IMF Executive Board Concludes 2021 Article IV Consultation with Cyprus
IMF News, June 16, 2021
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- Published: June 16, 2021
Overview and context
- The Executive Board concluded the Article IV consultation with Cyprus and endorsed the staff appraisal without a meeting on May 18, 2021.
- COVID-19 impacts and fiscal/financial response:
- The economy contracted by 5.1 percent in 2020.
- The current account deficit widened to 11.9 percent GDP in 2020.
- Inflation turned negative in 2020 due to weaker demand and declining energy prices.
- Overall general government fiscal balance swung to a deficit of 5.7 percent of GDP in 2020.
- Public debt increased to 119 percent of GDP in 2020.
- Crisis-related fiscal measures and pre-crisis balance sheet buffers helped limit loan defaults and job losses and enabled a rapid, albeit uneven, recovery.
- Health situation (as of end-April 2021):
- Cyprus was in the midst of a third wave of infections, leading to a renewed lockdown.
- Vaccination rate stood near the European average level.
Near-term outlook and risks
- GDP projection:
- GDP is projected to grow by 3 percent in 2021 as vaccine rollout gathers pace and international tourism gradually recovers.
- Growth is projected to recover moderately to 3 percent in 2021 after output fell by 5.1 percent in 2020.
- Further projection: 3.9 percent in 2022.
- External and fiscal outlook:
- Current account deficit is expected to narrow moderately.
- With recovery, fiscal balances are expected to improve, allowing the public debt ratio to start declining from 2021.
- Uncertainty and downside risks:
- High uncertainty about the path of the pandemic and pace of vaccine rollout.
- Risks include weakening of underlying fiscal position (increased risk premia), a larger than expected drop in foreign direct investment inflows due to the termination of the Cyprus Investment Program, and the large economic exposure to tourism.
- Premature withdrawal of policy support risks wider bankruptcies, loan repayment difficulties, and permanent scarring.
Executive Board assessment — key findings
- Cyprus managed the COVID-19 shock relatively well: swift containment measures and high testing kept hospitalization and mortality rates relatively low.
- Despite dependence on tourism and high private and public debt levels, widespread defaults and high unemployment have largely been avoided so far, thanks to timely policy support and pre-crisis balance sheet buffers.
- Near-term recovery is expected to be gradual but uneven with significant downside risks.
- Policy priorities depend on health and economic developments; near-term policy should focus on crisis mitigation and vaccine distribution, while later shift toward sustainable and inclusive growth.
Financial sector and NPL resolution
- Key recommendations and observations:
- Extend targeted support measures and effectively resolve legacy and potential new NPLs by banks and increasingly by the CACs.
- Targeted credit support measures (such as interest subsidy schemes for SMEs and guaranteed loans) are needed to incentivize banks to supply new credit.
- Support measures should ensure firm viability and fully utilize banks’ assessments of borrower creditworthiness.
- Supervisory guidance encouraging banks to flexibly use capital buffers and continue limiting dividend distributions is welcome.
- Close monitoring and transparency in asset quality assessment should continue.
- Timely restructuring of viable businesses is key to preserving production capacity.
- Continued progress with judicial reforms is needed to improve collateral execution and incentives for debt workouts.
- Avoid reversal of reforms to the foreclosure framework to prevent obstruction of ongoing NPL resolution and risks to financial stability.
- As the Estia scheme approaches conclusion, banks should consider stepping up foreclosure on NPLs of borrowers who did not apply for the scheme, while authorities should ensure further burden sharing or consider targeted support for applicants deemed unviable.
- Oversight of the CACS should continue to be strengthened.
- The proposed expansion of the public AMC (subject to EC state aid approval) should be carefully assessed for costs, benefits, and impact on repayment behavior.
Fiscal policy guidance
- Near-term:
- Given high uncertainties, avoid premature withdrawal of fiscal support.
- The fiscal stance in 2021, which includes continued sizeable policy support, is appropriate.
- Recalibrate fiscal support to target viable but vulnerable firms (such as in tourism) to avoid unnecessary bankruptcies.
