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Cyprus: First Post-Program Monitoring Discussions Summary

Core Content

The International Monetary Fund (IMF) conducted the First Post-Program Monitoring (PPM) Discussions with Cyprus in March–April 2017, with the Executive Board concluding on June 7, 2017. The discussions evaluated Cyprus's economic recovery, fiscal and financial sector performance, and structural reforms since exiting the Fund-supported program in early 2016.

Main Economic Developments

• Economic Recovery: Cyprus has experienced a strengthening recovery since exiting the Fund program. Real GDP growth reached 2.8% in 2016, well above the previous year's 1.7%, with broad-based growth and a sharp drop in the unemployment rate.
• Fiscal Position: The fiscal primary surplus reached 2.3% of GDP in 2016 and is expected to rise to 3% in 2017 and moderate to 2.5% in 2018–22. Public debt remains high at 107.8% of GDP, but is projected to decline to 87% by 2022.
• External Adjustment: The current account deficit narrowed to 2.3% of GDP in 2016, excluding one-off imports, and is expected to continue to narrow. The real effective exchange rate (REER) depreciated by 10% in terms of consumer prices and 20% in terms of unit labor costs.
• Inflation and Labor Market: Inflation turned positive in 2016, reaching 2% in April. The unemployment rate dropped to 12.8% in 2017:Q1, although it remains above pre-crisis levels. Nominal disposable incomes increased due to improved payment discipline and lower prices.
• Banking Sector: Banks have adequate liquidity and capital, but asset quality remains poor. Nonperforming loans (NPLs) fell by €5.0 billion to €24.2 billion in 2016, representing 135% of GDP and 46% of total loans. NPLs in the three major banks remain at 60% of total loans.
• Private Sector: Private sector indebtedness remains very high, with domestic nonfinancial corporate debt at 225% of GDP. Household debt is the highest in the euro area at 123% of GDP.

Main Views and Recommendations

IMF Staff Views

• Repayment Capacity: The IMF believes Cyprus's capacity to repay the Fund is satisfactory under the baseline scenario, supported by sustained primary fiscal surpluses and solid GDP growth. However, it is vulnerable to adverse shocks.
• Debt Management: The country has a backloaded maturity profile of official debt, which helps reduce the burden on public finances. The cost of market-based borrowing is relatively low, but it is expected to rise due to global monetary tightening.
• Recommendations:
  • Fiscal Reforms: Create fiscal headroom by reversing some recent structural loosening, saving windfall revenues, and selling public assets.
  • NPL Reduction: Accelerate NPL workouts and restructuring of viable debts, including write-downs and greater use of third-party debt servicers.
  • Structural Reforms: Advance macro-critical structural reforms in areas such as commercial claims enforcement, judiciary, revenue administration, and privatization.
  • Banking Sector: Streamline court procedures for claims settlement, improve payment culture, and encourage sustainable loan workout packages for viable debtors.
  • Public Debt: Focus on reducing public debt through increased fiscal discipline, growth-enhancing investments, and structural reforms to avoid unfunded tax cuts and expenditure slippages.

Executive Board Assessment

• The Board welcomed Cyprus's economic achievements, including improved growth, reduced unemployment, and progress in banking sector recovery.
• However, it emphasized that the high levels of private and public sector debt remain a challenge.
• The Board urged more ambitious policies to reduce debt and build policy buffers, especially in light of the lack of an investment-grade rating and ESM program eligibility.

Key Economic Indicators (2014–2018)

Key Policy Recommendations

• Fiscal Policy: Strengthen fiscal discipline, improve public investment, and ensure that reforms in healthcare, public sector wages, and pensions do not undermine fiscal sustainability.
• Financial Sector: Accelerate NPL resolution, improve payment culture, and enhance access to third-party debt servicers.
• Structural Reforms: Establish a dedicated commercial court, streamline court procedures, and revive the privatization program.

Capacity to Repay the Fund

• Repayments to the Fund are expected to begin in 2017 and continue through 2026.
• Obligations to the Fund are projected to peak at €184 million (0.9% of GDP) in 2021.
• The Fund's credit is currently more expensive than market-based funding, but early repayments are permissible.
• Cyprus's ability to repay is supported by sustained GDP growth and primary fiscal surpluses, but risks remain due to high public debt and lack of investment-grade status.

Conclusion

The IMF acknowledges Cyprus's progress in economic recovery and banking sector reform, but stresses the need for continued efforts to reduce private and public sector debt and enhance fiscal sustainability. The country is expected to maintain moderate growth over the medium term, supported by improved financial discipline and structural reforms.