## Cyprus -- 2010 Article IV Consultation: Preliminary Conclusions _IMF News, July 6, 2010_ ## Source details **Canonical URL:** [Cyprus -- 2010 Article IV Consultation: Preliminary Conclusions](https://www.imf.org/en/news/articles/2015/09/28/04/52/mcs070510) ## Other formats - [Markdown version](/en/news/articles/2015/09/28/04/52/mcs070510/index.md) - [Structured JSON version](/en/news/articles/2015/09/28/04/52/mcs070510/index.json) - [Bundle manifest](/en/news/articles/2015/09/28/04/52/mcs070510/bundle-manifest.json) ## Bibliographic details - Published: July 6, 2010 --- ### Overview - IMF mission presents preliminary findings and main recommendations of the 2010 Article IV surveillance mission. - Key messages: - Economic conditions have started to stabilize after the downturn; the economy is poised to return to modest growth in 2011. - Global financial risks remain elevated and growth prospects in main trading partners remain muted, weighing on Cyprus’s outlook. - Pressures in Euro area sovereign debt markets have intensified. - Cyprus should act forcefully and with greater urgency to reverse high fiscal deficits to safeguard public financing sustainability and increase scope for private sector growth. - Banking sector remains sound overall, but growth in non-performing loans calls for vigilance. - Containing public spending growth and enhancing wage flexibility are needed to boost productivity and improve medium-term growth. *IMF Mission Concluding Statement, Cyprus — 2010 Article IV Consultation (July 6, 2010).* ### Economic outlook - Crisis impact and recent developments: - The global crisis hit Cyprus in the second half of 2009. - Conservative financial sector practices, strict supervision, and euro adoption initially sheltered the economy. - Deteriorating international conditions and close links with the U.K. and Russia exposed Cyprus to sharp corrections in housing demand and declines in tourism and service revenues. - Downturn led by declines in private consumption and fixed investment and significant destocking. - External balance: - Current account deficit fell by more than half in 2009, to 8.5 percent of GDP. - The current account deficit will likely stabilize in 2010 and decline gradually toward more sustainable levels over the medium term as external demand recovers. - Growth outlook: - The economy is projected to bottom out in 2010 and give way to a mild recovery in 2011 and stronger growth in following years. - The mission expects growth to be around zero or slightly below in 2010, followed by a modest recovery in 2011 and a gradual acceleration in later years. - Headwinds include sizeable increase in unemployment, declining consumer borrowing, negative confidence shock, subdued investment due to weak property and construction sectors, and restrained public consumption because of fiscal consolidation needs. ### Fiscal policy - Main challenge: - Foremost policy challenge is reversing the large structural fiscal deficit that has emerged in recent years. - Drivers of the deficit: - Rapid growth in public sector wages and employment. - Expansion of social spending, much of which was not well-targeted. - End of the real estate boom causing enduring loss of associated revenues. - Fiscal position and targets: - Cyprus has moderate levels of public debt relative to many other Euro area countries, but must act to preserve this legacy and protect debt sustainability. - Government targets reducing the deficit to below 3 percent of GDP by 2012, which would put the public debt ratio on a declining path, are appropriate but require bold measures. - Recent measures (gradual reduction in public sector employment; foregoing general public sector wage increases) will help stabilize the deficit near last year’s levels of 6 percent of GDP, but further actions are needed to meet official targets. - Recommended measures to reduce expenditures while keeping tax rates low: - Reduce the wage bill and better target social transfers, given the large size of the public sector (close to half of GDP). - Consider adjustments to incremental salary step increases. - Introduce contributions of government employees toward their unfunded government pensions. - Reform the cost of living adjustment to increase wage flexibility while protecting lower paid workers. - Pensions: - Further pension reforms are needed; last year’s reforms helped prolong solvency, but as workforce matures pension outlays will rise and outstrip contributions. - Long-term solution will require bringing pension outlays more in line with contributions through some combination of lower replacement rates and higher retirement age. ### Financial sector - Overall assessment: - Banking sector remains sound, helped by focus on traditional banking activities and conservative balance sheet management. - Predominant reliance on more stable retail funding, negligible exposure to complex securities, high liquidity, and strong supervision helped shield the sector. - Recent and ongoing stress tests by the Central Bank of Cyprus indicate the system has capacity to absorb further shocks. - Deposits have continued to grow. - Bank and supervisory responses: - Banks are securing funding, preserving high liquidity, retaining a greater proportion of earnings, and tightening risk management. - Supervisors have stepped-up vigilance and strengthened the regulatory framework. - Significant progress in implementing European Union Directives and recommendations from the IMF’s 2008 Financial Sector Assessment Program. - Forthcoming introduction of a legal framework for covered bonds should improve access to liquidity from markets and the European Central Bank. - Draft law on crisis management should facilitate preemptive addressing of potential insolvency problems. - Risks and priorities: - Preserve stability through continued strong supervision and early detection of risks. - Economic downturn has negatively affected bank profitability, non-performing loan ratios, and capital buffers; these pressures likely to persist until recovery. - Large size of banking sector relative to economy and high concentration ratios mean sector problems could escalate to systemic proportions with spillovers to the economy and public finances. - Pursue cross-border cooperation with Greece and other Southeastern European supervisors given extensive international financial linkages. - Cooperative credit societies: - Improve transparency and supervision to prevent undetected problems: - Impose uniform definitions of non-performing loans across commercial banks and cooperative credit sectors. - Apply the same stress testing framework used for commercial banks to cooperatives. - Full and timely reporting of financial system indicators by the Authority for Supervision and Development of Cooperative Societies consistent with commercial bank requirements. - Over the medium term, establish a single independent supervisor for all credit institutions operating in Cyprus to enhance efficiency, reduce risks, and create a level playing field. ### Structural reforms - Objectives: - Preserve competitiveness to support near-term recovery and enhance longer-term growth potential. - Challenges: - Growth of wage and labor costs in excess of productivity has reduced competitiveness, particularly in manufacturing and tourism. - Medium-term potential growth likely to be permanently lower due to the global crisis, fading construction and real estate boom, and convergence toward per capita income levels of other Eurozone countries. - Recommended structural measures: - Improve labor market flexibility. - Streamline regulatory framework, reduce red tape, and improve the business climate. - Reverse steady growth of public sector wages and employment to free resources for growth and reduce wage pressures while protecting a low tax environment. - Implement active labor market policies: - Training programs for low skilled and immigrant workers. - Measures to reduce the high gender gap to ease labor market segmentation and increase productivity. - Promote flexible forms of employment to enhance market flexibility and employment conditions. - Reduce incentives for early retirement to enhance long-term fiscal sustainability and support labor supply in view of demographic aging. *IMF Mission Concluding Statement, Cyprus — 2010 Article IV Consultation (July 6, 2010).* --- ## References - [Cyprus and the IMF](http://www.imf.org/external/country/CYP/index.htm) - [Mission Concluding Statements](https://www.imf.org/en/news/searchnews) - [PRESS CENTER](http://presscenter.imf.org/) - [Article IV](https://www.imf.org/external/pubs/ft/aa/aa04.htm) - [https://www.imf.org/en/home](https://www.imf.org/en/home) _Source: https://www.imf.org/en/news/articles/2015/09/28/04/52/mcs070510_