regulations. ### Explanation for strong 2014 fiscal outturn (Box 4) - Expectations vs actuals: - Projected overall general government cash deficit for 2014 at time of fourth review: -5.1 percent of GDP. - Actual overall general government cash deficit for 2014: -0.2 percent of GDP. - Projected general government primary cash deficit: -1.6 percent of GDP; actual primary surplus: 2.8 percent of GDP. - Four main factors explaining difference: - Shallower recession: - Real GDP contracted by 2.3 percent rather than projected 4.2 percent, resulting in higher revenues (2.6 percent of GDP) and lower social transfers (0.1 percent of GDP). - Large additional discretionary tightening: - Discretionary spending lower by 1.2 percentage points of GDP relative to projections, mainly due to lower goods and services and capital expenditures. - Favorable wage bill developments: - Wage bill was 0.6 percent of GDP lower than projected due to faster reduction in early retirements and general government employment. - Higher nominal GDP: - Change to ESA 2010 methodology increased nominal GDP by 10 percent, reducing balance as share of GDP by 0.5 percentage point. - Other factors: - ESA 2010 reclassification effects and a lower interest bill more than offset additional spending on sewerage boards’ projects and compensation of pension funds for banks’ bail-in impact. - Composition of additional revenue (Percent of GDP): - Taxes on Production and Imports: 0.7 - Social Security Contributions: 1.1 - Current Taxes on Income and Wealth: 0.3 - Other Revenue: 0.5 *International Monetary Fund staff summary of Cyprus program review and related analyses contained in the provided content unit.* ### Box 5. Fiscal Impulse in 2013–15 ### Box 5. Fiscal Impulse in 2013–15 ### Summary of findings - Fiscal policy, as measured by the fiscal impulse, had a contractionary impact on the economy in 2013–14, and is projected to be broadly neutral in 2015. - The negative fiscal impulse is estimated at 4 percent of GDP for 2014, and broadly neutral in 2015. - The smaller drag from fiscal policy in 2015 is identified as one factor that could help facilitate the recovery. ### Methodology and key assumptions - The fiscal impulse measure estimates the impact of discretionary fiscal policy on the economy, abstracting from one-offs and changes in fiscal aggregates caused by cyclical fluctuations. - The change in the primary balance is decomposed into three components: - (B) Fiscal adjustment (program measures and other tightening including measures related to higher than expected social contribution collections in 2014, reductions in the wage bill due to faster reduction in public employment, early retirements, and/or gratuity payments than anticipated, and unanticipated discretionary reductions in goods and services and capital expenditure). - (C) Estimated impact of macro developments (derived by excluding from the fiscal projection the impact of one-offs and of measures related to revenue and social transfers). - (D) Other (notably, the impact of one-offs, EU directives on revenue collection, and the change in nominal GDP on primary balance ratios). - Automatic stabilizers are estimated as a fixed percentage of the estimated impact of macro developments (E = C × share of macro impact that is temporary). - In a normal recession the temporary share is estimated at 70 percent. - For this banking crisis-related recession, automatic stabilizers are assumed to capture 50 percent of the macro impact (i.e., E = C/2), reflecting a larger permanent component of the macro impact. ### Quantitative estimates (Percent of GDP) - Fiscal Impulse Estimates (Percent of GDP, unless otherwise indicated) - Change in the Primary Deficit (cash basis, + means reduction) (A = B + C + D): - 2013: 1.3 - 2014: 4.4 - 2015: -1.9 - Total: 3.9 - Fiscal Adjustment (B) 1/: - 2013: 6.4 - 2014: 4.4 - 2015: 0.4 - Total: 11.2 - Estimated Impact of Macro Developments (C): - 2013: -5.2 - 2014: -0.8 - 2015: -0.4 - Total: -6.4 - Other (D): - 2013: 0.1 - 2014: 0.9 - 2015: -1.9 - Total: -0.9 - Estimated Fiscal Impulse of Automatic Stabilizers (E = C/2): - 2013: 2.6 - 2014: 0.4 - 2015: 0.2 - Total: 3.2 - Net Estimated Fiscal Impulse (+ means contractionary) (B − E): - 2013: 3.8 - 2014: 4.0 - 2015: 0.2 - Total: 8.0 ### Drivers of the 2014 contractionary impulse - 2014 tightening was driven primarily by: - Spending-side: reductions in the wage bill and in goods and services. - Revenue-side: higher social security contributions. - These measures more than offset higher social transfers stemming from more extensive use of safety net benefits, including unemployment insurance, and redundancy and retirement benefits. - Automatic stabilizers were limited in 2014 (consistent with the assumed 50 percent share for temporary effects in a banking crisis). ### Outlook for 2015 - Limited fiscal measures (mostly legislated at end-2012) and negligible automatic stabilizer effects given still-low growth imply a fiscal impulse close to 0 in 2015. - A near-neutral fiscal impulse is seen as reducing the drag from fiscal policy and helping facilitate the recovery. *Source: IMF Staff Estimates* ### Annex I. The NPL Problem: Assessing the Impact of the New ### Annex I. The NPL Problem: Assessing the Impact of the New Private Debt Restructuring Framework ### The NPL problem - Cyprus’s private sector debt is described as "over 400 percent of GDP." - Ratio of nonperforming loans (NPLs) over total loans in the domestic banking sector stands at "59 percent." - Credit to the private sector has contracted by "about 8 percent" in the last two years. - Given limited fiscal space and "high public debt," solutions relying on state support (e.g., state-backed asset management companies) are not available. ### Debt restructuring: framework, objectives, and incentives - Strategy focuses on enabling a private sector-led approach built on three pillars: - (i) building banks’ capacity to deal with NPLs, including by setting up internal workout units and procedures; - (ii) strengthening the supervisory framework; - (iii) reforming the legal framework for private sector debt restructuring to incentivize voluntary restructuring, with unilateral measures (such as liquidation) as a backstop. - Revised legislation aims to: - Provide incentives for borrowers via the threat of foreclosure to re-establish payments if able; - Incentivize banks to proactively restructure NPLs to avoid heavier losses from bankruptcy or liquidation. - The annex emphasizes holdout incentives in the absence of clear legal frameworks and highlights the role of foreclosure/insolvency regimes in reducing holdout behavior. ### Transmission channels and trade-offs of NPV-reducing restructurings - Debt restructuring that reduces net present value (NPV) affects credit through opposing channels: - Private Sector Deleveraging Channel: Reduction in private sector debt → Higher credit demand. - Bank Lending Channel: Hit on bank capital and tighter lending policy → Tighter credit supply. - Uncertainty Channel: Reduction