We thank staff for the first post-program monitoring (PPM) discussions that followed the exit of the Extended Arrangement under the Extended Fund Facility (EFF). The economic recovery has been broad based and continues to strengthen. Nevertheless, there is no room for complacency and ambitious policies should be further pursued, with a focus on further public and private debt reduction and structural reforms that foster strong and sustainable long term growth.
Under the macroeconomic adjustment program, the Cyprus authorities have implemented significant reforms. These reforms aimed to address imbalances in the financial sector, to promote fiscal consolidation and to support competitiveness and sustainable and balanced growth. The results are noteworthy. In 2016, economic growth accelerated to 2.8%, which is expected to be sustained in the following years. More recent data, in particular the real GDP flash estimate for 2017Q1 (y-o-y growth of 3.3%) points to a further acceleration of economic activity. The resilience of the financial sector has improved considerably through inter alia strengthening of the regulatory and supervisory framework, a significant reduction in its size as a percentage to GDP and much healthier capital adequacy and solvency ratios. The excessive deficit in the general government sector has been corrected and public finances have been put on a sustainable path. In fact, a budget surplus of 0.4% of GDP and a primary surplus of 3% of GDP was achieved in 2016. Moreover, major reforms were implemented to address issues with social welfare, the state’s pension schemes and public financial management.
In this context, the authorities have formally informed the Managing Director on May 30, 2017 of their intention to repay early part of the credit outstanding under the Extended Arrangement under the EFF. The successful completion of the macroeconomic adjustment program has reduced the cost of borrowing from the markets significantly. For the IMF credit outstanding exceeding 187.5% of quota, the basic rate of charge plus the surcharges clearly exceed the market rate of the Republic of Cyprus’ bonds. An early repayment of the credit outstanding above 187.5% could be financed from existing excess cash reserves and therefore improves the debt sustainability profile of the Republic of Cyprus.
Even though with the early repayment the amount of credit outstanding will fall below the threshold for PPM, the authorities see merit in maintaining close monitoring of capacity to repay in the context of PPM until 2020. The authorities appreciate staff’s assessment of Cyprus’s repayment capacity and policy recommendations to enhance this capacity, and would welcome continuation of this monitoring during the first years after the EFF arrangement. With staff’s in-depth assessment and policy advice, the authorities will be able to further strengthen the recovery and enhance strong and durable economic growth.
The authorities expect that growth will overperform staff’s forecasts. They project 3% for both 2017 and 2018 and beyond 2018 growth is expected to be around 2.75% (staff projects 2.7% for 2017 and 2.1% over the medium term). The recovery is expected to be broad-based and mainly driven by the implementation of important investment projects in transport, gaming, energy and higher education, as well as in tourism. The construction of the casino is expected to diversify the tourism product, further increasing the sector’s growth prospects. Improvements in competitiveness, partly due to the significant decline in wages and unit labor costs in the last few years, have played a role in the strong performance of exports.
The authorities agree that faster progress with non-performing loans (NPLs) reduction is needed and are currently considering refinements to existing policies. Although the available data indicate that the level of NPLs was reduced by a sizable amount during the last two years, they remain high. This is notwithstanding intensified efforts to restructure them since the end of 2015. It should be noted that following a steep learning curve, both on the part of credit institutions and on the part of borrowers, more sustainable solutions are being offered. Both in terms of restructuring, by way of other tools being used, such as write-offs, split of loans, debt-to-asset swaps and by the solutions provided by the foreclosures and insolvency laws. The revision of the Business of Credit Institutions Law has provided flexibility to credit institutions to better manage properties acquired in satisfaction of debts, as to administer them and not to flood the market and thus negatively impact prices. Furthermore, credit institutions are also looking to external solutions such as joint ventures, outsourcing of the management of NPLs, or selling NPLs.
The Central Bank of Cyprus (CBC) is monitoring progress and developments in reducing NPLs, and stimulate and facilitate solutions to address this serious challenge. Several regulatory and supervisory reforms have been implemented, for example the enactment of legislation enabling to accelerate transfers of title deeds, and legislation on foreclosures and insolvency. As part of further legislative developments, the authorities are preparing for the introduction of a securitization law. In addition, the CBC assesses on a quarterly basis the credit-to-GDP gap as well as other macro-financial variables, and has the necessary macroprudential tools to prevent a new boom-bust cycle.
The fiscal strategy of the government is focused on reducing the level of public debt, without harming GDP growth. Fiscal policy is geared towards maintaining a high primary surplus over the medium term averaging 3% GDP. Any windfall revenue – and there was a sustained revenue overperformance over the last years - will be used to further reduce debt. The recommendation by staff for an additional fiscal effort of 0,5% percentage point GDP seems overly prescriptive and not needed to bring the debt level firmly on a downward path and thus meeting the requirements under the SGP. The authorities do agree that there is no room for complacency and are working hard to ensure the National Health Service, the public-sector wage bill and public sector pension costs do not pose risks to fiscal sustainability.
The authorities appreciate staff’s recommendations on key structural reforms, which will be useful for the maintenance of the reform agenda. The Action Plan for Growth that was approved in February 2015 was updated in November 2016. This action plan includes around 70 targeted actions with specific timeframes aimed at enhancing the competitiveness of the economy, increasing productivity and unlocking investment potential. The modernization and reorganization of the courts is moving forward and a bill to establish a separate, dedicated commercial court will be submitted to parliament in the third quarter of 2017. There is some progress in selling several smaller state-owned assets. Larger scale privatizations and further streamlining of business procedures are expected to be intensified after the upcoming elections when the authorities will recalibrate the comprehensive reform agenda.