Cyprus: IMF Staff Concluding Statement of the 2019 Article IV Mission
September 26, 2019
A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF’s Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.
The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.
Cyprus has made significant progress in recovering from the
financial crisis. Real GDP has now surpassed its pre-crisis peak
and the unemployment rate has declined rapidly coming close to the
Large disposals of non-performing loans (NPL) have strengthened bank
stability, and sizable fiscal surpluses have lowered risk premia and
reduced financing risks.
Challenges remain however in sustaining the relatively robust growth
momentum. Given still-high NPLs, recent efforts to undo key reform
initiatives are undermining the hard-won gains in restoring
macro-financial stability. Increasing external headwinds are slowing
near-term growth, while a sizable debt overhang and weak productivity
growth also hold back medium-term growth potential.
Policies should focus on reforms to secure financial stability and
raise the growth potential of the economy. Priorities are to
steadfastly implement the strengthened legal tools to lower NPLs and
private debt and to build bank capital buffers; to reduce public debt
by ensuring strict spending discipline and improving the efficiency of
public spending; and to increase productivity through institutional
reforms and the promotion of technology adoption.
Outlook and Risks
Cyprus has made significant strides in recovering from the
financial crisis and in addressing its legacy challenges
. With economic growth averaging about 4½ percent over the past
three years, the pace of recovery in Cyprus has been more rapid
than many other euro area post-crisis economies. The
unemployment rate has declined although it is still above the
pre-crisis level. Efforts to address high NPLs and banking
system vulnerabilities also gained momentum.
The disposal of large NPL portfolios, supported by a strengthened
foreclosure and insolvency framework last year, and the resolution
of Cyprus Cooperative Bank paved the way for a more consolidated
and deleveraged banking system. GDP levels have now surpassed
pre-crisis levels, while in the banking system, NPLs as a share of
GDP have declined by nearly two-thirds from its post-crisis peak.
Although public debt has spiked in the process, strict spending
discipline and large fiscal surpluses have helped Cyprus to
capitalize on favorable market conditions and reduce debt
While economic growth is gradually moderating, the near-term
economic outlook remains favorable
. Growth is expected to decelerate to around 3 percent in 2019–20
on weaker external demand, from nearly 4 percent last year.
Investment is expected to remain strong, driven by housing and
infrastructure construction projects that are primarily foreign
financed, while robust labor market recovery and rising income
continue to support private consumption. The current account
deficit is expected to widen, reflecting slowing growth among
trading partners and continued high construction-related imports.
Over the medium term, growth is expected to slow to its
long-run potential growth rate of around 2½ percent, as the
transitory effect of the investment boom gradually dissipates.
Risks to the outlook are mainly on the downside
. Delays in NPL resolution could negatively affect the capital
position of banks and weigh on availability of credit. Realization
of fiscal contingent liabilities could slow the pace of debt
reduction, eroding confidence and raising risk premiums. The high
level of external debt makes the economy vulnerable to interest
rate and growth shocks. External risks from rising protectionist
trade policies, a sharper-than-expected slowdown in euro area
growth or a hard Brexit could affect tourism and shipping revenues
and foreign direct investment (FDI) flows.
A negative assessment on Anti-Money Laundering/Combating
Financial Terrorism (AML/CFT) compliance risks could affect
confidence and deter investments.
On the upside, exploitation of offshore gas deposits and energy
sector investments could boost growth over the longer term.
Important challenges remain in sustaining the growth momentum
over the longer term
. Private sector deleveraging has been lagging given ongoing
challenges in debt workouts. The NPL ratio has declined from more
than half of loans at end-2017 to less than one-third today but
remains among the highest in Europe, and banks suffer from low
profitability, constraining credit and investment growth. In this
context, the amendments to the foreclosure framework, which were
recently approved by the Parliament but have not entered into
effect and are currently being reviewed by the Supreme Court, are a
setback creating uncertainties for NPL reduction and deleveraging
of the economy. Longer-term economic growth potential is hindered
by weak productivity growth, reflecting financial sector weakness
as well as broader institutional bottlenecks and a slow pace of
technology diffusion. Policies should thus focus on reforms to
secure financial stability and strengthen growth potential by
enhancing efficiency and productivity.
Financial Sector Policy: Supporting Deleveraging and Strengthening
NPL resolution and sustainable debt workouts remain key
. Efforts should focus on ensuring a well-functioning NPL
resolution toolkit through restructuring, foreclosure, and
insolvency. To this end, the recent amendments to the legislation
risk reducing the effectiveness of foreclosure as a credible threat
against strategic default, thereby weakening prospects for
collateral recovery and increasing the need for additional
provisioning. Adequate supervisory oversight of durable
restructuring is crucial. The finalization of the framework for
electronic auctions and continued progress with complementary
judiciary reforms aimed at reducing backlogs will also be key to
improve collateral execution and incentives for debt workouts.
Strengthening of the supervisory and regulatory framework of
credit acquiring companies (CACs) should continue.
While progress has been made on multiple fronts, including
staffing, on-site inspections and off-site monitoring,
strengthening of data reporting and analysis will be crucial given
that a sizable stock of NPLs is now held by CACs. It is also
important to swiftly finalize the state-owned Cyprus Asset
Management Company’s (CAMC) governance and operational structure,
business strategic plan, and performance measurement framework,
with an appropriate sunset clause and a clear mandate to maximize
recovery, while balancing operational independence with public
accountability and transparency.