in uncertainty and greater confidence → Support to both supply and demand. - The net impact on credit is empirical and depends on the balance of these channels and on how uncertainty evolves. - The positive effect of lower debt may take time because large-scale restructuring is disruptive. ### Empirical estimate of the impact of insolvency-driven debt reduction on credit growth - Assessment context and scenario parameters: - NPLs eligible for insolvency process as assessed by banks: "€1–3 billion (6–7 percent of GDP)." - Scenario parameters used: - Portfolio at risk of strategic default: either "€1 billion" or "€3 billion" (equal to eligible portfolio). - Strategic default ratio: "15 or 30 percent" of the at-risk portfolio may actually default. - Additional write-downs required beyond existing provision coverage ratio of "33 percent": "10 or 20 percent." - Resulting estimated ranges: - Insolvency process could bring about a debt reduction in the private sector of "about €0.5–2.1 billion or 3–12 percent of GDP." - Corresponding impact on bank capital due to additional provisioning: "€0.2–1.1 billion." - Estimated effect on credit growth: - Cross-country variation in the euro area (2000–14) yields: "a 1 percentage point decline in private sector debt is associated with a 0.2 percentage point increase in credit growth." - Applying this elasticity to the estimated debt reduction ("€0.5–2.1 billion, or 3–12 percent of GDP") implies that lower private debt could raise credit growth by "between 0.6–2.4 percentage points" over the medium term. - Key assumptions and caveats for this estimate: - Assumes banks were adequately capitalized according to the comprehensive assessment exercise and that the additional impact on bank capital ("€0.2–1.1 billion") will not significantly tighten credit supply. - Assumes no mid-term effect from a reduction to corporate debt (restructured companies are not expected to increase leverage anytime soon). - The calculation is acknowledged to be speculative and to rest on strong assumptions. ### Voluntary restructuring, short-term dynamics, and dampening factors - Voluntary restructuring upside: - Any impact from voluntary restructuring would be an upside to the insolvency-based estimate. - In the first three quarters of 2014, credit facilities restructured amounted to "12 percent of NPLs (19 percent of GDP)," though a substantial fraction of these solutions are at significant risk of re-default. - Factors that could dampen credit recovery even if deleveraging occurs: - Availability of good quality borrowers: the pool has shrunk given high NPLs and uncertainty about already restructured loans. - Sensitivity of bank capital to writedowns: a large capital impact may inhibit lending capacity and risk appetite. - Impact on banks’ lending policy: the new framework may affect lending decisions; literature suggests potential regressive impacts on credit allocation and increased lending rates in some contexts (cited studies). ### Linking credit growth to economic growth - A simple model for euro area countries regresses real GDP growth on growth of household debt and real government expenditure, controlling for country and time fixed effects (based on Martin and Philippon (2014)). - Results: - Credit growth is an important determinant of GDP growth in the euro area generally. - For Cyprus (and similarly Greece and Ireland), credit growth has lower explanatory power for GDP growth, suggesting other factors may be hindering economic recovery. - Even if credit growth recovers in Cyprus, effective policies targeting other areas of the economy may be needed to restore growth. *Prepared by Ruchir Agarwal, Alejandro Hajdenberg and Oliver Wuensch.* ### 2013. Finally, these indicators should be interpreted with caution, given the unusually high ### _cr15155 - 2013. Finally, these indicators should be interpreted with caution, given the unusually high ### Debt structure: vulnerabilities and mitigating factors - Significant external gross financing needs reflect mainly the large amount of foreign deposits; improved conditions have led to their stabilization and have allowed the removal of external payment restrictions. - Large share of public debt owned by non-residents reflects mainly the large official financing in the context of the program, the Russian loan, and loans from the EIB and CEDB. - The relatively low and/or fixed interest rate of official liabilities combined with their long term maturity mitigates interest rate and financing risks. - Bond yields and spreads remain higher than in other countries but have been on a steady decline (see chart in page 7). ### Public sector debt vulnerability: main stress test results and scenarios - Growth risk: - Assumption: decline in growth by two historical standard deviations (i.e. about 7 percentage points) for 2016 and 2017. - Assumption: corresponding deterioration in non-interest revenue of 0.4 percent per percentage point of growth reduction, recovering to baseline levels in two years thereafter. - Assumption: decline of 0.25 percentage points per point of growth of the deflator. - Result: debt ratio would increase to 114 percent of GDP by 2016 and 120 percent by 2020. - Primary balance risk: - Assumption: shock reducing the planned fiscal adjustment in 2016–18 by 80 percent (captures risk of reform fatigue). - Result: debt ratio would increase to 100 percent of GDP in 2016 and to 83 percent of GDP by 2020. - Interest rate risk: - Note: growing share of official financing in coming years reduces interest rate risks, but ESM financing and new market financing after the program depend on market conditions. - Assumption: shock increasing the real interest rate by 3 percentage points each year during 2016–20. - Result: debt would reach 99 percent of GDP in 2016 and slightly above 79 percent of GDP in 2020. - Combination of macro-fiscal risks: - Combination of the growth, interest rate, and primary balance shocks above would lead to a debt ratio of 114 percent of GDP in 2016 and 124 percent of GDP in 2020. - Deflation scenario: - Risk: deflator growth could be lower than envisaged if downward wage pressures or oil price pass through to prices is more persistent. - Result: debt would increase to 100 percent of GDP in 2016 and 83 percent of GDP in 2020. - Slower recovery scenario: - Assumption: slower and prolonged deleveraging including due to implementation problems of the new public debt restructuring framework. - Combined with a lower deflator (0.25 pt per point of growth). - Result: debt would rise to 100 percent of GDP in 2016 and to 87 percent of GDP by 2020. - Risks related to asset swap and privatization proceeds (not shown): - If the €0.6 billion debt swap were not carried out, debt in 2020 would increase by about 3 percentage points of GDP. - If the envisaged privatizations were not implemented, this would increase debt by about 8 percentage points of GDP in 2020. ### Contingent liabilities and bank-related shocks - Use of program buffer changed from assumed non-debt creating