Cyprus should urgently reduce NPLs, IMF says

The IMF Executive Board has stressed the urgency of reducing non-performing loans in a decisive and durable manner in Cyprus, while extending the Post-Program Monitoring.

The position was outlined in the IM Executive Board which also highlighted the need to ensure that banks remain adequately capitalized and provisioned.

The Executive Board of the International Monetary Fund (IMF) concluded on Monday the Second Post-Program Monitoring Discussions with Cyprus and supported extending post-program monitoring through July 31, 2019.

Noting Cyprus’s economic recovery has strengthened, it added that GDP growth has reached 3.9 percent in 2017, with upbeat activity concentrated in construction, tourism and professional services. The unemployment rate has continued to decline at a sustained pace, while moderate price and wage rises have supported competitiveness, helping to contain the increase in the current account deficit, despite higher imports. Improved economic conditions have supported robust fiscal revenue collection, contributing to a sizable primary surplus and a decline in the public debt ratio.

Despite the vigorous upswing, the IMF Executive Board said, non-performing loans still weigh on banks’ profitability and have prevented significant improvement in households’ and corporations’ financial health. Political and social acceptance of strategic default continue to undermine financial intermediation.

The current strong expansion is forecast to extend well into the future, with growth inching up to 4 percent this year and 4.2 percent in 2019. The brisk pace of economic activity is underpinned by ongoing and planned construction projects, and is only partly dented by decelerating private consumption, as households step up loan repayments over time.

In the medium term, it added, growth is projected to ease gradually towards 2.5 percent, as construction projects reach completion. Investment, mainly in the tourism sector, is expected to raise potential growth somewhat. Sustained fiscal primary surpluses of around 4�4.5 percent of GDP during 2018�23, combined with buoyant nominal GDP growth, would help lower the public debt ratio to 72 percent of GDP by 2023, after a 12-percentage point increase in early 2018 from restructuring of the Cyprus Cooperative Bank. Banks’ weak asset quality and insufficient diversification of economic activity are sources of downside risks to this outlook.

In its assessment, the Executive Board Directors welcomed the economy’s strengthening recovery, which has been accompanied by a sustained decline in the unemployment rate, a sizeable primary fiscal surplus, and a reduction in the public debt ratio. Directors observed, however, that despite the economy’s strong upswing, banks’ non-performing loans and private sector debt remain high, reflecting continued weak payment discipline. They urged the authorities to strengthen efforts to address these legacy problems.

Directors noted that Cyprus’s capacity to repay the Fund is expected to be adequate under staff’s baseline scenario, but is subject to significant downside risks. They agreed that sustained strong economic growth and accompanying fiscal primary surpluses would be crucial to achieve a projected rapid decline in the public debt-to-GDP ratio and allow continued access to financial markets on favorable terms. Strong and continued efforts to implement ambitious macroeconomic policies and structural reforms would further reinforce Cyprus’s capacity to repay. In this context, Directors welcomed the authorities’ willingness to continue post-program engagement with the Fund.

Directors stressed the urgency of reducing non-performing loans in a decisive and durable manner. They highlighted the need to ensure that banks remain adequately capitalized and provisioned and that loans transferred to the special purpose vehicle are restructured swiftly. They recommended amending the current framework for insolvency and foreclosure to improve payment discipline. They emphasized that any scheme aimed at encouraging vulnerable borrowers to begin servicing their loans should be subject to tight eligibility criteria to avoid moral hazard and contain fiscal costs.

Directors also welcomed the rapid improvement in the fiscal position. They highlighted the need to avoid procyclicality and supported capping fiscal spending increases at the medium-term output growth rate. They also recommended instituting a durable mechanism to control the public-sector wage bill and keeping in check the fiscal risks arising from the planned introduction of the National Health System. These efforts would help safeguard the downward path of debt and create space to absorb contingent fiscal shocks.

Directors urged the authorities to restart macro-critical structural reforms to help diversify the economy. To attract capital into innovative sectors, they recommended focusing efforts on strengthening the enforcement of commercial claims and the efficiency of the courts, as well as pursuing privatization.

They also suggested avoiding an excessive concentration of economic activity in construction. Directors highlighted the importance of full compliance with AML/CFT standards and strengthening the anti-corruption framework.

Source: Cyprus News Agency