Cyprus’ banks are making progress in cleaning up their balance sheets, but the banking sector still faces one of the highest NPL ratios in Europe, while both private and public sectors have a large debt overhang, the IMF said on Monday.
In a statement following the conclusion of its Article IV consultation with Cyprus, the IMF said Cyprus is recovering strongly following the 2012–13 crisis. GDP grew by 4% (yoy) in the first half of 2018, driven by tourism, professional services and foreign investment in construction as well as continued strength in private consumption.
The unemployment rate continued to decline to 7.4% in September from 10.2% a year earlier. Inflationary pressures remain low. Supported by subdued unit labour costs, Cyprus has maintained its export competitiveness, although the current account deficit widened last year as strong domestic demand pushed up imports. Fiscal performance has strengthened on the economic recovery with the primary surplus widening to 4.3% of GDP in 2017.
The near-term outlook for the economy is favourable, with growth expected to remain at around 4.2% in 2018–19, supported by the services sector and largely foreign-financed investments.
Over the medium term, economic growth is projected to slow to its long-run potential rate of around 2½%, as the transitory effects of the investment boom gradually dissipate.
Fiscal performance is expected to improve with a primary surplus of around 5% in 2018–19. Public debt is thus expected to be on a firm declining path, falling below 70% of GDP by 2023, despite a sharp increase earlier this year following the resolution of the Cyprus Co-operative Bank. The economic outlook could weaken if implementation of NPL resolution is delayed, while public debt sustainability could be undermined by realization of contingent liabilities or erosion of fiscal discipline.
The IMF’s executive directors welcomed the strong post-crisis economic recovery, which has supported large fiscal surpluses and lowered the unemployment rate. They also welcomed the recent reforms undertaken to address key vulnerabilities in the banking sector, including the resolution of a large systemic state-owned bank. They noted, however, that private and public debt remain large while NPL ratios are still among the highest in Europe and encouraged the authorities to make further efforts to address these legacy problems and strengthen economic growth over the medium term.
They emphasised the importance of further measures to facilitate a steady decline in NPLs on a durable basis and called for steadfast implementation of the amended legislative framework on foreclosure, insolvency, sale of loans, and securitisation, supplemented by a strengthening of the court system and removal of uncertainties related to title deeds.
Directors also stressed the need to enhance the governance and supervisory framework for the recently-established asset management company. They recommended that to limit moral hazard, the proposed Estia scheme aimed at encouraging distressed borrowers to begin servicing their loans be better targeted and based on appropriate assessment of borrowers’ capacity to repay.
The IMF highlighted the need for banks to continue efforts to strengthen their balance sheets. They urged banks to diversify income sources and consolidate operations to improve cost-income ratios and better position themselves against increased competition. It recommended strengthening regulatory guidance on loan restructuring and exercising vigilance over bank lending policies, the adequacy of provisioning, and debt-to-asset swap policies.
The IMF welcomed Cyprus’s robust fiscal performance and emphasised that strict spending discipline should be maintained.
It cautioned against relying on transitory revenues from cyclical gains and one-off measures to finance permanent spending initiatives, and took positive note of the authorities’ commitment to cap expenditure increases, including the public wage bill, in line with the medium-term GDP growth rate, in order to create room for growth-enhancing spending.
It noted that the transition to public insurance in the health sector should be carefully managed and agreed that fiscal structural reforms are needed, and recommended strengthening public financial management, monitoring risks from local governments and the state-owned sector, and improving the corporate governance of commercial state-owned enterprises.
The IMF stressed the need to undertake institutional reforms and further enhance the investment climate and raise medium-term growth potential. It agreed that reforms to increase the efficiency of the courts, speed up the enforcement of commercial claims, and clear the backlog of cases should continue. It also recommended expediting legislation to strengthen the governance and autonomy of the Central Bank of Cyprus and encouraged further efforts to mitigate AML/CFT risks.
The IMF noted that active labour market policies and investment in higher value-added sectors can help reduce high youth unemployment and skills mismatch, thereby promoting more inclusive growth.