operations to debt-creating capital injections would raise public debt. - Illustration: a €1 billion bank recapitalization need assumed. - Result: debt would reach 104 percent of GDP in 2016 and 86 percent of GDP in 2020. - Implicit contingent liabilities from banks’ reliance on central bank financing pose similar risks to debt sustainability (not shown). - Full materialization of government loan guarantees: - Assumption: all €3 billion government guarantees are called. - Result: debt would reach 116 percent of GDP in 2016 and 101 percent of GDP in 2020. ### Baseline projections and key numerical indicators (selected figures as reported) - Nominal gross public debt (in percent of GDP): 2013: 60.4; 2014: 102.2; 2015: 107.5; 2016: 106.3; 2017: 98.4; 2018: 92.3; 2019: 87.6; 2020: 82.3; 2021: 78.7; 2022: 74.5; (cumulative to 2022) 70.7. - Public gross financing needs (in percent of GDP): 2013: 12.4; 2014: 17.4; 2015: 16.0; 2016: 13.3; 2017: 6.8; 2018: 4.2; 2019: 5.6; 2020: 9.4; 2021: 11.6; 2022: 6.5; 2022 projection: 7.3 (table entries shown). - Real GDP growth (in percent): 2013: 2.1; 2014: -5.4; 2015: -2.3; 2016: 0.2; 2017: 1.4; 2018: 2.0; 2019: 2.2; 2020: 2.1; 2021: 1.8; 2022: 1.9. - Inflation (GDP deflator, in percent): 2013: 2.7; 2014: -1.4; 2015: -1.2; 2016: -0.9; 2017: 0.7; 2018: 1.2; 2019: 1.4; 2020: 1.7; 2021: 1.6; 2022: 1.9; 2022: 1.5 (table entries shown). - Primary deficit (in percent of GDP): 2013: 0.0; 2014: 1.6; 2015: -2.8; 2016: -1.0; 2017: -2.4; 2018: -3.0; 2019: -3.6; 2020: -3.6; 2021: -3.6; 2022: -3.6; cumulative to 2022: -17.2. - Primary (noninterest) revenue and grants (in percent of GDP): 2013: 37.9; 2014: 37.6; 2015: 40.2; 2016: 39.3; 2017: 39.2; 2018: 38.8; 2019: 39.0; 2020: 39.0; 2021: 39.1; 2022: 39.0; cumulative: 234.4. - Primary (noninterest) expenditure (in percent of GDP): 2013: 38.0; 2014: 39.2; 2015: 37.4; 2016: 38.4; 2017: 36.8; 2018: 35.8; 2019: 35.8; 2020: 35.4; 2021: 35.5; 2022: 35.4; cumulative: 217.1. - Effective interest rate (in percent): 2013: 4.9; 2014: 3.3; 2015: 2.9; 2016: 2.5; 2017: 2.3; 2018: 2.2; 2019: 2.4; 2020: 2.5; 2021: 2.9; 2022: 3.1; 2022: 3.2 (table entries shown). - Change in gross public sector debt (cumulative, percent of GDP): 2013: 1.8; 2014: 22.7; 2015: 5.3; 2016: -1.2; 2017: -7.8; 2018: -6.1; 2019: -4.7; 2020: -4.7; 2021: -4.2; 2022: -4.2; cumulative to 2022: -28.8. - Automatic debt dynamics (contribution, percent of GDP): 2013: 0.0; 2014: 8.4; 2015: 6.6; 2016: 3.4; 2017: 0.2; 2018: -0.9; 2019: -1.1; 2020: -1.1; 2021: -0.5; 2022: -0.5; cumulative to 2022: -0.1; to 2022: 0.1. - Of which: real interest rate contribution (percent): 2013: 1.1; 2014: 3.9; 2015: 4.2; 2016: 3.7; 2017: 1.7; 2018: 1.0; 2019: 0.9; 2020: 0.7; 2021: 1.0; 2022: 0.9; cumulative: 1.2; 2022: 8.9. - Of which: real GDP growth contribution (percent): 2013: -1.2; 2014: 4.6; 2015: 2.4; 2016: -0.3; 2017: -1.5; 2018: -1.9; 2019: -2.0; 2020: -1.8; 2021: -1.5; 2022: -1.4; cumulative: -1.3; 2022: -8.8. - Other identified debt-creating flows (percent of GDP): 2013: 1.8; 2014: 12.6; 2015: 1.5; 2016: -0.8; 2017: -5.7; 2018: -2.2; 2019: 0.0; 2020: 0.0; 2021: 0.0; 2022: -0.1; cumulative: 0.0; to 2022: -8.7. - Net privatization/asset sales proceeds (negative, percent of GDP): 2013: 0.0; 2014: 0.0; 2015: 0.0; 2016: -0.6; 2017: -5.6; 2018: -2.2; 2019: 0.0; 2020: 0.0; 2021: 0.0; 2022: 0.0; cumulative to 2022: -8.4. - Residual, including asset changes (percent of GDP): 2013: 0.0; 2014: 0.0; 2015: 0.0; 2016: -2.9; 2017: 0.0; 2018: 0.0; 2019: 0.0; 2020: 0.0; 2021: 0.0; 2022: 0.0; cumulative to 2022: -2.9. - Baseline assumptions highlighted in scenario tables: - Real GDP growth (percent): 2015: 0.2; 2016: 1.4; 2017: 2.0; 2018: 2.2; 2019: 2.1; 2020: 1.8; 2021: 1.8; 2022: 1.9. - Inflation (percent): 2015: -0.9; 2016: 0.7; 2017: 1.2; 2018: 1.4; 2019: 1.7; 2020: 1.6; 2021: 1.9; 2022: 1.5. - Primary Balance (percent of GDP): 2015: 1.0; 2016: 2.4; 2017: 3.0; 2018: 3.6; 2019: 3.6; 2020: 3.6; 2021: 3.6; 2022: 3.6. - Effective interest rate (percent): 2015: 2.5; 2016: 2.3; 2017: 2.3; 2018: 2.4; 2019: 2.5; 2020: 2.9; 2021: 3.1; 2022: 3.2. *Italic: Source: IMF staff estimates (content from the provided IMF document).* ### Appendix I. Cyprus: Letter of Intent ### Appendix I. Cyprus: Letter of Intent ### Recent developments and outlook - Output contracted by 2.3 percent in 2014, compared to the fourth review forecast of 4.2 percent and to 5.4 percent in 2013. - Expectation of a return to positive economic growth in the second half of 2015 and envisaged growth of 0.2 percent for 2015. - Primary surplus in 2014 close to 3 percent of GDP (excluding the recapitalization of the cooperative sector). - All quantitative performance criteria (PC) for end-September 2014 and indicative targets for end-December 2014 were observed, except the PC on the ceiling on the stock of general government debt at end-September 2014 (missed due to a delay in completing the debt-asset swap between the government and the Central Bank of Cyprus). - Financial system recovery indicators: Comprehensive Assessment by the European Central Bank, stabilization of deposit base, increasing banking system liquidity, removal of remaining external payment restrictions on April 6, 2015, and successful international bond issuance in April (second since the 2013 crisis). - Risks to the outlook: stronger contraction of the Russian economy could negatively affect exports; euro depreciation could be an upside risk; slower progress on addressing NPLs could delay balance-sheet repair and constrain medium-term growth. ### Financing requests and program adjustments - Request completion of the fifth, sixth, and seventh reviews under the EFF arrangement and three purchases under this arrangement in the amount of SDR 74.25 million each. - Request waiver for non-observance of the end-September 2014 PC on the ceiling on the stock of general government debt. - Request establishment of new quantitative PCs for end-June 2015, end-September 2015, and end-December 2015. - Request re-phasing of the remaining undisbursed amount evenly over three reviews instead of four as per the original schedule. ### Financial sector policies — addressing high NPL levels - NPL ratio for the core domestic banking sector reached 59 percent at end-December 2014. - Central priorities: strengthen legal framework and supervisory tools for arrears management; make functional foreclosure and insolvency regimes operational to incentivize voluntary restructurings and expedite balance-sheet clean-up. Subsection: Legal framework - Foreclosure framework: - Enacted amendments to the foreclosure law to streamline the foreclosure process and provide incentives for voluntary debt restructurings. - Necessary regulations adopted; review of civil procedure and court rules to be completed and necessary changes adopted by end July 2015, including legislative amendments if warranted. - Insolvency framework: - Mid-April parliamentary adoption of a package of five pieces of legislation: (1) amendments to the Company Law for faster, cost-effective