The IMF said on Thursday that Cyprus’ economic recovery has strengthened, but that non-performing loans (NPLs)continue to weigh on banks’ profitability and have prevented significant improvement in households’ and corporations’ financial health.
In it second post-programme monitoring report, the IMF said noted that GDP growth, which reached 3.9% in 2017, was forecast to extend well into the future. It projected GDP growth to rise to 4% this year and to 4.2% in 2019.
“The brisk pace of economic activity is underpinned by ongoing and planned construction projects, and is only partly dented by decelerating private consumption, as households step up loan repayments over time. In the medium term, growth is projected to ease gradually towards 2.5%, as construction projects reach completion. Investment, mainly in the tourism sector, is expected to raise potential growth somewhat,” it added.
Sustained fiscal primary surpluses of around 4%–4.5% of GDP during 2018–23, combined with buoyant nominal GDP growth, would help lower the public debt ratio to 72 % of GDP by 2023, after a 12-percentage point increase in early 2018 from restructuring of the Cyprus Co-operative Bank. But banks’ weak asset quality and insufficient diversification of economic activity are sources of downside risks to this outlook, it noted.
The IMF welcomed the economy’s strengthening recovery, which has been accompanied by a sustained decline in the unemployment rate, a sizeable primary fiscal surplus, and a reduction in the public debt ratio.
But it noted that despite the economy’s strong upswing, banks’ NPLs and private sector debt remain high, reflecting continued weak payment discipline. They urged the authorities to strengthen efforts to address these legacy problems.
The IMF was the third partner with the European Commission and European Central Bank in the 2013 bail out of the Cyprus economy.
It said that Cyprus’ capacity to repay the Fund is expected to be adequate under staff’s baseline scenario, but is subject to significant downside risks. “Sustained strong economic growth and accompanying fiscal primary surpluses would be crucial to achieve a projected rapid decline in the public debt-to-GDP ratio and allow continued access to financial markets on favourable terms. Strong and continued efforts to implement ambitious macroeconomic policies and structural reforms would further reinforce Cyprus’s capacity to repay.”
The IMF stressed the urgency of reducing NPLs in a decisive and durable manner and highlighted the need to ensure that banks remain adequately capitalised and provisioned and that loans transferred to the special purpose vehicle are restructured swiftly. They recommended amending the current framework for insolvency and foreclosure to improve payment discipline.
Any scheme aimed at encouraging vulnerable borrowers to begin servicing their loans should be subject to tight eligibility criteria to avoid moral hazard and contain fiscal costs, it said.
In welcoming the rapid improvement in the fiscal position, the IMF highlighted the need to avoid procyclicality and supported capping fiscal spending increases at the medium-term output growth rate. It also recommended instituting a durable mechanism to control the public-sector wage bill and keeping in check the fiscal risks arising from the planned introduction of the National Health System. These efforts would help safeguard the downward path of debt and create space to absorb contingent fiscal shocks.
The IMF also urged the authorities to restart macro-critical structural reforms to help diversify the economy. To attract capital into innovative sectors, it recommended focusing efforts on strengthening the enforcement of commercial claims and the efficiency of the courts, as well as pursuing privatisation. It also suggested avoiding an excessive concentration of economic activity in construction. And it highlighted the importance of full compliance with AML/CFT standards and strengthening the anti-corruption framework.