Transcript of a Conference Call on the Completion of the First Review of the Extended Fund Facility (EFF) for Cyprus

September 18, 2013

With Delia Velculescu, Mission Chief for Cyprus
Ángela Gaviria, Communications Department
Washington, September 18, 2013

MS. GAVIRIA: Hello, everyone. I’m Angela Gaviria, press officer at the IMF. Welcome to this conference call on the staff report of the First Review of Cyprus’s Extended Fund Facility (EFF) arrangement. Here with me is the Mission Chief for Cyprus, Delia Velculescu, who’s going to talk to you briefly at the start and then she’ll be happy to take your questions.

MS. VELCULESCU: Thank you, Angela. Welcome, everyone. Let me start with a brief overview of our findings and recommendations following the first review of Cyprus’s macroeconomic adjustment program.

The review found the program to be on track with both fiscal and structural conditionality met. On this basis, the IMF Executive Board approved this past Monday the completion of the first review of Cyprus’s program.

What are some of the key takeaways? On financial sector policies, significant progress was made since program approval. First, Bank of Cyprus was fully recapitalized without public support and exited resolution at the end of July. Second, a strategy for the recapitalization of Hellenic Bank has been announced, and legislation was recently passed to facilitate it. Third, a strategy for the restructuring and recapitalization of the cooperative sector with public funds as needed was also announced. The cooperative sector will be significantly consolidated. Legislation was recently passed to strengthen the supervision of the cooperative credit sector and to establish a framework governing the management of the state’s future stake in the sector. Fourth, a milestone-based roadmap to gradually lift payment restrictions was published in August. This roadmap links relaxation of existing restrictions with the achievement of specific targets in the bank restructuring strategy. It is state rather than time dependent and maintains flexibility to adjust in line with developments.

Turning to fiscal policy, end-of-June fiscal targets were met with comfortable margins. This is due to the adjustment measures implemented at the end of last year and early this year, as well as to prudent budget execution. Moreover, the authorities have announced important structural reforms complementing their consolidation effort. These relate to reforming budget processes, revenue administration, and the welfare system.

Looking forward, the authorities have a full policy agenda ahead of them.

On the financial sector side, the new Board of Bank of Cyprus, which was recently appointed, as well as its new management team, needs to finalize a restructuring plan to return the bank to profitability. Moreover, the restructuring and recapitalization of Hellenic Bank and the cooperative credit sector need to proceed as planned. Also, the roadmap to gradually lift restrictions needs to be implemented carefully while safeguarding financial stability. Finally, efforts need to continue to strengthen bank supervision and regulation, implement the anti-money laundering framework, and strengthen the private sector debt restructuring framework.

On the fiscal side, continued prudence in budget execution is called for, given still high macroeconomic uncertainty. The macroeconomic outlook remains difficult. While economic developments in the first half of the year were somewhat better than expected, the program’s macroeconomic baseline and fiscal targets were prudently left unchanged given the large uncertainty and risks that remain tilted to the downside.

In the outer years, additional consolidation is called for to ensure debt sustainability. Further, structural reform efforts need to continue to ensure the implementation of the new reforms, which are aimed at improving revenue collections and protecting vulnerable groups in the downturn.

In sum, the authorities have made good progress in program implementation and have set an ambitious agenda ahead. Still, with large uncertainty and downside risks, fiscal prudence and strong and timely policy implementation remain critical for the program’s success.

QUESTIONER: Yesterday President Anastasiades suggested that he will be able to lift the restrictions on the banking sector by January 2014. Do you think this is feasible according to the roadmap you have planned?

MS. VELCULESCU: In line with the published roadmap of the authorities, we expect further relaxations to take place this year and the next as progress is being made with the financial sector recapitalization and restructuring. As you may know, following the exit from resolution of Bank of Cyprus, steps have already been taken to facilitate domestic transactions. Ultimately, the full relaxation of restrictions depends on the implementation of the banking sector strategy and the return of confidence.

QUESTIONER: I want to ask something because there is a report right now saying that the Cypriot economy would contract 13 percent this year and not 6.8 percent as you said in previous forecasts. Are there any changes?