liquidation of insolvent, nonviable companies; (2) a Law on Examinership to facilitate restructuring and rehabilitation of viable companies; (3) a Law and regulations on Insolvency Practitioners establishing qualification, licensing and regulation; (4) amendments to modernize the Bankruptcy Law to allow discharge after three years of bankruptcy, subject to safeguards; (5) a Law on Personal Insolvency allowing restructuring of secured and unsecured debts and debt relief for individuals with virtually no income or assets. - Implementation steps: establish and launch the new Insolvency Service; adopt administrative acts and regulations by end-August 2015 (new structural benchmark); prepare an action plan for capacity building of courts and other actors; review relevant civil procedure and court rules by end-September 2015. - Monitoring: continuous monitoring to identify deviations from international best practices; concerns noted that explicit provisions allowing debtors to apply for suspension of enforcement without obligation, and provisions shielding guarantors, could weaken incentives—will monitor performance continuously. - Review of the framework: submit to the Council of Ministers by end September 2015 any necessary adjustments to insolvency and foreclosure frameworks, including legislative changes (new structural benchmark); comprehensive review of private sector debt restructuring legal framework by early 2016 with an action plan of modifications. - Title deeds: - By end-June 2015, adopt legislation ensuring ownership of titles reflects economic ownership at all times (new structural benchmark), covering future transactions and legacy cases with rule-based mechanism for equitable treatment and compensation if available. - Financial sector impact assessment performed by the CBC in close cooperation with the Ministry of Interior will inform legislation. - By end-October 2015, present legal or contractual standards for property sales contracts and connected loan and mortgage arrangements to program partners, and propose further measures to incentivize swift transfer of title deeds. Subsection: Banks’ arrears management capacity - Adopted a revised Arrears Management Framework and Code of Conduct, limiting protections to individuals and small and micro-enterprises up to a pre-determined threshold and covering treatment of guarantors consistent with the insolvency framework. - CBC to publish a comprehensive and user-friendly guide to restructuring under the Code of Conduct on its website. - CBC will assess appropriateness of restructuring solutions using a semi-annual sustainability audit available since end-May 2015 and repeated twice yearly; by end-June 2015 the CBC will provide to the SSM its findings and recommendations regarding revision of banks’ internal policies and processes for follow-up. - Debt resolution targeting framework: - CBC will agree with banks on institution- and portfolio-specific targets for phases of the restructuring process for at least the following two quarters on a rolling basis. - CBC will publish aggregate targets and banks’ past performance after each quarter, first publication by end-July 2015 (new structural benchmark), explaining discrepancies and revisions. - Supervisory reporting improvements: banks to submit data in line with revised requirements starting with the third quarter of 2015. - CBC to carry out and publish a study of the financial situation of borrowers by end-July 2015 to assess strategic defaults and inform debt-resolution policies. - Core banks required to submit updated condensed capital and funding plans based on updated and consistent economic assumptions, including on resolution of non-performing assets; plans to be updated quarterly. - Secondary market for loans: - Task force evaluating actions to promote development of a secondary market for distressed assets and facilitate transfer of existing loans. - Legislative changes to remove impediments to securitization, including removal of requirement to obtain prior consent of borrowers, to be submitted to Parliament by end-July 2015. - By end-June 2015, Council of Ministers to approve legislation enabling sale of loans to non-banks while retaining borrower protections under the Code of Conduct. ### Restructuring of the Cooperative Credit Sector - Sector has undergone thorough restructuring and passed the ECB’s Comprehensive Assessment; executive management strengthened and IT provider placed under control of the Cooperative Central Bank (CCB). - Remaining deficiencies: operational, staffing, and information technology issues slowing loan restructuring. Focus areas and deadlines: - Arrears management: coops required to submit by end-June 2015 a time-bound action plan to address deficiencies and strengthen arrears management capacity via external operational support. - Governance: by end-June 2015 streamline CCB’s divisions and enhance control functions, centralize where possible; amend the affiliation directive by end-June 2015 to strengthen CCB oversight over Cooperative Credit Institutions (CCIs). - Financial control and risk processes: CCB conducted an independent audit and submitted in March a time-bound action plan; by July 2015 CCB will submit an implementation strategy to ensure a smooth transition and management of additional responsibilities. ### Normalizing financial flows and liquidity - CBC will continue to ensure adequate liquidity in the banking system following full liberalization of deposits and external flows; stands ready to take appropriate measures following Eurosystem procedures and rules. - Although liquidity has improved, additional government guarantees in line with state aid rules for issuance of bank bonds could be used as collateral for liquidity, but only if necessary to safeguard financial stability. *Source: Appendix I. Cyprus: Letter of Intent (Nicosia, May 29, 2015).* ### 7. We will continue strengthening banking supervision. To this end, we have two near-term ### 7. We will continue strengthening banking supervision. To this end, we have two near-term priorities ### Banking supervision: near-term priorities - Transition to the SSM - The CBC has presented a supervisory work plan of its involvement in the SSM supervisory activities in 2015. - The CBC has hired ten additional staff to ensure sufficient resources are available to carry out its duties. - Further staffing needs will be determined by end-June 2015, also taking into account increased responsibilities in the area of bank resolution. - Resolution of Laiki - The resolution authority will finalize in June 2015 a plan for completing the resolution of Laiki. - The full implementation of the plan will be completed without delay. ### Strengthening insurance and pension fund supervision - By end-September 2015, present a report with proposals to improve the capacity and governance of the insurance and pension fund supervisors in line with international best practice. - The report will: - Set priorities for the next steps. - Provide a comprehensive inventory