Press Release No. PR17/107

IMF Staff Completes Mission for the First Post-Program Monitoring to Cyprus

April 3, 2017

• Since exiting the IMF program a year ago, Cyprus’s economic recovery has gathered momentum, banks’ liquidity has improved, restructuring of nonperforming loans has accelerated, and the fiscal primary surplus has increased.
• For 2017, GDP growth is forecast at around 2.5% on continued support from foreign demand and external financing.
• Continued very high levels of private sector indebtedness, nonperforming loans and general government debt remain vulnerabilities.

An International Monetary Fund (IMF) mission visited Nicosia during March 27–31, 2017, for the first post-program monitoring (PPM) discussions since Cyprus exited the Extended Arrangement under the Extended Fund Facility. PPM is part of the IMF’s regular monitoring of countries with significant outstanding IMF credit, with a focus on capacity to repay the Fund. The IMF mission coordinated with the post-program surveillance activities of the European Commission and the European Central Bank, and the early warning system of the European Stability Mechanism. At the conclusion of the visit, the IMF mission issued the following statement:

“Since exiting the IMF program one year ago, Cyprus’s economic recovery has gathered momentum, banks’ liquidity positions have improved, the restructuring of nonperforming loans (NPLs) has accelerated and the fiscal primary surplus has increased. These developments served to strengthen Cyprus’s repayment capacity. Nonetheless, continued very high levels of private sector indebtedness, nonperforming loans and general government debt remain vulnerabilities. Decisive progress on repairing private balance sheets, while upholding fiscal prudence and completing pending structural reforms are essential to build resilience, reduce the risk of adverse shocks to balance sheets and raise potential growth.

“Over the medium term, growth is expected to remain brisk, although moderating gradually from the rapid pace of last year. For 2017, GDP growth is forecast at around 2.5 percent on continued support from foreign demand and external financing. Thereafter, growth is expected to ease marginally as repayment of private sector debt picks up, stabilizing at just above 2 percent from 2020. Under these conditions, capacity to repay the Fund is expected to be satisfactory, supported by sizable fiscal primary surpluses, the back-loaded maturity profile of official debt and possible further operations to smooth redemptions of market-based debt. However, repayment capacity would be weakened in the event of a new boom-bust growth cycle, if fiscal discipline is eroded or if risks in banks’ balance sheets materialize.

“A decisive upfront reduction in public and private debt is needed to rebuild policy buffers, cement confidence in macroeconomic fundamentals and policy commitments, deliver balanced, sustainable growth, and support balance sheet repair. This requires effort in three main areas:

1. Accelerating NPL workouts and reducing excessive debt burdens . Restructuring has gained momentum over the past year, but NPLs remain very high and a portion of previously restructured loans tend to re-default. High NPLs also weaken banks’ profits. Restructuring progress across banks has been uneven, reflecting differences in the structure of their loan portfolios, the intensity with which various legal and other tools have been used, as well as in banks' capacities to manage NPLs. Banks should be further encouraged not to defer restructuring in the expectation that future increases in output and property prices would autonomously improve recovery rates. Instead, they should focus on durable and sustainable loan work-outs, including through solutions that reduce a borrower’s debt to affordable levels. Operational barriers to NPL resolution, such as regulatory incentives encouraging banks to delay recognition of losses or disposal of collateral, remaining impediments in the legal framework and capacity constraints in the courts, should be addressed. It is important that newly-issued bank lending, which is providing welcome support to the economy, is underpinned by robust lending policies, strong business plans from borrowers and close monitoring of credit risk.

2. Frontloading public debt reduction . Accelerating public debt reduction would help to create a prudent buffer and safeguard the downward trajectory of debt in the event of adverse shocks. Recent fiscal outturns have been buoyed by cyclical developments, despite a sizable weakening of the underlying structural position since 2015. Targeting a primary surplus of 3 percent of GDP (on a cash basis) for the next several years while saving any over-performance and directing additional resources to growth-enhancing investment would accelerate debt reduction and bolster potential output without materially lowering GDP growth. Guarding against fiscal slippages, including from the envisaged national health service as well as from wage and social benefit spending, will also be essential. Restarting the privatization program would also contribute to lowering public debt. Completing pending reforms in the areas of revenue administration and public financial management, and adopting the package of civil service reform bills would also help safeguard public finances over the medium term.

3. Reinvigorating structural reforms . Progress with macro-critical reforms has largely stalled. Advancing the reform agenda would increase capacity to cope with external shocks and create sustainable employment opportunities by improving the business environment. Focus should be on expediting judicial reform to strengthen legal enforcement of commercial claims and speed up court procedures, restarting the privatization program to increase economic efficiency and competition, and streamlining business procedures to attract new service sectors.

“We would like to thank the Cypriot authorities, our European partners and our private sector counterparts for informative discussions and their cooperation and hospitality.”