Statement by the European Commission, ECB and IMF on
the Fifth Review Mission to Cyprus
Staff
teams from the European Commission (EC), European Central Bank (ECB),
and the International Monetary Fund (IMF) visited Nicosia during
July14-25, 2014 for the fifth review of Cyprus's economic programme,
which is supported by financial assistance from the European
Stability Mechanism (ESM) and the IMF. Cyprus’s programme seeks to
ensure the recovery of economic activity to preserve the welfare of
the population by restoring financial sector stability, strengthening
public finance sustainability, and adopting structural reforms to
support long-run growth.
Staff-level
agreement was reached on policies that could serve as a basis for
completion of the fifth review. The authorities have continued to
meet the fiscal targets with significant margin in the first half of
the year, as a result of prudent budget execution. In the financial
sector, banks are advancing with their restructuring plans and
capital raising while supervisory monitoring of their actions and
operational capacity to address non-performing loans has been
enhanced. Structural reforms are proceeding: the authorities have
implemented a welfare reform providing a guaranteed minimum income
for all those in need, have commenced the integration of the revenue
administration, and have strengthened the administration’s powers
to fight tax evasion.
The
macroeconomic outlook remains broadly unchanged compared to the
fourth review. Output in 2014 is expected to contract by 4.2 percent,
with growth in the tourism sector cushioning weak activity in other
sectors. Unemployment remains very high, although signs of
stabilization are emerging. Growth in 2015 is projected at 0.4
percent, with the recovery constrained by the high level of private
sector debt. Risks remain significant, related to constraints to the
supply of credit, as well as to the ongoing crisis in Ukraine.
Reversing
the rising trend of non-performing loans is critical to restoring
credit, economic growth, and the creation of jobs. Putting in place
without delay an effective legal framework for foreclosure and
insolvency is essential to ensuring adequate incentives to borrowers
and lenders to collaborate to reduce the level of non-performing
loans. Moreover, the debt-restructuring supervisory framework needs
to be further strengthened. Ongoing efforts by banks to proactively
raise capital in the private markets are welcome. Such efforts will
also be conducive to a smooth transition to the Single Supervisory
Mechanism following the completion of the pan-European comprehensive
assessment and should therefore help to strengthen the banks’
resilience to shocks and ability to revive lending.
Banks
and the coop sector should continue to implement their restructuring
plans. Further reducing operational costs, ensuring stable funding,
strengthening arrears management capacity and processes, and
improving governance are key ingredients for a healthy banking sector
that can support the economy and allow for the gradual relaxation of
capital controls according to a revised milestone-based roadmap. To
prevent vulnerabilities from re-emerging and preserve the integrity
of the financial sector, the authorities need to further strengthen
supervision and regulation and step up the implementation of the Anti
Money-Laundering (AML) framework, in particular with respect to AML
supervision of banks.
The
authorities have pursued a cautious fiscal policy, which helped allow
them to over-achieve fiscal targets consistently. Such prudence
should continue, in light of lingering risks. In particular, next
year’s budget needs to be based on conservative assumptions, ensure
the fiscal neutrality of the new welfare reform, and help achieve a
smooth path towards the medium-term primary fiscal surplus target of
4 percent of GDP in 2018 that will put public debt on a sustained
downward path.
The
authorities should maintain the structural reform momentum. With the
welfare reform adopted, the authorities must focus on its
implementation to ensure that vulnerable groups are protected during
the downturn. They also need to advance the implementation of the
revenue administration reform by taking further steps toward the
integration of the two tax departments under a unified and more
effective administration. This should be complemented by continued
efforts to combat tax evasion and non-compliance and strengthen the
management of public debt and of fiscal risks. Timely implementation
of the privatization plan is necessary to increase economic
efficiency, attract investment, and reduce public debt.
Given
still high risks, continued full and timely policy implementation
remains essential for the success of the programme.
Conclusion
of this review is subject to the approval process of both the EU and
the IMF. The matter is expected to be considered by the Eurogroup,
the ESM Board of Directors, and the Executive Board of the IMF in
late September. Their approvals would pave the way for the
disbursement of €350 million by the ESM, and about €86 million by
the IMF.
