Cyprus faces excessive imbalances, the European Commission notes in the context of the publication of the winter package of the European semester, which was approved by the College of Commissioners and presented in Brussels by Vice-President Valdis Dobrobowski, Commissioner Moscovici and the Commissioner Tysen.
In the category of countries with "excessive imbalances", only three countries are ranked this year: Greece, Cyprus and Italy. Similarly, there is a softer ranking of countries with just "imbalances" in which Bulgaria, Germany, France, Croatia, Spain, Ireland, the Netherlands, Portugal, Romania and Sweden are included.
More specifically the paragraph on Cyprus reads as follows: Cyprus is experiencing excessive imbalances. A very high share of non-performing loans burdens the financial sector and high stock of private, public, and external debt hangs on the economy, in a context of still relatively high, even though declining, unemployment and weak potential growth."
The Commission warns that "the current account deficit is significantly negative, even taking into account the presence of special purpose entities, reflecting strong domestic demand as well as the negative saving among households, and is not adequate to guarantee a sustainable adjustment of the large stock of net external liabilities" and states that deleveraging of private sector debt is ongoing but only slowly. New lending to the private sector remains limited."
Meanwhile "the transfer of a significant portfolio of non-performing loans from the Cyprus Cooperative Bank to the public sector in the context of the bank`s sale and wind-down reduced significantly the share of non-performing loans in the banking system", however, "non-performing loans remain high for both households and corporations."
"The government support in the sale of the Cyprus Cooperative Bank had a one-off increasing impact on public debt in 2018."
"Looking forward, the high public debt is expected to be on a declining path on the back of a continued strong fiscal performance. Compared to last year, the reform momentum has been stepped up especially on the front of measures to address the vulnerabilities from non-performing loans, but more progress is needed on structural reforms to increase the growth potential", states the European Commission report.
Furthermore, in the official "Communication from the Commission to the European Parliament, the Council, the ECB and the Eurogroup", (2019 European Semester: Evaluation of progress in structural reforms, prevention and correction of macroeconomic imbalances and results of in-depth reviews under Regulation EU No 1176/2011) it is stated that: "in Cyprus, despite the improved economic context and some recent stepping up of policy efforts, significant weaknesses persist in relation to falling but still high levels of non-performing loans and external, private and government debts."
Furthermore the communication notes "Cyprus is putting in place a new system of healthcare contributions paving the way for universal health coverage and limiting high out-of-pocket payments".
It goes on stating that "on aggregate, bank capital and liquidity positions have continued to improve in 2018, supported by the economic environment as well as legislative and supervisory action. Fourteen Member States had low non-performing loans of less than 3%."
"There has been a significant reduction in Cyprus, Ireland, Italy, Spain, Portugal, Hungary, Slovenia, Romania, Austria and Germany, where the pace of non-performing loans disposals has picked up significantly since 2017 amid persistent supervisory pressure and / or and further development of secondary non-performing loans markets", according to the same text.
"Cyprus has taken significant action to support regular employment with the establishment of a Single Inspections Service", it is noted.
"Investment in research, development and innovation is needed in most Member States to boost their productivity growth and competitiveness. In many Member States and regions there is a significant scope to strengthen links between business, academia, research and public sector actors through cooperation in value chains, including through smart specialization", EC says. "This is the case for instance in Belgium, Bulgaria, France, Cyprus, Poland, Latvia and Estonia. Moreover, digitalisation of companies and digital public services need further investment in Belgium, Cyprus, Austria, Slovenia, Spain, Slovakia, Poland, Estonia, Germany and Bulgaria."
It goes on noting that "in Estonia, Luxembourg, Slovakia, Portugal, Bulgaria, the Netherlands, Italy, Cyprus, and France, there is a need for investment related to resource efficiency and climate risk prevention" and "satisfying investment needs requires a favorable investment environment" and "to address some of these challenges, Italy, Slovakia and Latvia have revised their whistle-blower protection regime, while Lithuania, Spain, Cyprus and Greece are currently considering reforms in this area."
Greece is also experiencing excessive imbalances, due to large stock of legacy issues, according to the report. Vulnerabilities are linked to "high government indebtedness, the negative external position, the high share of non-performing loans, incomplete external rebalancing, in a context of high although declining unemployment and low potential growth".
Greece managed to successfully exit the European Stability Mechanism support programme in August 2018 after making "substantial improvements in recent years". Nonetheless, "large stock imbalances remain, including a deeply negative net international investment position that is still deteriorating amid moderate nominal GDP growth and a current account balance that remains negative".
There have been "considerable improvements in cost competitiveness in past years which stalled recently in light of subdued productivity growth". While the level of public debt remains high, it is mostly held by the official-sector creditors and financing needs "will be relatively low for at least a decade". The pace of debt reduction crucially depends on the continued achievement of the agreed fiscal targets and implementation of reforms to generate a sustainable increase in the growth potential. The financial sector is vulnerable due to a very large stock of non-performing loans and a low profitability, hampering credit growth and the recovery of investment. Private debt is decreasing while active deleveraging is still ongoing. Wide-ranging measures were taken during the financial assistance programmes to address many of the structural weaknesses of the Greek economy. On top of consolidating earlier reforms and adjustment efforts, the authorities have committed to ensure continuity and completion of reforms, which are monitored in the framework of enhanced surveillance."
Finally, Italy is experiencing excessive imbalances as high government debt and protracted weak productivity dynamics imply risks with cross-border relevance, in a context of still high level of non-performing loans and high unemployment. "The government debt ratio is not expected to decline in the coming years, as the weak macroeconomic outlook and the government`s current fiscal plans, though less expansionary than its initial plans for 2019, will entail a deterioration of the primary surplus", says the EC.
The EC warns that "cost competitiveness is stable, but weak productivity growth persists. This is rooted in long-standing issues with the functioning of labour, capital and product markets, compounded by weaknesses in the public administration and justice system, which drags down potential GDP growth."
Also in Italy, "the stock of non-performing loans has continued to decline significantly, but maintaining the pace of reduction of non-performing loan could prove challenging given market conditions. Higher sovereign yields compared to the levels of early 2018 are affecting banks` funding costs and capital buffers weighing on lending to the rest of the economy and on GDP growth."
"Despite some progress in banks’ balance sheet repair, insolvency reforms and active labour market policies, the reform momentum broadly stalled in 2018. The 2019 budget includes policy measures that reverse elements of previous important reforms, in particular in the area of pensions, and does not include effective measures to increase potential growth", warns the EC.