Cyprus: Staff Concluding Statement of the 2022 Article IV Mission
IMF News, March 30, 2022
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- Published: March 30, 2022
Mission summary
- IMF mission met virtually with Cypriot authorities from March 11–28, 2022.
- Key near-term challenge: calibrate policy response to the economic fallout from the war in Ukraine.
- Baseline: automatic stabilizers allowed to operate; 2022 budget provides sufficient fiscal support in the baseline.
- If shock is larger than expected, any additional discretionary support should be temporary, targeted, and not hinder reallocation of labor to expanding sectors.
- Medium-term objective: gradual fiscal adjustment to rebuild buffers, aiming to bring the budget close to balance by 2024.
- Financial vulnerability reduction: more forceful implementation of existing deleveraging strategy, including:
- removing uncertainties in implementation of the foreclosure framework;
- improving the working environment for credit acquiring companies (CACs);
- using examinership and restructuring tools for viable businesses.
- Structural reforms recommended: strengthen governance, improve judicial efficiency, address skills gaps and mismatches, and close infrastructure gaps to improve growth prospects.
Context and outlook
- Vulnerabilities:
- Cyprus remains highly vulnerable to the economic fallout from the war in Ukraine despite reduced exposures to Russia.
- Tourism has not fully recovered and is highly dependent on arrivals from Russia (about 20 percent of the total).
- Pandemic largely phased out policy support; limited impact on private balance sheets overall, but some debtors weakened.
- Direct financial sector impact from sanctions likely limited given diminished exposures and winding down of RCB Bank.
- Growth projections:
- Growth projected to slow from 5½ percent in 2021 to around 2 percent in 2022.
- Recovery expected in 2023 if situation normalizes; potential growth gradually increasing from 2½ percent to about 3 percent by 2027.
- Inflation and risks:
- Inflation expected to rise in 2022 and then start declining but will remain elevated in 2023 and beyond given prolonged pass-through.
- Key risks tilted to the downside: escalation/longer duration of the war and sanctions; uncontrolled Covid outbreaks; abrupt monetary tightening in advanced economies; higher-than-expected credit default rates.
Gradually rebuilding fiscal buffers
- Fiscal position and targets:
- 2021 deficit declined to 1¾ percent of GDP from 5¾ percent in 2020.
- Public debt: 104 percent at end-2021.
- Government fiscal target: a ¾ percent of GDP surplus in 2024.
- Short-term policy stance:
- 2022 budget provides sufficient support in the baseline; automatic stabilizers should be allowed to operate fully.
- Cyprus’s social safety net based on a Guaranteed Minimum Income scheme will cushion the most vulnerable.
- Additional discretionary support, if needed, should be temporary, targeted, and not hinder labor reallocation; options include extending unemployment benefits tied to labor market activation and scaling up active labor market policies.
- Support to viable businesses—especially in tourism—may be needed but could be less necessary if other sectors absorb idle workers.
- To cushion higher energy prices: recommend stricter targeting through temporary transfers and avoid pushing the cost onto the energy sector.
- Medium-term measures:
- Maintain strict fiscal discipline; control public sector wage bill and strengthen finances of the National Health System (NHS).
- NHS: authorities should address irregularities and continue plan to ensure financial self-sufficiency of public hospitals by [2024].
- Reinstating the immovable property tax would help offset spending pressures or alternatively could be used to scale up public investment.
- Next Generation EU (NGEU) / RRP:
- Total budget of Cyprus’s RRP amounts to €1.2 billion (over 5 percent of 2021 GDP).
- RRP expected to implement pro-growth reforms and support transition to greener, digital, sustainable economy.
- Absorption could be challenging; strengthened public investment management would help.
Safeguarding financial stability
- Current resilience and challenges:
- Financial system resilient: liquidity high and capital ratios broadly stable.
- ‘stage 2’ loans—performing exposures with significantly deteriorated credit quality—have remained elevated post-pandemic.
- Significant progress offloading legacy NPLs, but resolution has been slow; legacy NPLs mostly reside in CACs and public asset management company (KEDIPES).
- Monitoring and asset-quality measures:
- Worsened outlook calls for enhanced monitoring; problem loans concentrated in tourism-related sectors.
- Insolvency tools and timely implementation of the EU Directive on Preventive Restructuring and Second Chance are key to restructure viable businesses.
- NPL resolution and foreclosure framework:
- More forceful implementation of existing tools required.
- Effective foreclosure framework critical to address strategic defaulters and incentivize restructurings.
- Address uncertainties arising from implementation of the 2019 amendments of the Foreclosure Law.
- Improve working environment for CACs, including access to the land registry database; continue strengthening CAC oversight.
- Measures for vulnerable borrowers:
- Authorities plan to transfer primary residences and business premises with market value below €350,000 used as collateral to NPLs to KEDIPES after debt-to-asset swap, and introduce a subsidized mortgage-to-rent scheme for vulnerable borrowers.
- Scheme should be limited to the most vulnerable households on a means-tested basis, timebound, include robust transfer pricing to minimize fiscal costs and risks, and have strong governance with emphasis on transparency and accountability.
Structural reforms and green transition
- RRP-driven reforms:
- RRP measures target rule of law (recruiting and training judges; improving processing to reduce backlog), control of corruption (whistle-blower protection legislation; new independent anti-corruption agency), and government efficiency (e-government, public service reform, administrative decentralization).
- Skills and education measures: improve teaching quality, enhance digital skills at all education levels, and strengthen vocational education.
- Public investments in digital infrastructure and steps to improve e-communications market functioning.
- Mission recommends faster implementation of these well-targeted reforms.
- Emissions reduction plans:
- Authorities target a reduction of 32 percent for the sectors not included in the EU Emissions Trading Scheme (ETS) by 2030 (relative to 2005).
- Planned measures: reduce energy dependency and enhance energy efficiency by promoting electricity generation from cleaner sources, improving electricity connectiveness, increasing energy efficiency in the residential sectors, and enhancing public transport.
- Government plans to introduce a carbon tax on fuels used in non-ETS sectors.
- Planned measures would go a long way toward meeting the target, but financing needs to be identified and additional measures (such as feebates) may be needed to fully achieve it.
Source: Cyprus: Staff Concluding Statement of the 2022 Article IV Mission (March 30, 2022).