Fri. Jul 1st, 2022

June 1, 2022

Washington, DC: The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with Cyprus on May 25, 2022.

Cyprus staged a strong recovery last year on the back of its successful management of the pandemic and sizeable policy support. Output returned to its pre-pandemic level and unemployment declined. The current account deficit has remained elevated but narrowed to 7¼ percent of GDP with a recovery in exports. Inflation edged up, driven mainly by higher energy prices. The fiscal deficit dropped to around 2 percent of GDP on the back of a cyclical revenue recovery. The public debt ratio has stayed high but declined to 104 percent. The liquidity in the banking sector has remained high and capital ratios broadly stable. Banks have made progress in offloading legacy non-performing loans and the effects of the pandemic on credit quality have been limited.

Growth this year will be set back by the fallout from the war in Ukraine and, with a partial recovery in exports and private consumption, is forecast at around 2 percent. It will also be supported by investment spending under the Cyprus’s Recovery and Resilience Plan, which, combined with structural reforms, improves medium-term growth prospects. The current account is projected to temporarily worsen with a deterioration in the terms-of-trade and higher imports. Inflation will increase further before declining in the medium term. The slower recovery will stymie fiscal consolidation this year, but the fiscal deficit is still expected to narrow after the phase-out of Covid-related support, and the public debt ratio is set to remain on a firmly declining path.

The outlook remains highly uncertain with risks from an escalation and prolonged duration of the war and sanctions, de-anchoring of inflation expectations in advanced economies, and uncontrolled and more severe Covid outbreaks.

Executive Board Assessment [2]

Executive Directors commended the authorities for their policy response to the pandemic, which supported the recovery of output and employment. Directors noted that the pace of the recovery is expected to slow down in the near-term—mainly due to the war in Ukraine—but should regain momentum over the medium-term. However, the outlook is subject to risks, stemming from a prolonged war in Ukraine, uncontrolled COVID outbreaks, and abrupt monetary tightening in advanced economies. Directors stressed the need to calibrate a policy response to manage the pandemic and war-related shocks in the near-term, while pressing ahead with financial sector and structural reforms to reduce vulnerabilities and improve growth prospects and resilience over the medium-term.

Directors concurred that fiscal policy should continue providing support but aim to gradually rebuild buffers. They supported a gradual fiscal adjustment and emphasized that additional discretionary measures, if needed, should be temporary and well-targeted, and not hinder labor reallocation. Directors underscored the importance of fiscal discipline over the medium-term to place the public debt on a firmly declining path. They encouraged further efforts to control public sector wage growth, address risks from the National Health System, and monitor the financial sector’s contingent liabilities.

Directors noted that the financial system has stayed resilient. They agreed that the authorities should enhance monitoring and address asset quality given the worsened outlook. Directors emphasized that resolving legacy non-performing loans requires more forceful implementation of existing tools, including by further improving the working environment of credit acquiring companies and credit servicing companies. They underscored the criticality of an effective foreclosure framework for addressing strategic defaulters and providing incentives for borrowers to engage in restructurings and recommended enhancing the implementation of the 2019 amendments to the framework. Directors also stressed that the planned Mortgage-to-Rent scheme should be well-targeted to minimize the fiscal cost and to ensure transparency and accountability.

Directors emphasized that structural reforms are key to raise medium-term growth potential. They welcomed the progress in implementing the Recovery and Resilience Plan, including passing legislation on corruption and on civil service and local government reforms. Directors encouraged the authorities to continue to make progress in strengthening 2 the AML-CFT and governance frameworks, and in tackling the skills, digital, and infrastructure gaps. Reforms of the judicial system are also a priority.

Directors agreed that achieving the national climate goals can help Cyprus transition to a more resilient and sustainable growth model. They recommended continued efforts to address the challenges to implement the green agenda, including the planned green tax reform. Additional measures, including feebates, to enhance the emissions reduction could also be considered.

IMF-Cyprus-2022

[1] Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

[2] At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summings up can be found here: http://www.IMF.org/external/np/sec/misc/qualifiers.htm .

Source – IMF