MS. VELCULESCU: Let me clarify. The program projections have not changed. The current projections are for an 8.7 output decline this year and a 3.9 output decline next year. So the total for both this year and the next is close to 13 percent. And as I’ve said earlier, the output decline in the first half of the year was around 5 percent year on year in the first half of the year, which is much less than we had expected for this period. However, given the uncertainty that is still out there, we have not changed the program forecast.

QUESTIONER: I wanted to ask a question about the asset quality in Bank of Cyprus. Right now the bank has a capital ratio of 12 percent and your projections place that ratio above the 9 percent threshold for the end of the program period. I was wondering what kind of concerns you might have given some of the reports in the press about provisions that aren’t there and some recognition of losses that still isn’t there. Secondly, do you have any comments on the delays on approving the board, which is still not in place in the Bank of Cyprus?

MS. VELCULESCU: As you correctly pointed out, the Bank of Cyprus now has a capital ratio well above 9 percent to ensure that the bank can deal with both existing and prospective losses. The capital needs have been calculated on a forward-looking basis, projecting a rapid deterioration in asset quality given the difficult macroeconomic conditions. These projections have been undertaken by two independent audits, one from PIMCO and the other from KPMG, on which basis of the recapitalization took place. In other words, while we expect the rapid deterioration of asset quality to continue, we see the capitalization now in place in Bank of Cyprus to help to deal with this deterioration.

Clearly, as you also noted, the new board of directors needs to become operational as soon as possible and, together with the management team, needs to make progress with the restructuring plan. This plan will be instrumental for the return of confidence in this bank.

QUESTIONER: We would like to ask a question regarding your projections on the economic growth for 2013-2014. The authorities say that possibly in 2013 the recession will not be that much, I mean the projection of -8.7 percent. Why would the recession accelerate further than your projection in 2014? Are you considering a revision of this forecast?

MS. VELCULESCU: As I’ve said, the available data that we have so far, which covers the immediate and the deepest impact of the bank resolution and payment restrictions, point to a smaller growth contraction in the first half of the year than what we had expected. However, growth projections were maintained unchanged given the still high macroeconomic uncertainty. We will be looking at the new data as it comes in; should those new data indicate the need for a revision, we will consider it at that time.

QUESTIONER: It’s about a bank question related to what the colleague asked earlier, but broader. I wanted to know, given that a healthy bank system is going to be needed to get the economy growing again, what is the single most important, significant, dangerous challenge that the banks face, specifically Bank of Cyprus? And how must it deal with it?

MS. VELCULESCU: Clearly given the deteriorating economic conditions, the largest challenge for the banks is to deal with the rapid deterioration of asset quality and to put in place restructuring plans that adequately address it and can return the banks -- not just Bank of Cyprus, but the other banks as well -- to profitability. The key here will be to develop these plans, which we will be examining very carefully in the next program reviews, to ensure that all the banks can ultimately achieve a return of confidence and profitability.

QUESTIONER: You mentioned before the greatest challenge for the banks. What’s the greatest challenge for the state?

MS. VELCULESCU: The greatest challenge for the authorities is to continue to maintain the pace of implementation that they have demonstrated during the first review. Given the difficult economic environment, implementation could become more difficult. However, the authorities have demonstrated that they can make difficult decisions if they are necessary, and they will need to continue to do so in the months ahead.

QUESTIONER: Just a question at sort of a more microscopic level. From the data available right now, it seems that the economy is adjusting very fast. But at the same time, a lot of analysts are beginning to wonder if we’re looking at a shallower, U-curve, kind of depression rather than the V-curve we were expecting originally. I was wondering how you see the prospects of the economy further down the road towards 2015 and whether or not we’ll have a more protracted depression before returning to growth.

MS. VELCULESCU: We are continuing to analyze the short-term data. Having a more protracted recession is one of the risks that we have highlighted in our staff report. At the moment, we are projecting a modest recovery in 2015. This is predicated on full and timely implementation of our policies under the program. To recall, these policies are aimed at stabilizing the banking sector and putting public finances on a sustainable footing. If the authorities achieve this aim, we would expect a recovery to materialize. This will depend on the authorities’ efforts between now and then.

MS. GAVIRIA: We end this conference call here. Thank you all for participating.

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