of pension and provident funds. - The corresponding legislative proposal will be submitted to Parliament by end-December 2015. ### Strengthening the AML/CFT framework - AML/CFT supervision of banks - The CBC implemented in 2014 a new risk-based AML/CFT supervision methodology. - The CBC completed the remaining onsite inspections reports from the 2014 supervisory plan in March 2015 and will apply, as needed, appropriate supervisory measures. - The CBC has adopted its risk based supervision plan comprising 13 credit institutions (including 4 CCIs) that will be implemented by end December 2015. - The CBC put the local branch of FBME Bank Ltd. under resolution after its designation by the US authorities as a financial institution of primary money laundering concern and will continue taking appropriate supervisory actions. - AML/CFT supervision of professions - Supervisors of lawyers, accountants, and trust and company service providers will adjust the risk-based tools by end June 2015. - These tools will be used to develop comprehensive annual inspection programs to be implemented by end December 2015. - Registrar of Companies - Parliament adopted amendments to the company law in mid-May to streamline registration and de-registration of non-compliant companies and strengthen the Companies Registrar enforcement powers. - Following adoption by the House of Representatives, implementation of the reform will start by the end of July 2015. ### Fiscal policy: outcomes and targets - 2014 outturn - The cash primary surplus—excluding the recapitalization of the cooperative sector—was 2.8 percent of GDP in 2014, exceeding the target. - Drivers: stronger than anticipated economic activity (higher tax revenues and social security contributions); faster reduction in early retirements lowering wage bill; containment of discretionary spending reducing intermediate consumption and capital expenditure. - 2015 target and adjustments - Revised 2015 cash primary balance target: 1 percent of GDP. - Accommodations factored into the 2015 target: - Loss of revenues due to EU directives on changes to the VAT place of supply for certain services. - Contribution to the National Resolution Fund. - Lower central bank dividends. - One-off factors including: a retroactive contribution to the EU budget arising from the ESA 2010 GDP revision; compensation payments to pension funds related to bank restructuring; and other specific outlays. - 2016–2018 targets - 2016 cash primary balance target: surplus of 2.4 percent of GDP. - 2017 cash primary balance target: surplus of 3 percent of GDP. - Target for 2018 and thereafter: primary surplus in a range of 3 to 4 percent of GDP (revised from 4 percent previously) to maintain debt on a clear downward path. ### Structural reforms: welfare, tax administration, fiscal risks, privatization, public administration - Welfare reform (Guaranteed Minimum Income, GMI) - Fully staffed unit established to monitor implementation; benefit payments started. - Actions and timelines: - By end-June 2015: prepare plans to consolidate disability and education benefits in line with adopted welfare reform. - By end-September 2015: require recipients of social benefits to declare all benefits received; finalize an assessment report of GMI implementation covering outcomes, number of applications, fiscal costs, targeting accuracy, and coverage; discuss possible refinements. - By end-December 2015: build a registry of benefits in line with new welfare law including profiles and eligibility of all beneficiaries, cross-checked with other databases. - By end-March 2016: re-examine the overall welfare reform once the registry is in place to realize efficiency gains from consolidated information. - Note on registry: will link three registries via an interface—Ministry of Labor, Welfare and Social Insurance; Ministry of Education and Culture; and Ministry of Interior—to establish a single view of social benefits for each beneficiary. - Tax administration reform - Legislation passed to integrate two tax authorities into a single Department of Taxation and to enhance tax collection enforcement powers. - Addressing tax arrears and evasion - Finalized a tax debt recovery plan as part of a wider compliance improvement strategy. - Implementation has started, including pilot use of bank garnishing powers. - Quarterly implementation reports to monitor progress; first quarterly progress report to be prepared by end-June 2015. - Reforming the revenue administration - In January, established a new large taxpayer office (LTO) covering 40 percent of total revenue collections. - By end-June 2015: establish a single registration process for all domestic taxes. - By end-December 2015: LTO to be fully functional including taxpayer services, risk assessment and compliance activities aiming to expand coverage to 50 percent of total revenue collections; allocate appropriate human resources. - By end-September 2015: an integrated legal framework for tax procedures under a new tax procedures code to be approved by the Council of Ministers. - Fiscal risks from government guarantees and FRBSL implementation - Stock of government guarantees: 20 percent of GDP. - With a comprehensive guarantee database in place: - Council of Ministers to approve by end June 2015 the institutional framework to monitor and manage existing and new government guarantees (new structural benchmark). - Framework to define responsibilities for the MoF and line ministries, and guidelines/procedures for issuance, management, restructuring, and recovery of guarantees. - Update of risk assessment report by end-June 2015. - Public investment guidelines finalized and submitted to the Council of Ministers; Council to approve guidelines by early June. - Pending FRBSL regulations to be approved by the Council of Ministers by end-June 2015 and by Parliament by end-September 2015. - Privatization of state-owned enterprises - A privatization unit has been established and is operational. - Advisors selected for privatization of CyTA (telecom company) and commercial activities of CPA in Limassol port. - Legislation to convert CyTA into a limited liability company to be adopted by end-September 2015. - Regulatory framework amendments for CPA privatization by end-October 2015. - By end-July 2015: hire an independent energy advisor to prepare a study for legal unbundling and ownership structure of EAC and required regulatory review. - Legal unbundling of EAC to be implemented by end-March 2016. - Other public administration and growth measures - Implementing the Action Plan for Growth to improve the business environment. - Develop a time-bound action plan to strengthen enforcement of contracts, including streamlining judicial procedures. - By end-September 2015: prepare an action plan with measures to simplify regulations and licensing requirements hampering businesses. - Public administration reform package - By end-June 2015: submit a reform package (including revision of the wage setting framework and opening of promotion