## Cyprus: Staff Concluding Statement of the 2018 Article IV Mission

_IMF News, October 5, 2018_

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**Canonical URL:** [Cyprus: Staff Concluding Statement of the 2018 Article IV Mission](https://www.imf.org/en/news/articles/2018/10/05/mcs10518-cyprus-staff-concluding-statement-of-the-2018-article-iv-mission)

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## Bibliographic details
- Published: October 5, 2018

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### Key findings and recent developments
- Five years after the financial crisis, the Cypriot economy has turned the page on its recovery path: growth momentum is strong and fiscal performance is robust.
- The economy grew by over 4 percent in 2017 and the first half of 2018, supported by tourism, professional services, and construction.
- Wages and property market prices are rising after an extended period of stagnation, but the pace remains very gradual, contributing to low underlying inflationary pressures.
- Increased domestic demand has boosted imports, widening the underlying current account deficit.
- Economic growth has been largely supported by external financing because the banking sector remains hamstrung by weak balance sheets.
- Important strides were made in addressing banking-sector vulnerabilities:
  - Resolution of the government-owned Cyprus Cooperative Bank (CCB), the second-largest bank, albeit at a high cost to the public purse.
  - Passage of a legislative package to strengthen insolvency and foreclosure frameworks.
  - These measures have catalyzed bank balance-sheet cleanup and contributed to a sovereign ratings upgrade to investment grade status.
- Notwithstanding progress, the economy is weighed down by very high private and public debt and NPL ratios that, while declining, remain among the highest in Europe.

### Outlook and risks
- Near-term growth:
  - Growth is expected to exceed 4 percent in 2018–19, driven by domestic demand.
  - Private consumption growth is expected to decelerate as borrowers step up debt servicing.
  - Investment is expected to pick up further, reflected in a pipeline of construction projects in residential properties, education, health and tourism infrastructure.
  - These import-intensive projects, plus slowing tourism growth in some source markets, will somewhat widen the current account deficit.
- Medium-term outlook:
  - Over the medium term, as the transitory effects of the investment boom and euro area cyclical growth dissipate, growth is expected to slow towards a potential growth rate of around 2½ percent.
  - Sustaining medium-term growth requires progress in structural reforms to lower systemic financial risks and catalyze productivity-enhancing investments.
- Risks (tilted to the downside):
  - Delays in NPL resolution and limited strengthening of payment discipline will weigh on investor sentiment and growth potential.
  - Increase in moral hazard and realization of contingent liabilities from publicly supported schemes could weaken the fiscal position and raise risk premiums, especially under tightening global financial conditions.
  - High dependence on Citizenship-by-Investment (CbI) financed investments could pose risks to sustainability.
  - External risks include escalating trade tensions, a sharper-than-expected slowdown in euro area growth, or a hard Brexit.
- Upside risk:
  - Prospect of offshore hydrocarbon development.
  - Faster progress in dealing with NPLs could attract additional FDI, increase credit flows, and strengthen economic growth.

### Policy priorities — Financial sector: lowering NPL and private debt overhang
- Steady reduction of NPLs and high corporate and household debt is a priority.
- Recent legal and institutional changes:
  - Amendments to foreclosure and insolvency legislation, the sales of loans law, and adoption of a law on securitization enhance tools for addressing NPLs.
  - Strengthened foreclosure framework intended to act as a credible threat against strategic default and improve payment discipline.
- Implementation and complementary measures:
  - Steadfast implementation of the enhanced frameworks is essential to facilitate timely enforcement and ensure durable resolution.
  - Structural reforms are needed to strengthen institutions, in particular the court system, and to remove uncertainties related to title deeds.
- Regulatory and governance needs for credit-acquiring companies and CAMC:
  - Central bank should develop a regulatory and supervisory framework for credit-acquiring companies, including reporting requirements, on-site inspections, and off-site monitoring.
  - Governance framework for the government-owned Cyprus Asset Management Company (CAMC) needs to balance operational independence with public accountability and transparency, with a clear mandate, operational targets, an independent board, and skilled, performance-based management compensation.
- Design of the proposed subsidy scheme (Estia):
  - Estia should be better targeted to those most in need; tighter eligibility criteria and clearer communication would help avoid moral hazard.
  - Appropriate assessment of borrowers’ capacity to repay restructured debt on a sustained basis is important.
  - Banks should maintain adequate provision coverage and promptly utilize foreclosure and insolvency frameworks to address re-defaults.
  - The scheme’s design and impact assessment should be informed by a detailed analysis of borrower data.
- Other bank-strengthening measures:
  - Continue efforts to diversify income sources and consolidate operations to improve cost-income ratios.
  - Focus on bank lending policies, sustainability of restructurings, adequacy of provisioning coverage, and debt-to-asset swap policies to encourage sound risk management.