Efforts should be made to address the moral hazard risks
inherent in the Estia subsidy scheme
. Close monitoring to prevent potential abuse of the scheme and
timely reassessment of borrower eligibility will be needed, to
ensure that taxpayers are not called on to subsidize individuals
who are capable of servicing their mortgages. Any complementary
schemes for vulnerable primary owners deemed unviable under Estia should ensure further burden sharing and be
well-targeted with a full cost-benefit analysis undertaken to
control fiscal and implementation costs.
More broadly, efforts to further improve bank profitability and
capitalization are crucial.
Narrowing interest margins and excess liquidity in a declining
interest rate environment are creating pressures on profitability,
which is being further weighed down by an inefficient cost
structure with excess staffing levels and branch networks in the
banking system. Banks should continue to maintain adequate
provisions and capital buffers to insulate against potential
further losses from NPL sales and workouts and reduce property
holdings to targeted levels. Policies should encourage lowering of
cost-to-income ratios through rationalization of operational costs,
diversifying income sources, and undertaking of digitization
Macro-financial risks from the property market appear limited
for now but warrant close monitoring.
The segmented nature of the property market calls for close
monitoring of sectoral developments, for example, to ensure that
any overheating in the luxury segment is not fueled by domestic
credit, or that concentration of future sales of repossessed
collateral properties does not lead to fire-sales. Macroprudential
measures tailored to the market segment should be undertaken if
Fiscal Policy: Mitigating Risks to Debt Sustainability and Enhancing
Fiscal performance is strong, but risks remain
. Cyprus is projected to maintain large primary surpluses that
will allow public debt to decline rapidly over the medium term.
However, this outlook is subject to risks, including from
court-mandated increases in the public wage bill reversing
crisis-era measures, higher-than-expected spending under the
newly introduced National Health System (NHS)—particularly from
lagging competitiveness of the public health sector vis-à-vis
the private sector—and contingent liabilities from public
entities, as well as the Asset Protection Scheme and weak asset
quality in the financial sector.
Spending should be firmly controlled to reduce risks to debt
sustainability, while the composition of expenditure should
seek to enhance efficiency
. Expenditure growth should be capped by nominal medium-term output
growth to keep debt firmly on a downward path. Prioritizing public
spending to support structural reform efforts would help achieve
faster and more inclusive medium-term growth. To this end, growth
of the wage bill should be contained below that of nominal GDP, to
create space for more productive expenditure. There is scope to
improve the efficiency of education spending, including by
reallocation towards investment in innovation and human capital. To
contain risks from the NHS, strict monitoring and finetuning of the
regulatory framework for controlling incentives and costs of
services, together with improving the competitiveness of the public
health sector, will be important.
Structural Reforms: Improving Productivity and Strengthening Growth
Productivity enhancing structural reforms are key for
bolstering medium-term growth potential
. While Cyprus has maintained its cost competitiveness, it suffers
from low labor productivity growth and faces challenges to
investment and economic efficiency. These include difficulties with
access to finance, costly and lengthy judicial processes,
inefficiency of government administration, low investment in new
innovations, and skills mismatches.
Policies to support greater market diversification,
competition, and technology adoption are needed to enhance
. Greater investment in Information and Communications Technology
infrastructure, intangibles such as science, technology,
engineering and mathematics training, research and development
innovation and easier access to finance are needed to facilitate
technological diffusion. Given strong reliance on services exports,
reducing remaining restrictions in implementing the EU Market
Services Directive could facilitate competition and attract FDI.
These reforms would enable greater market diversification, which
would support faster economic growth and reduce volatility. Other
competitiveness-enhancing policies could focus on strengthening
business linkages and external connectivity to international
Ongoing efforts to improve efficiency of the judiciary should
continue, in order to better enforce commercial claims, support
deleveraging and reduce the cost of doing business
. The recent specialization of selected judges in financial
litigation, the ongoing recruitment of additional judges, and work
on establishing a court of appeals should be complemented by
reforms of the rules for civil procedures, clearance of the backlog
of cases and introduction of the e-justice system. Strengthening
the institutional framework for the insolvency service and
insolvency professionals is also important. Efforts are needed to
create a more efficient system of issuing and transferring title
deeds and accelerate the clearance of the backlog.
Efforts to reform public sector governance and efficiency
should be renewed
. Approval of pending legislation to reform the assessment of
candidates for appointment and promotions and the structure of the
civil service would facilitate greater mobility and enhance
effectiveness. Legislative efforts to strengthen the governance and
autonomy of the Central Bank of Cyprus should also be expedited.
Successful implementation of local government reforms would
streamline procedures and improve service delivery. Fiscal
institutional measures for strengthening governance of state-owned
enterprises, public financial management controls at the local
government level and reforms in tax administration would help
contain risks while improving public efficiency.
Ensuring that growth is inclusive is key to sustaining growth
. While unemployment is rapidly declining, the share of youth not
in employment, education or training and long-term unemployment
remain high, partly reflecting skill mismatches. Programs focused
on job retraining and improving linkages between educational and
job opportunities would help reduce this gap.
We thank the Cypriot authorities and our other interlocutors, including
from the private sector, for informative discussions and their
cooperation and generous hospitality. We also thank the European
Commission, the European Central Bank, and the European Stability
Mechanism for their collaboration during part of the mission
A report by MONEYVAL (the Committee of Experts on the Evaluation of
Anti-Money Laundering Measures and the Financing of Terrorism, a
permanent monitoring body of the Council of Europe) is expected
later this year.
IMF Communications Department
Phone: +1 202 623-7100Email: MEDIA@IMF.org