posts to the wider civil service) to the Council of Ministers for adoption by Parliament by end-December 2015 (new structural benchmark). - Salary and employment decisions to be consistent with a public wage bill as a share of GDP on a descending path over the medium term. - Complementary reforms to enhance staff mobility to promote efficient allocation of human resources. ### Program financing, monitoring, and IMF requests - Financing - Transfer of rights and liabilities associated with coins issuance from the CBC to the MoF and additional financing of €100 million associated with this transfer by end-December 2015. - CBC expected to transfer an additional €100 million in central bank profits to the government during 2016. - Intention to issue additional debt in international markets in the second half of the year to smooth maturities and minimize refinancing risk after the program, market conditions permitting. - IMF program review and disbursements - Request completion of the combined fifth, sixth, and seventh reviews under the Extended Fund Facility Arrangement and a disbursement of SDR 222.75 million. - Request that the remaining amount under the EFF (SDR 297 million) be re-phased in three equal disbursements over the remainder of the arrangement. - Monitoring - Policies will be monitored through quarterly PCs and reviews. - Program includes continuous performance criteria, indicative targets, and structural benchmarks as defined in annexed Tables and the Technical Memorandum of Understanding (TMU). - Continuous performance criteria include: non-accumulation of external payment arrears; non-imposition of restrictions of payments and transfers for current international transactions; and non-introduction of multiple currency practices. - Authorization - Government authorizes the IMF to publish the Memorandum of Economic and Financial Policies, its attachments, and the related staff report. ### Quantitative conditionality and targets (selected figures from tables) - Floor on the general government primary balance: 4029 (Jun-15 target), 552 (Sep-15 adjusted target) ... (table presents additional period-specific numbers). - Ceiling on the stock of general government debt: 18,172 (Jun-15 target), 18,393 (Sep-15 adjusted target), 18,994 (Dec-15 target) ... (table contains further quarterly figures). - Financing and program numbers: - €100 million associated with CBC coins transfer by end-December 2015. - €100 million additional CBC profits transfer expected during 2016. - Disbursement request: SDR 222.75 million. - Remaining EFF amount: SDR 297 million to be re-phased in three equal disbursements. ### Technical Memorandum of Understanding (TMU): reporting and definitions - Program exchange rates for valuation of foreign currency-related items: - €1 = U.S. 1.1221 dollar - €1 = 134.90 Japanese yen - €1.25403 = 1 SDR - Reporting standards - MOF and CBC will employ reporting standards and templates considered appropriate given data transmission covered by the TMU, unless otherwise stated or agreed with the EC, the ECB and the Fund. - Definition of general government for program purposes (per ESA 2010) - Includes: - Central government: Constitutional Powers, Constitutional Services, Independent services, Independent offices, Ministries and supervised departments, 21 special purpose funds, and 14 semi government organizations. - Local governments: 39 municipalities, 356 village authorities, and attached agencies/institutions classified as local governments. - Social security funds: medical treatment scheme, regular employees’ provident fund, social insurance fund, holiday fund, redundancy fund, protection of the rights of employees’ fund. - Any newly created institution defined as general government under ESA 2010. - Government will inform IMF, EC and ECB staff immediately of creation or pending reclassification of any such funds, programs, or entities. - For program monitoring, general government for a given year shall not include entities re-classified from outside general government into general government during that year. *Cyprus — IMF staff report excerpt as provided in the source content unit.* ### 5. The performance criteria are set on the general government cash primary balance (GGPCB), ### _cr15155 - 5. The performance criteria are set on the general government cash primary balance (GGPCB), ### Definition of the General Government Cash Primary Balance (GGPCB) - GGPCB is defined as the general government cash balance (GGCB) minus general government interest receipts plus general government interest payments. - GGCB is defined as total revenue (tax revenue, social security contributions, grants and other revenue) minus total expenditure. - The payment of called guarantees will be recorded as cash expenditures. - Privatization receipts, as defined below, and the proceeds from the sale of land and buildings, will be excluded from revenue. - The floor on the GGPCB in each year will be measured cumulatively from the start of that calendar year. - Privatization receipts are those receipts associated with the disposal to private owners by a government unit of the controlling equity of a public corporation or quasi-corporation. - The floor on the GGPCB will be adjusted downwards by the payments related to bank support, when carried out under the program’s banking sector support and restructuring strategy. Transactions that may be excluded from the balance include loans to financial institutions and investments in equity of financial institutions (requited recapitalization); unrequited recapitalization and purchases of troubled assets. - Any financial operation by central government to support banks, including the issuance of guarantees or provision of liquidity, will be immediately reported to IMF, European Commission and ECB staff. ### Adjustments to the GGPCB floor (2015 specific) - The 2015 targets will be adjusted downwards by the payments to compensate pension funds for the losses related to the resolution of Laiki Bank up to €4.5 million. - The 2015 targets will be adjusted upwards by the dividends received from the CBC in excess of €133 million and in excess of €58 million from the semi-government organizations. - The 2015 targets will be adjusted downwards by the dividends received from the CBC below €133 million and below €58 million from the semi-government organizations. - The 2015 targets will be adjusted downwards by the payments to cover called government guarantees up to €80 million. ### Ceiling on the General Government Primary Expenditure (GGPE) - GGPE includes compensation of employees, goods and services, subsidies, social benefits, other recurrent expenditure, and capital expenditure. - The ceiling on the GGPE will be adjusted upwards by the payments related to bank support, when carried out under the program’s banking sector support and restructuring strategy. Transactions that may be excluded include loans to financial institutions and investments in equity of financial institutions (requited recapitalization); unrequited