Abstract
The economic recovery has continued to gain strength even as progress on the structural reform agenda has been modest. Economic activity through September continued to exceed expectations; fiscal outturns are running ahead of projections; non-performing loans have stabilized; and bank deposits are rising. All end-September performance criteria were met. However, the implementation of the structural reform agenda has suffered delays. Discussions focused on key remaining policy priorities envisaged under the program and for the period beyond. The emphasis was on policies to accelerate reductions in non-performing loans (NPLs) in order to revive lending and boost growth. These included expanding the range of legal instruments available to banks and stepping up implementation of the new private debt restructuring framework. Discussions also stressed the need to lock in fiscal gains given still-high public debt, and avoid further delays in implementing structural reforms that are essential to sustainably re-invigorate growth and create employment.
We thank staff for their constructive assessment of the ninth review under the Extended Fund Facility for Cyprus. The paper appropriately captures the economic developments since the last review and covers topics of relevance for future reforms during the remainder of the program and beyond.
With only one review remaining, it is important to mention that the current program, underpinned by the authorities’ firm commitment, brought back economic stability and lays the foundation for sustained growth and improved living standards for the people of Cyprus.
The economic recovery has continued and despite a challenging external environment, Cyprus posted three consecutive quarters of positive growth. In the financial sector, loan restructurings continued to accelerate, deposits are showing moderate growth and the liquidity buffers have improved. Moreover, the recent adoption of the law on the sale of loans is an important additional element in the toolkit to facilitate the cleaning up of banks’ balance sheets. Furthermore, the authorities have taken measures to strengthen the cooperative credit sector, including reinforcing its capital base and deepening the ongoing restructuring process. Fiscal performance has continued to exceed expectations and, with that, all end-September and subsequent performance criteria have been met. Despite some delays, progress has been made on the program’s structural reform agenda. One of the structural benchmarks scheduled through end-December was met and important work is being done to complete the three remaining benchmarks.
Macroeconomic developments
The economic performance continues to exceed expectations, maintaining the positive trend, in the third quarter. Economic indicators reflect a slow pick-up in private consumption and a broader recovery across economic sectors. Notwithstanding the high level of NPLs, the financial sector continues to strengthen, while the pace of lending is slowly accelerating. Together with the positive fiscal surplus, these developments have improved the sovereign debt situation, with upgrades from two rating agencies, while strong demand for the recently issued Eurobond (the third one since the 2013 crisis) pushed the yields to historically low rates. However, the unemployment rate remains elevated, at around 15 percent.
Fiscal policy
The program’s fiscal performance continues to run ahead of expectations. This reflects the authorities’ commitment to reform as well as a better economic environment that has contributed to reducing unemployment social transfers. These results should help Cyprus achieve its medium-term fiscal targets, a primary surplus of 3 percent of GDP for 2017 and 3-4 percent of GDP for 2018 and beyond. The already adopted 2016 budget documents also include a medium term fiscal framework encompassing the described fiscal targets for the period 2016-18.
Financial Sector
Notwithstanding the marked improvement of the economic environment, the authorities keep reducing the high level of NPLs high on their agenda. Three steps are envisaged: i) ensuring effective implementation of the recently established foreclosure and insolvency regimes; ii) enforcing the supervisory tools for arrears management, and iii) improving the legislation to facilitate banks’ disposal of distressed assets. This approach aims to further encourage voluntary debt restructuring and increase the pace of durable solutions, with the ultimate objective of expediting the cleanup of private sector balance sheets and reviving credit growth. Moreover, the authorities are committed to monitoring the implementation and to adjust the legal framework as needed, to ensure an effective implementation of the new insolvency and foreclosure laws.
The authorities are also focusing on the secondary market for loans. To facilitate the creation of this market, a law on the sales of loans has been adopted end–September 2015. This law, which retains the protection of borrowers under the Code of Conduct, will be a useful addition to the toolkit to address the high levels of banks’ NPLs. Also, the Council of Ministers is expected to approve -by the end of this month- a draft legislation to remove existing impediments to the securitization of assets. The bill includes, inter alia, removing the requirement to obtain the prior consent of borrowers for inclusion in the securitization, as well as any changes to the tax system deemed necessary. The law will be adopted by Parliament by the end of next month.
Structural reforms
The authorities have used the crisis as a window of opportunity to lay the foundation for a more viable and sustainable growth model. Important progress is being made, inter alia, in the goods and services market, public administration, public financial management, housing market, health, and energy. With the economy being stabilized and most urgent issues addressed, the reform effort is now focused on the remaining structural reforms to deal with longstanding inefficiencies that are hampering growth, reduce productivity incentives and foster unjustified social imbalances.
Significant efforts are made towards a comprehensive welfare reform that ensures a guaranteed minimum income for all those in need and that makes the administration of social benefits more efficient. The Cypriot authorities will continue to implement the reform of the revenue administration and the integration of the new tax department by mid 2016, while protecting revenue performance.
Despite a few delays, some progress with privatizing state-owned enterprises has been made and the process is moving ahead. The authorities’ privatization plan includes, among others, CyTA telecommunication, EAC, and the commercial activities of the port of Limassol. In regards to the telecommunication company, the authorities are making efforts to have the bills on the corporatization process and on the employment options for current employees adopted by Parliament by end-January 2016. The call for expression of interest is expected to be launched immediately afterwards, with a view to finalize CyTA’s privatization later this year. Regarding the energy company, the authorities appointed an independent energy advisor to assist with drafting legislation on the effective and efficient unbundling of the Electricity Authority of Cyprus during this year in order to promote effective competition in the electricity market. Regarding the port of Limassol, the announcement of the selected bidder for the concession of the commercial activities is expected by end-March 2016, with a view to sign the concession agreement by end-April 2016. The regulatory framework of the Cyprus Port Authority (CPA) will be amended by end-January 2016 and implemented before the new concessioner is in place.
Conclusion
After almost three years of difficult adjustments, there are clear signs that the efforts are finally being rewarded. While the Cypriot authorities are aware of the remaining significant challenges, we are happy to conclude that Cyprus has reached the penultimate program review with a strong performance.