## Statement by J. de Beaufort Wijnholds on Cyprus — August 3, 2000

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### Recent Economic Developments and Outlook
- Cyprus is preparing for accession to the European Union; authorities are consolidating macroeconomic performance and implementing wide structural reforms.
- Output growth:
  - 1998: 5 percent
  - 1999: slowed modestly
  - 2000: expected to register a growth of 4.8 percent
- Unemployment: averaging 3 percent of the labor force in the last seven years.
- Inflation:
  - end-1998: 1 percent
  - end-1999: 3.7 percent
  - 2000 forecasts:
    - staff: inflation to average around 5.4 percent
    - authorities: average inflation of around 4.5 percent
  - VAT increase from 8 to 10 percent contributed to acceleration in inflation.
- Recent exogenous pressures: higher oil prices, depreciation of the Euro, persistent drought.
- Current account:
  - 1999: improvement; deficit 2.6 percent of GDP
  - 2000 projections:
    - staff: deficit to rise to 3.4 percent of GDP
    - authorities: deficit to rise to 3.1 percent of GDP
- Drivers of strong growth: tourism boom (benefiting from solid growth in Europe and depreciation of the Euro).

### Policy Mix over the Near Term
- Fiscal policy constraints:
  - Government lacks a parliamentary majority, limiting ability to pass stronger fiscal measures.
  - Staff projection: fiscal deficit to deteriorate in 2000 to 4.5 percent if no additional measures are taken.
  - Authorities’ updated projection: fiscal deficit to reduce to 3.7 percent in 2000, from 4.1 percent in 1999.
- Revenue and expenditure developments supporting authorities’ forecast:
  - Gross income tax collections in H1 2000: soared by 28 percent.
  - VAT proceeds in H1 2000: rose by 19 percent.
  - VAT rate increase will boost revenues in H2 2000.
  - Restraint on defense expenditure expected; ratio of expenditure as percent of GDP expected to remain constant in 2000.
  - Policy measures cited by authorities: better tax administration, tax on stock market transactions, capital gains tax for 1999 (to be collected beginning in 2000), restrictions in civil service employment growth, abolition of grants to the Cyprus Tourism Organization.
- Public debt and external obligations:
  - Public debt expected to increase marginally in 2000 to 61 percent of GDP.
  - Foreign debt: 17.8 percent of GDP; all foreign borrowing is medium and long term.
- Monetary policy and CBC measures in 2000:
  - Interest rate ceiling to be abolished as of January 1, 2001.
  - CBC measures taken beginning 2000:
    - imposed a ceiling on personal loans;
    - raised margin requirements to 100 percent to slow credit for stock market investments;
    - stiffened penalties linking payment of interest on bank reserves to observance of directives;
    - increased reserve requirements by one percentage point as of July;
    - reintroduced credit ceilings as of June (to be observed continuously as of July rather than quarterly).
  - Stock market correction: from 714 at the end of 1999 to 402 today — likely to reduce demand for stock market loans.
  - CBC lifted restrictions on loans for stock market purchases late last week in response to the correction; existing credit ceilings applicable to banks remain unchanged (penalties if divergence from target is more than 20 percent).
- Overall assessment:
  - Authorities view current policy mix as sufficient to address near term risks given lower fiscal deficit, stock market correction, recent appreciation of the Euro relative to the dollar, lower oil prices, and more favorable agricultural product prices.
  - Authorities disagree with staff characterization that policy mix is insufficient, attributing differences to divergent risk assessments and differing incorporation of measures taken by the CBC.

### Medium Term Challenges: Capital Account Liberalization
- Authorities pursuing careful, well sequenced plan for capital account liberalization.
- Preparatory macro measures:
  - Medium term program for gradual fiscal tightening.
  - CBC prepared to use new powers (post-interest ceiling abolition) to enhance interest rate flexibility.
  - Intend to widen exchange rate bands while maintaining an inner band as a nominal anchor.
  - CBC setting up a mechanism for intervening in the foreign exchange market.
- Supervisory and banking sector measures:
  - Cypriot banking system based on modern legal framework; prudential standards in line with EU directives and BIS standards.
  - About 75 percent of the banking system is already exposed to a liberalized capital environment via operations abroad.
  - CBC raised minimum capital requirements to 9 percent in July 2000 and will raise them to 10 percent in January 20001.
  - Supervisory framework for credit cooperatives needs significant improvements; most coop activity involves small collateralized lending; coops required to transfer a minimum of 25 percent of any surpluses to their reserves.
  - Fate of coops to be decided in EU negotiations: either treated as banks (subject to same regulatory and supervisory standards) or as institutions of special character.
- International banking units:
  - Subject to same regulatory standards as domestic banks; strong regulatory framework since 1986.
  - Modern anti-money laundering legislation introduced in 1996.
  - FATF June 2000 assessment: Cyprus had a comprehensive anti-money laundering system and was cooperating in the international fight against money laundering.
  - Authorities surprised by FSF listing Cyprus in the third group of countries seen as having low quality of supervision and/or cooperation.
  - Cyprus agreed to phase out preferential tax treatment of offshore companies by the end of 2005.

### Structural Reforms
- Sector liberalization timelines and actions:
  - Air transportation sector: liberalize by the end of 2002 (one year earlier than anticipated); partial privatization of Cyprus Airways underway.
  - Telecommunications:
    - New legislation to transform the telecommunications company into a joint stock company and reduce government participation.
    - Legislation to enable a telecom authority regulator and enforce competition rules in accordance with European directives; new regime expected to be implemented by the end of 2001.
    - Telecommunications sector to be liberalized by January 1, 2003.
  - Authorities intend to sell entire stake in a number of small businesses.
- Public ownership and fiscal footprint:
  - Government has majority share ownership in just six enterprises.
  - Value of government equity holdings in these companies: just under one percent of GDP.
  - Central government, local authorities and semi-government organizations together account for around 24 percent of GDP.
- Diversification away from tourism:
  - Policies to promote new technology and support non-tourist services (consultancy services, banking, education).
  - Non-tourist services (finance, communications, distribution and transit trade) have registered strong growth and reduced dependence on tourism.
- Financial sector reforms:
  - Deposit insurance scheme to take effect on September 1, 2000.
  - Legislation to ensure independence of the central bank (requiring constitutional amendment) expected to be in place by June 2002.
  - Cyprus Stock Exchange: progress on mutual funds legislation approved by the Council of Ministers (in line with EU directives); bill on financial services with the Attorney General’s Office for evaluation before submission to Parliament.
- Cost of Living Allowance (COLA):
  - COLA mechanism longstanding; abolition appears unlikely in near term.
  - Authorities modified system: excise taxes are no longer included in the calculation of COLA; current system is not one of full indexation.

### Conclusion
- Cypriot authorities are determined to ensure macroeconomic stability in the short and medium term.
- Committed to undertaking reforms required for EU accession, including cautious, steady capital account liberalization.

*Source: Statement by J. de Beaufort Wijnholds on Cyprus, August 3, 2000.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-publications/external/np/a4pilot/2000/_stm00110.pdf_