recapitalization and purchases of troubled assets. - Any financial operation by central government to support banks, including issuance of guarantees or provision of liquidity, will be immediately reported to IMF, European Commission and ECB staff. - The 2015 ceilings on the GGPE will be adjusted upwards by the payments to compensate pension funds for the losses related to the resolution of Laiki bank up to €4.5 million. - The 2015 ceilings will be adjusted upwards by the payments to cover called government guarantees up to €80 million. ### Ceiling on the Stock of General Government Debt - General government debt constitutes total outstanding gross liabilities as defined by ESA 2010, includes debt of all institutions included in the general government and other ESA 2010 adjustments. - Debt will be measured at nominal value. - The program exchange rate will apply to all non-euro denominated debt. Adjustments to the debt ceiling: - Upwards (downward) by the amount of any upward (downward) revision to the stock of end-December 2014 general government debt. - Upwards (downwards) by the amount of any increase (decrease) to the disbursement of the Cyprus Entrepreneurship fund EIB loan, currently projected at €20 million for 2015. - Upwards, by debt arising from payments for bank restructuring carried out under the program’s banking sector support and restructuring strategy. These payments may include loans to financial institutions and investments in equity of financial institutions (requited recapitalization); unrequited recapitalization and purchases of troubled assets. Any such central government financial operation to support banks will be immediately reported to IMF, European Commission and ECB staff. - Upwards by the amounts disbursed under the EIB loan to finance projects authorized in the 2015 budget under the National Strategic Reference Framework. - Upwards by €600 million if the debt-to-asset swap between the government and the central bank is not finalized according to the current timeline. - Upwards by the size of the revision of the stock of general government debt due to methodological changes in the definition of the government sector. ### Ceiling on the Accumulation of New General Government Guarantees - The ceiling includes 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. - The stock of guarantees at end December 2014 was €2.95 billion. - For reporting purposes, the stock of guarantees within the year will be derived on the basis of material fluctuations. Adjustments to the guarantees ceiling: - 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 2015 relative to the amounts presented in Table 1 of the MEFP. The annual provision of guarantees cannot exceed €131 million. ### Ceiling on the Accumulation of External Arrears (continuous performance criterion) - External payment arrears are payments on debt to non-residents contracted or guaranteed by the general government, which have not been made within seven days after falling due. - The stock of external payment arrears as of end-December 2014 was €0. ### Ceiling on the Accumulation of Domestic Arrears (performance criterion) - Domestic expenditure arrears are unpaid invoices that have past the due date by 90 days by the budgetary central government, extrabudgetary funds, semi-government organizations, and local governments excluding village communities. - If no due date is specified on the supplier contract, an unpaid commitment is considered to be in arrears 90 days after the initiation of the invoice. - The stock of domestic expenditure arrears as of end 2014 was €9.6 million. - Increases below €1 million will not be considered a breach of the performance criterion. ### Ceiling on the Accumulation of VAT Refund Arrears (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. - The stock of VAT refund arrears as of end-December 2014 was €117.3 million. - The stock of VAT refund arrears shall not exceed 150 million euros. ### Monitoring of Prior Actions, Structural Benchmarks and MEFP Commitments - Prior action: Adoption by parliament of amendments to the Mortgage Law (“Foreclosure Law”). - Specification: new foreclosure procedure elements: - Only condition for initiation is default on payment of more than 120 days past, while acknowledging mortgage creditor may be otherwise stayed by other laws or rules. - Swift procedures for obtaining market valuation by independent valuators. - Allow initial auction with reserve price at 80% of market value, subsequent lowering of reserve price to no less than 50% after three months of initial auction, and a new valuation after 12 months of unsuccessful auctions or sales after the initial auction, maintaining a reserve price of no less than 50% of this new valuation. - Precise deadlines for all procedural steps and respective preclusive periods for appeals. - Provisions to safeguard integrity of foreclosure process, including transparency and anti-fraud provisions. - Regulations pursuant to the new law will facilitate a swift and transparent sale process without delays or hurdles. - AML supervision implementation: - On a quarterly basis, in program reviews, 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 2015 annual inspection program, onsite supervision missions will start in the first quarter and step-up during the year. 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. - 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 and Key Reporting Timelines - 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. Authorities will transmit any data revisions in a timely manner. - Selected reporting requirements (information, frequency, provider, maximum time lag): - Detailed execution of revenues, expenditure and financing provided in EDP reporting format — Monthly — MOF. Budget Department/Cystat Government Financial Statistics — 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 — 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 — 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 — 5 days after the end of the month. - Stock of expenditure arrears and their corresponding monthly flows by type of expenditure — Monthly — MOF. Treasury Department — 15 days after the end of the month. - Stock of VAT refund arrears — Quarterly — Tax Department — 15 days after the end of the quarter. - Stock of government guarantees and their monthly flows by institution — Quarterly — MOF. Treasury Department — 27 days after the end of the month. - Stock of external arrears — Monthly — MOF. Treasury Department — 15 days after the end of the month. - Assets and liabilities of the central bank — Monthly — Central Bank of Cyprus — 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 — 30 days after the end of the month. - Assets and liabilities of the banking system (consolidated, including foreign operations) — Quarterly — Central Bank of Cyprus — 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 — 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 — Next working day. - Deposits by institution, currency, and residency and end-of-day