- Measures encouraging equity increases could help address potential solvency problems.
- Front-load mature public investment projects and promote private investment through utilization of the EU’s RRF.
- Provide transparency and accountability on the use of COVID-19-related spending to build public support.
- Medium-term:
- As recovery takes hold, shift focus to maintaining fiscal sustainability and promoting inclusive, growth-enhancing policies.
- Continue to modernize tax administration, contain growth of the public wage bill, and reorient spending toward improving human capital, facilitating digitalization, and transitioning to a green economy.
- Contain fiscal risks from the NHS as it embarks on the first year of full NHS reform implementation.
Structural reforms and inclusiveness
- Structural reform priorities:
- Support resource reallocation and strengthen growth potential.
- Transition labor market policies from job preservation toward facilitating efficient labor reallocation through active labor market policies and public employment services.
- Improve digital infrastructure and upgrade digital skills to enhance competitiveness.
- Implement climate-friendly policies and facilitate transition to a green economy through greater investment in renewable energy and green taxation to help meet the 2030 emission targets set in the Cyprus National Energy and Climate Plan.
- Social inclusiveness:
- Priority should be given to mitigating crisis repercussions on inequality.
- The crisis impacted young people and women more adversely.
- Policies should enhance female labor force participation and job search for young people.
- Any consideration of a national minimum wage should account for potential impact on competitiveness and youth employment.
Cyprus: Selected Economic Indicators, 2018–2022 (Projections)
- Years: 2018 | 2019 | 2020 | 2021 | 2022
- Output/Demand
- Real GDP: 5.2 | 3.1 | -5.1 | 3.0 | 3.9
- Domestic demand: 2.6 | 5.1 | 0.8 | 1.2 | 3.4
- Consumption: 4.4 | 4.5 | -0.3 | 1.1 | 3.6
- Private consumption: 4.7 | 1.8 | -3.9 | 0.7 | 3.2
- Public consumption: 3.5 | 15.1 | 13.1 | 2.2 | 4.8
- Gross capital formation: -4.5 | 7.7 | 5.3 | 1.5 | 2.4
- Foreign balance 1/: 2.5 | -1.8 | -5.8 | 1.9 | 0.3
- Exports of goods and services: 8.0 | -0.4 | -12.4 | 3.8 | 7.8
- Imports of goods and services: 2.0 | -4.2 | 0.9 | 6.7 | —
- Potential GDP growth: 2.1 | 3.3 | —
- Output gap (percent of potential GDP): 4.9 | -1.6 | -1.1 | -0.5 | —
- Prices
- HICP (period average, percent): 0.6 | 0.5 | —
- HICP (end of period, percent): 1.0 | -0.8 | —
- Employment
- Unemployment rate (EU standard, percent): 8.4 | 7.1 | 7.6 | 7.5 | 7.0
- Employment growth (percent): 5.6 | -1.5 | 1.4 | —
- Public Finance
- General government balance: -3.5 | -5.7 | -4.8 | —
- Revenue: 39.5 | 41.2 | 40.9 | 42.9 | 44.0
- Expenditure: 43.0 | 39.7 | 46.6 | 47.6 | 45.0
- Primary Fiscal Balance: -3.6 | -2.4 | —
- General government debt: 99.2 | 94.0 | 119.1 | 114.0 | 106.4
- Balance of Payments
- Current account balance: -6.3 | -11.9 | -8.1 | -6.0 | —
- Trade Balance (goods and services): -6.2 | -4.3 | —
- Nominal GDP (billions of euros): 21.4 | 22.3 | 20.8 | 21.5 | 22.7
- Memorandum Item:
- Underlying primary fiscal balance 2/: 6.3
Notes from source:
- 1/ Contribution to growth (percentage points).
- 2/ Expenditure excluding fiscal impact of the Cyprus Cooperative Bank (CCB) transaction and state-owned AMC of 7.4 percent of GDP.
Source: Press Release No. 21/178 — IMF Executive Board Concludes 2021 Article IV Consultation with Cyprus (June 16, 2021).
