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IMF Executive Board Concludes 2019 Article IV Consultation with Cyprus

On November 27, 2019, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with Cyprus.

Following a period of rapid recovery from the 2012–13 financial crisis, Cyprus’s economic growth momentum is gradually slowing. Growth decelerated to 3.2 percent (year-over-year) in the first semester of 2019, from 4.0 percent in 2018, amidst a slowing global economy and Brexit-related uncertainty which has taken a toll on tourism receipts and service exports. The underlying current account deficit widened due to slower growth of trading partners. Fiscal performance was strong as the underlying general government primary surplus rose to 5.4 percent of GDP in 2018. Inflationary pressure remained low, and the unemployment rate continued to decline, reaching close to pre-crisis levels. While the banking sector has made significant improvements, challenges remain. Non-performing loans, at 30 percent of loans, remain among the highest in Europe. A large private sector debt overhang persists, given continued difficulties in debt workouts. Lagging productivity growth and political pressure to unwind key reforms also weigh on the outlook.

The near-term outlook remains robust despite increasing external headwinds. Real GDP growth is projected to moderate to around 3 percent in 2019–20, supported by construction and services sectors. Over the medium term, economic growth is projected to slow to its long-run potential rate of around 2½ percent, as the transitory effects of the investment boom dissipates. Private consumption is expected to remain resilient, however, on the back of tightening labor markets and the gradual credit recovery as banks’ balance sheet improves. Public debt is projected to decline to 65 percent of GDP by 2024 on the back of continued high primary surplus. Risks to the outlook are predominantly on the downside arising from sharper-than-expected external shocks.

Executive Board Assessment [2]

Executive Directors agreed with the thrust of the staff appraisal. They welcomed the strong economic recovery and declining unemployment rate, and commended the authorities for the good progress in addressing banking sector vulnerabilities and improving macroeconomic fundamentals. Directors pointed out that productivity growth has been weak, reflecting institutional bottlenecks and the slow pace of technology adoption, and that private sector indebtedness remains high amid ongoing challenges in debt workouts. Looking ahead, given the significant downside risks, Directors encouraged further steadfast efforts to address crisis legacies by continuing to reduce debt vulnerabilities, improve public spending efficiency, and raise economic growth potential and inclusiveness.

Directors emphasized the importance of steady NPL resolution and sustainable debt workouts. They highlighted the need for ensuring a well‑functioning NPL resolution toolkit, including through implementation of a credible foreclosure framework, along with complementary reforms in the judiciary. Directors also stressed the need to continue strengthening the supervisory and regulatory framework of credit acquiring companies and to finalize the governance structure of state‑owned Cyprus Asset Management Company. They underlined the importance of minimizing moral hazard risks inherent in the state‑subsidy scheme for primary homeowners (Estia).

Directors saw a need for broader efforts to further strengthen banks’ balance sheets and profitability. They advised that banks should continue to maintain adequate provisions and capital buffers. Directors agreed that to ease pressures on profitability, policies should encourage lower cost‑to‑income ratios through diversifying income sources, rationalizing operations, and implementing digitization solutions. Directors noted that macro‑financial risks from the property market appear limited now but warrant close monitoring.

Directors welcomed Cyprus’s strong fiscal performance, and stressed the need to continue to reduce debt sustainability risks and to enhance the efficiency of expenditures. Directors considered that expenditure growth, particularly that of the wage bill, should be contained to keep debt firmly on a downward path and to prevent crowding out of productive spending. They agreed that there is scope to improve the efficiency of education spending and increase investment in technological innovation and human capital buildup to reduce skills mismatches and achieve more inclusive growth, particularly among the youth. Managing incentives and costs of services as well as ensuring the competitiveness of the public health sector is key to control fiscal risks from the recently implemented National Health System.

Directors emphasized that structural reforms are key to raise medium‑term growth potential. Given low labor productivity growth and challenges to investment and economic efficiency, they called for policies to support greater market diversification, competition, and technology adoption. Directors welcomed the authorities’ strategy to improve STEM training and research and development innovation and to ease access to finance, as well as their national digital strategy. They recommended continued efforts to improve the efficiency of the judiciary and strengthen public sector governance. Directors agreed that mitigating existing inherent AML/CFT risks remains a critical priority.

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