liquidity buffers — Daily — Central Bank of Cyprus — Next working day. - Financial soundness indicators—core set, deposits, NPLs, capital adequacy ratios — Quarterly — Central Bank of Cyprus — 60 days after the end of the month. ### Key macroeconomic and program performance highlights (excerpted) - Program performance: all but one performance criteria observed with considerable margins; remaining one on track to be completed in Q3 2015. - Return to growth: Cyprus expanded by 1.5 percent on a quarter-on-quarter basis (0.2 year-on-year) in Q1 2015. - Exports of goods: increased by 45.5 percent in January-March 2015 compared to January-March 2014. - Tourism: arrivals increased by 13.7 percent in January-April 2015 compared with the same period last year. - Unemployment: the unemployment rate in April 2015 stood at 15.6 percent. *Source: _cr15155 - 5. The performance criteria are set on the general government cash primary balance (GGPCB),* ### 16.0 percent recorded in March 2015. Compensation per employee in 2014 declined by ### _cr15155 - 16.0 percent recorded in March 2015. Compensation per employee in 2014 declined by ### Labour market and unit labor costs - Employment/compensation developments: - "16.0 percent recorded in March 2015." - "Compensation per employee in 2014 declined by around 4.7 percent compared to 2013, the steepest correction in the EU." - Decline in compensation contributed to a decline of nominal unit labor cost and improving cost competitiveness. - These developments "are expected to diffuse any remaining unemployment pressures." ### Fiscal performance and near-term targets - Program fiscal outturns and characteristics: - In 2013, Cyprus delivered a primary deficit of "1 percent of GDP" against an original target of "3.3 percent of GDP." - In 2014, a surplus of "2.8 percent of GDP" was recorded against an originally targeted deficit of "2 percent of GDP." - For the period until April 2015, the primary balance "remained in surplus in the order of 0.6 percent of GDP." - Staff assessment: these outcomes "reflect largely permanent factors." - For 2015, a primary balance target of "1 percent of GDP" is envisaged despite "considerable negative one-off factors amounting to almost 2 percent of GDP." - Staff view: "Should downside risks to growth materialize ... flexibility may be required." - Authorities' stance: "there remains an unwavering commitment to keep up with the strong track record for 2015 and the coming years." ### Public debt, financing and sustainability - Improvements in debt profile and market access: - Long-term bond yields "continued to drop in April and May," attributed largely to enactment of foreclosure and insolvency legislation and expectations regarding ECB asset purchase program access. - Cyprus "successfully placed a new seven-year Eurobond on April 2." - Proceeds used "to repay more expensive outstanding debt," yielding a "lower interest bill and a smoother repayment profile over the medium term." - Program buffers "– about 12 percent of GDP – are now unlikely to be used for new financing." - Recognition of program buffers not being used "has led to a steep downward shift in the debt profile relative to the last staff update." - Debt trajectory: "already as of this year, debt is on a declining trajectory and a year earlier than what the program envisaged." ### Financial sector revival and reforms - Key milestones demonstrating bank-sector recovery: - ECB comprehensive assessment conclusion: "no further bank recapitalization by the State was necessary." - Banking system capitalization: "one of the highest average core tier 1 capital levels in Europe (14.2 percent at end 2014)." - Q1 2015 reporting season: "all three major credit institutions’ return to profitability." - Capital controls: authorities "abolished all capital controls on April 5 2015." Deposit levels "have increased since then." - Legislation to address NPLs: "the Foreclosure Law, the Insolvency Framework and the relevant Regulations ... have been enacted by the House of Representatives on April 17 2015." - These establish "the legal and regulatory infrastructure capable of effectively addressing arrears, accelerating sustainable restructurings and advancing the banks’ deleveraging process." - Some parliamentary provisions "may weaken its efficiency," but "under no circumstance should they diminish the significance and value of these new legislative tools." - Authorities will "implement and monitor the performance of the insolvency and foreclosure frameworks and have agreed to make adjustments, if necessary." - Additional measures and institutional actions: - Draft legislation submitted on facilitating sale of loans and transfer of issued title deeds to speed NPL resolution. - Central Bank is "creating a framework that monitors NPL management and incentivizes banks to expedite and improve their processes and policies with a view to increasing the pace of restructurings." ### Structural reforms and medium-term agenda - Reform priorities and progress: - Crisis viewed as "a window of opportunity to lay the foundation for a viable and sustainable growth model." - Reforms already undertaken include goods and services market, public administration review, public financial management, housing market, health, tourism and energy. - Priority: completion of public administration reform to "permanently ensure the affordability of the public wage bill and address any remaining distortions in public sector compensation and staffing." - Privatizations and corporate governance reform of state-owned enterprises prioritized "not for their cash-raising merits, but for the associated benefits such as increased competitiveness and foreign investment." - Political challenges acknowledged, but authorities "are determined to pursue this, starting with the telecoms, ports and the state lottery." - Privatization Unit actions: "has appointed all relevant investment advisers for the telecom privatization and has made progress on its corporatization law." - Legislative objective: authorities "are aiming for the law to be adopted by the Council of Ministers in the next few weeks and by Parliament soon after the summer." ### Conclusion and overarching assessment - Overall program assessment and outlook: - After two years, "the economy is at last signaling that the authorities’ efforts and the people’s sacrifices have not been in vain." - Authorities caution that "the recent economic uptick does not in any way signify that the problems are over" and it "provides the impetus to keep working meticulously through the remaining challenges." - Program performance characterized as "strong" despite delays in reviews and setbacks linked to "navigating an ambitious reform agenda with a minority government." - Authorities express appreciation "to their international partners for the understanding and constructive help that has been demonstrated throughout this process." *IMF staff report content (excerpts provided).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15155.pdf_