30.09.2016 - European Commission staff, in liaison with staff from the European Central Bank (ECB), visited Cyprus from 26 to 30 September to conduct the first post-programme surveillance (PPS) mission. This visit also served as specific monitoring in the framework of the EU Macroeconomic Imbalance Procedure. It was coordinated with an International Monetary Fund (IMF) staff visit. Staff from the European Stability Mechanism (ESM) also participated in the mission on aspects related to its Early Warning System.
The reforms undertaken by Cyprus during the programme have started to bear fruit with robust economic growth and positive developments in the financial sector. Fiscal consolidation has been crucial for strengthening the credibility of the policy framework and facilitating market access of the sovereign. It is important to safeguard these achievements, including by withstanding the increased expenditure pressure. We note that the reform momentum has significantly weakened, with crucial legislation still awaiting adoption. Therefore, the mission encouraged the authorities to renew their efforts on this front to improve Cyprus's growth potential and attract more foreign investment.
Economic growth in 2016 has been stronger than expected, supporting fiscal performance. Growth has been driven by tourism and private consumption, which was supported by the effect of declining prices on real income and improving labour market conditions. Real GDP growth in 2016 is expected to exceed 2½%, and to remain strong in 2017. Unemployment is perceptibly declining, albeit long term and youth unemployment remain very high. Fiscal consolidation has continued and the government’s 2016 primary surplus target for 2016 is within reach. With the improved economic environment, the pressure for fiscal relaxation has increased. This should be resisted as fiscal risks remain significant; and because the downward path of public debt still remains to be firmly anchored. It is essential that legislative steps with a budgetary impact, such as the abolition of the immovable property tax, be compensated through well-specified measures at all government levels. In light of the fiscal risk, the mission underlined that fiscal discipline needs to be pursued, including by containing the public sector wage bill.
Accelerated loan restructuring efforts and the more supportive economic environment have led to a decline in the outstanding stock of non-performing loans (NPLs). However, NPLs remain at a very high level. The return of confidence has allowed banks to broaden their deposit base, improve liquidity and capital buffers. Their profitability, however, is constrained by a declining net interest margin and the need for additional provisioning. While new lending is strengthening, total credit to the economy continued to contract due to necessary balance sheet deleveraging, including through loan write-offs and restructurings. The mission underlined the need to pursue more forcefully the loan restructuring efforts, by making full use of all available tools, in order to accelerate the pace of reduction of NPLs.
The new insolvency and foreclosure frameworks are important achievements, but their implementation has to be stepped up. These tools are essential to help reduce the high levels of private debt and NPLs, as they provide debtors and creditors with diversified and efficient means to resolve unviable debts and reallocate economic resources to more productive uses. Their use has been limited so far due to the increasing recourse to debt-to-asset swaps, which is welcome; but also due to slow administrative capacity building and the reluctance of some stakeholders to engage in time-consuming procedures. The mission highlighted the need to increase administrative capacity and strengthen the efficiency of legal proceedings, in order to facilitate the use of the insolvency and foreclosure frameworks.
The pace of structural reform has considerably slowed. In the view of the mission, it is crucial to renew the reform momentum, including by legislating critical, but much delayed reforms. This includes key areas, such as public administration and the national health system. To further improve the business environment and attract more investment, progress needs to be achieved in key areas such as setting up a sustainable and efficient title deeds transfer system, modernising the justice system, and pursuing the efforts towards privatisation and the reform of the electricity market.
The mission would like to thank the Cypriot authorities and the IMF for their constructive and open discussions. The next PPS mission will take place in spring 2017.