The Ampitheatre at Kourion in Cyprus. Tourism has been helping to drive the country’s return to economic growth (photo: Scott S. Warren/National Geographic/Corbis)

ECONOMIC HEALTH CHECK

Cyprus Steps Toward Sustainable Growth

IMF Survey

June 23, 2015

Cyprus has made good progress in implementing its economic program, notably reforms to ease the burden of bad loans. In the first quarter of 2015, the nation returned to positive growth for the first time in four years.

In May 2013, the Fund approved a €1 billion loan over three years to help Cyprus in its efforts to stabilize its banking sector and set public finances on a sustainable path. The loan is subject to regular review checkpoints. On June 19, 2015 the IMF Executive Board signed off on three such reviews, giving a green light to release €278.4 million.

In an interview with IMF Survey, Mark Lewis, the IMF Mission Chief for Cyprus, reflects on the progress made and the road ahead.

IMF Survey: After some delays, the IMF has completed three reviews of the Cyprus program at the same time. What happened?

Lewis: Performance under the program has been good over the past year. Public finances have exceeded expectations, structural reforms have proceeded, and the authorities’ ownership of the program has remained high. However there were difficulties in reforming legislation to address non-performing loans. The Cypriot parliament froze approved changes to foreclosure rules, arguing that insolvency rules needed to be updated in parallel. This took longer than anticipated but Parliament ultimately provided broad-based support to the whole reform. This was a fundamental step forward for Cyprus and allowed the reviews to proceed.

IMF Survey: Why are the insolvency and foreclosure frameworks so important?

Lewis: The insolvency and foreclosure frameworks are critical to ensure the country returns to a sustainable path for jobs, stability and prosperity. A lot has been said about the impact of non-performing loans on banks’ balance sheets and capital, but not enough on the broader implications for the economy. Almost 60 percent of loans on domestic banks’ books are non-performing, which is preventing them from providing new credit. Modern and effective foreclosure and insolvency frameworks are good news for both banks and borrowers. They allow new credit to be extended to families and corporations, and on better terms, which supports growth and jobs.

IMF Survey: At the time of the crisis, many observers said Cyprus should look for another economic model. Has it found it?

Lewis: Prior to the crisis, growth had been driven by an outsized banking system, construction and real estate activity. These sectors have understandably and necessarily fallen back. Cyprus’s growth model is adapting to what we call a “credit-less” recovery. Sectors that are less dependent on loans, such as tourism and non-financial business services, are driving growth.

It is very encouraging to see that in the first quarter of 2015 Cyprus has returned to positive growth for the first time in four years. The path of gradual recovery has consistently exceeded our earlier expectations and those of other forecasters.

Looking ahead, Cyprus should redouble its efforts to make the country a good place to do business. The government’s plan to put in place a growth strategy is welcome. Efforts should include strengthening the legal system, privatizing state-owned enterprises, opening up closed professions, removing barriers to competition, reducing red tape, and fostering innovation. These are all steps that could support growth and a job-rich recovery.

IMF Survey: Cyprus seems to have come a long way since the height of the crisis in early 2013. What’s next?

Lewis: Cyprus has indeed made impressive progress, but important challenges remain for the program and beyond. Three priorities stand out. Firstly, banks should be in a position to extend new credit to the economy. Secondly, the corporate sector should attract more foreign direct investment. And thirdly, the government should continue to steer down public debt, which remains very high. This needs to be done while protecting vulnerable groups affected by the crisis and ensuring sufficient public investment.

It will also be important to proceed on reforms to support private debt restructuring in Cyprus, notably steps to ease the sale of loans, clean up the backlog of title deeds, and modernize judicial procedures. Continued structural reforms are also needed to support growth in the economy, jobs, and income.

IMF Survey: How would Cyprus be affected by turbulence in Greece?

Lewis: Cyprus has significantly reduced its exposure to Greece over time, and contagion effects should be contained. Nonetheless, it would be difficult for Cyprus to avoid altogether the effects of a protracted period of market volatility. The best response to these external shocks is steady and resolute implementation of the program reforms. The people of Cyprus should be given full credit for all the results the country has achieved so far. It is now a matter of continuing along the same path.