As Cyprus is recovering strongly following the financial crisis of 2012– 13, its banking sector still faces one of the highest non-performing loan ratios in Europe, the IMF said. It called for steadfast implementation of the amended legislative framework on foreclosure, insolvency, sale of loans, and securitization.
The remarks were made by the International Monetary Fund’s Executive Board which concluded Article IV consultation with Cyprus on November 28.
The IMF board said the GDP grew by 4 percent in the first half of 2018, driven by tourism, professional services and foreign investment in construction as well as continued strength in private consumption. The unemployment rate continued to decline to 7.4% in September from 10.2 percent a year earlier. Inflationary pressures remain low.
Supported by subdued unit labour costs, Cyprus has maintained its export competitiveness, although the current account deficit widened last year as strong domestic demand pushed up imports, the conclusions said. Fiscal performance has strengthened on the economic recovery with the primary surplus widening to 4.3 percent of GDP in 2017.
Banks, the IMF said, are making progress in cleaning up their balance sheets but the sector “still faces one of the highest non-performing loan ratios in Europe, while both private and public sectors have a large debt overhang”.
It said the near-term outlook for the economy is favorable, with growth expected to remain at around 4.2 percent in 2018 –19, supported by the services sector and largely foreign-financed investments. 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 gradually dissipate.
Fiscal performance is expected to improve with a primary surplus of around 5 percent in 2018 –19 and public debt is thus expected to be on a firm declining path, falling below 70 percent of GDP by 2023, despite a sharp increase earlier this year following the resolution of the Cyprus Cooperative Bank.
It warned that the economic outlook could weaken if implementation of NPL resolution is delayed, while public debt sustainability could be undermined by realization of contingent liabilities or erosion of fiscal discipline.
In their assessment, the Executive Directors welcomed the strong post-crisis economic recovery, which has supported large fiscal surpluses and lowered the unemployment rate.
Directors also welcomed the recent reforms undertaken to address key vulnerabilities in the banking sector, including the resolution of a large systemic state-owned bank. Directors observed, however, that private and public debt remain large while NPL ratios are still among the highest in Europe. They encouraged the authorities to make further efforts to address these legacy problems and strengthen economic growth over the medium term.
Directors, the IMF said, emphasized the importance of further measures to facilitate a steady decline in NPLs on a durable basis. They called for steadfast implementation of the amended legislative framework on foreclosure, insolvency, sale of loans, and securitization, supplemented by a strengthening of the court system and removal of uncertainties related to title deeds. Directors also stressed the need to enhance the governance and supervisory framework for the recently - established asset management company. They recommended that to limit moral hazard, the proposed Estia scheme aimed at encouraging distressed borrowers to begin servicing their loans be better targeted and based on appropriate assessment of borrowers’ capacity to repay.
The IMF Directors highlighted the need for banks to continue efforts to strengthen their balance sheets.They urged banks to diversify income sources and consolidate operations to improve cost-income ratios and better position themselves against increased competition. Directors recommended strengthening regulatory guidance on loan restructuring and exercising vigilance over bank lending policies, the adequacy of provisioning, and debt-to-asset swap policies.
Directors welcomed Cyprus’s robust fiscal performance and emphasized that strict spending discipline should be maintained. They cautioned against relying on transitory revenues from cyclical gains and one-off measures to finance permanent spending initiatives, and took positive note of the authorities’ commitment to cap expenditure increases, including the public wage bill, in line with the medium-term GDP growth rate, in order to create room for growth-enhancing spending. Directors noted that the transition to public insurance in the health sector should be carefully managed.
They agreed that fiscal structural reforms are needed, and recommended strengthening public financial management, monitoring risks from local governments and the state-owned sector, and improving the corporate governance of commercial state-owned enterprises.
Directors stressed the need to undertake institutional reforms and further enhance the investment climate and raise medium - term growth potential. They agreed that reforms to increase the efficiency of the courts, speed up the enforcement of commercial claims, and clear the backlog of cases should continue.
They also recommended expediting legislation to strengthen the governance and autonomy of the Central Bank of Cyprus and encouraged further efforts to mitigate AML/CFT risks. Directors noted that active labour market policies and investment in higher value-added sectors can help reduce high youth unemployment and skills mismatch, thereby promoting more inclusive growth.