On June 3, 2019, the Executive Board of the International Monetary Fund (IMF) concluded the Third Post-Program Monitoring discussions [1] with Cyprus.
Cyprus’s post-crisis economic recovery is gradually decelerating but remains strong. Real GDP grew by 3.9 percent in 2018, buoyed by the services and construction sectors, partly financed with foreign direct investment. The unemployment rate continued to decline, reaching 7.1 percent in February, compared to 9.4 percent a year earlier, while wage pressures and inflation remain low. A large fiscal surplus is helping to lower public debt following a sizable one-off increase related to the sale of Cyprus Cooperative Bank (CCB) last year. The removal of CCB’s non-performing loans (NPLs) and securitization of a large NPL portfolio have led to a sharp reduction in NPLs. Nevertheless, NPLs are still among the highest in the EU, public and private debt levels remain elevated and efforts to clean up bank balance sheets and build capital buffers are ongoing.
Executive Board Assessment [2]
Cyprus’s rapid recovery is expected to slow gradually, but the outlook remains favorable. Real GDP is projected to grow at a still-robust 3–3½ percent in 2019–20, supported by foreign-financed investment and private consumption. Over the medium term, growth is expected to ease to potential, as the investment boom dissipates and households step up debt servicing.
Capacity to repay the Fund is adequate under the staff’s baseline scenario. While risks remain, these have declined and their impact on repayment capacity should be manageable. Repayment capacity is underpinned by projected robust economic growth and sizable primary fiscal surpluses that anchor a durable decline in the gross public debt-to-GDP ratio and support continued favorable market borrowing terms. However, repayment capacity could be weakened if risks materialize from banks’ still weak asset quality, direct fiscal guarantees, and fiscal spending including the reversal of crisis-era measures. The growth outlook could be adversely affected in the event of a disorderly hard Brexit, tightening of foreign financing for investment, or realization of AML/CFT risks. Safeguarding the adequate repayment capacity therefore warrants ambitious financial and fiscal policies as well as structural reforms.
Durable declines in NPLs remain a priority to reduce sovereign-bank linkages further. A package of legislative amendments in 2018 have enhanced the toolkit to address NPLs. While banks have made significant progress in offloading NPLs, their successful workout outside of the banking system is still needed in order to reduce the high debt burden in the economy. The implementation of the foreclosure framework should be complemented by the planned introduction of e-auctions, ongoing reform of the court system and measures to eliminate uncertainties regarding title deeds. Banks should be encouraged to maintain adequate provisioning coverage and capital, including by diversifying revenue sources and rationalizing operational costs. Ensuring ongoing compliance with the eligibility requirements for the Estia scheme is crucial to minimize its fiscal cost. An appropriate governance structure for the state-owned AMC should be put in place expeditiously to avoid warehousing of assets and maximize recovery.
Strict fiscal discipline should be maintained. A neutral medium-term fiscal stance should be ensured. Spending growth should continue to be firmly maintained at a pace below that of medium-term GDP and cyclical and windfall revenues, including from state-owned AMC, should be saved to help safeguard the firmly downward path of public debt. In this regard, it is important to keep growth of the wage bill, including increases arising from the reversal of crisis-era public wage and pension cuts, below nominal GDP. Fiscal risks from the introduction of a public health insurance system should be mitigated by reforms aimed at making the public health sector more competitive and managing incentives for providers and patients.
A window of opportunity for structural reforms is opening and should be vigorously pursued. With CCB now resolved and the next Parliamentary elections scheduled only in 2021, the authorities are pursuing some long-delayed structural reforms, including judiciary and local government reforms, and the introduction of a national health insurance system. However, there has been little progress on some important reforms, such as the SOE law, privatizations, and broader civil service reforms. Reforms of civil procedures and the process to issue title deeds, and introduction of the e-justice system, would help resolve crisis legacies and improve access to financing and investment. Further efforts to mitigate AML/CFT risks and strengthen governance of commercial SOEs and the Central Bank of Cyprus will help reduce risks to growth and fiscal risks.
Continued monitoring of Cyprus’s repayment capacity under PPM is warranted during the next 12 months. Progress toward external viability is subject to risks, as realization of contingent liabilities arising from banks’ still high NPLs could adversely affect the sovereign’s market access. The Cypriot authorities have indicated their willingness to continue to engage with the Fund under PPM until 2020.
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Cyprus: Selected Economic Indicators, 2015–2019 |
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Projections |
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2015 |
2016 |
2017 |
2018 |
2019 |
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Output/Demand |
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Real GDP |
2.0 |
4.8 |
4.5 |
3.9 |
3.5 |
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Domestic demand |
3.9 |
6.1 |
8.5 |
3.0 |
4.5 |
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Consumption |
1.9 |
3.5 |
3.9 |
3.8 |
2.9 |
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Private consumption |
2.4 |
4.5 |
4.1 |
3.7 |
3.0 |
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Public consumption |
-0.5 |
-0.8 |
3.1 |
4.3 |
3.9 |
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Gross capital formation |
18.1 |
21.9 |
31.8 |
-0.3 |
10.9 |
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Foreign balance 1/ |
-1.8 |
-1.2 |
-3.9 |
0.7 |
-1.0 |
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Exports of goods and services |
5.2 |
4.6 |
6.0 |
3.3 |
-1.3 |
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Imports of goods and services |
8.4 |
6.6 |
12.2 |
2.0 |
0.2 |
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Potential GDP growth |
1.2 |
1.6 |
2.0 |
2.3 |
2.6 |
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Output gap (percent of potential GDP) |
-7.0 |
-4.1 |
-1.8 |
-0.3 |
0.6 |
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Prices |
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HICP (period average, percent) |
-1.5 |
-1.2 |
0.7 |
0.8 |
0.5 |
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HICP (end of period, percent) |
-0.5 |
0.1 |
-0.3 |
1.1 |
1.2 |
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Employment |
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Unemployment rate (EU standard, percent) |
14.9 |
13.0 |
11.1 |
8.4 |
7.0 |
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Employment growth (percent) |
-1.3 |
1.4 |
4.6 |
5.6 |
2.5 |
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Public Finance |
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General government balance |
-0.3 |
0.3 |
1.8 |
-4.8 |
3.3 |
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Revenue |
39.0 |
38.0 |
38.9 |
39.7 |
40.8 |
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Expenditure |
39.3 |
37.7 |
37.1 |
44.5 |
37.5 |
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Primary Fiscal Balance |
2.7 |
3.0 |
4.3 |
-2.3 |
5.7 |
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General government debt |
108.0 |
105.5 |
95.8 |
102.5 |
95.2 |
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Balance of Payments |
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Current account balance |
-1.5 |
-5.1 |
-8.4 |
-7.0 |
-7.3 |
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Trade Balance (goods and services) |
0.8 |
-0.6 |
-3.5 |
-2.2 |
-3.2 |
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Nominal GDP (billions of euros) |
17.7 |
18.5 |
19.6 |
20.7 |
21.8 |
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Sources: Statistical Service of the Republic of Cyprus, Central Bank of Cyprus, and IMF staff estimates. 1/ Contribution to growth (percentage points). |
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[1] The central objective of PPM is to provide for closer monitoring of the policies of members that have substantial Fund credit outstanding following the expiration of their arrangements. Under PPM, members undertake more frequent formal consultation with the Fund than is the case under surveillance, with a particular focus on macroeconomic and structural policies that have a bearing on external viability.
[2] The Executive Board takes decisions under its lapse-of-time procedure when the Board agrees that a proposal can be considered without convening formal discussions.