### Policy priorities — Fiscal policy: safeguarding fiscal space and reducing risks to public debt sustainability
- Fiscal stance and risks:
  - Cyprus is projected to maintain large primary fiscal surpluses that should reduce public debt going forward (despite a large one-off increase this year due to the CCB transaction).
  - Reversal of crisis-era wage cuts and interest levy, introduction of the Estia scheme, and likely increases in health expenditures following the rollout of the National Health System starting next year imply a modest structural loosening.
  - With the output gap closed, a procyclical fiscal stance could increase wage pressures and weigh on competitiveness.
- Recommended fiscal rules and constraints:
  - Strict spending discipline should be maintained given already elevated public debt.
  - Transitory revenues from cyclical gains and one-off measures should not finance permanent spending initiatives.
  - Expenditure rises should be capped by medium-term GDP growth (adjusted for permanent revenue changes).
  - Keep the public wage bill envelope within nominal GDP growth.
- Health sector transition:
  - Transition to public insurance in health needs careful management; phasing in and fine-tuning of the regulatory framework for service provision and reimbursement mechanisms may take time to control incentives for over-provision.
- Complementary fiscal structural reforms:
  - Implement spending reviews, public administration reform, local government reform, and governance improvements for state-owned enterprises to minimize fiscal risks.

### Policy priorities — Structural reforms: improving the investment climate and inclusive growth
- Judicial reform and enforcement of commercial claims:
  - Increase court efficiency, clear case backlogs, and speed enforcement of commercial claims to reduce cost of capital and improve access to financing and investment.
  - Add judges, reform the civil procedure code, and introduce an e-justice system to reduce length of court procedures.
  - Address persistent delays with issuance and transfer of title deeds, focusing on clearing the backlog and preventing recurrence.
- Public sector governance and public administration effectiveness:
  - Strengthen public financial management through better internal controls and monitoring of risks from local government and public bodies.
  - Improve corporate governance of commercial state-owned enterprises: strengthen financial oversight, implement a more effective planning and reporting framework with greater disclosure and transparency, and introduce a code of conduct consistent with OECD principles.
  - Legislation to reform assessment and promotion in the civil service would facilitate greater mobility and efficiency.
  - Local government reform would improve service delivery.
  - Expedite legislative efforts to strengthen the governance and autonomy of the Central Bank of Cyprus.
- Promoting inclusive growth:
  - Address high youth unemployment and low employment rates for recent tertiary graduates due to skills mismatch.
  - Promote Active Labor Market Policies (ALMPs) targeting youth and other vulnerable groups, strengthen education to better link work-based and school-based programs, and encourage investment in high value-added sectors.

*Staff thanks the Cypriot authorities and interlocutors for informative discussions and cooperation during the mission.*

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## References

- [Cyprus and the IMF](http://www.imf.org/external/country/CYP/index.htm)
- [IMF Policy Advice -- A Factsheet](https://www.imf.org/en/about/factsheets/imf-surveillance)
- [Mission Concluding Statements](https://www.imf.org/en/news/searchnews)
- [PRESS CENTER](http://presscenter.imf.org/)
- [https://www.imf.org/en/home](https://www.imf.org/en/home)

_Source: https://www.imf.org/en/news/articles/2018/10/05/mcs10518-cyprus-staff-concluding-statement-of-the-2018-article-iv-mission_