Statement by the staff of the European Commission and the European Central Bank following the third post-programme surveillance (PPS) mission to Cyprus

PR Newswire Policy

FRANKFURT, Germany, 29 September 2017 /PRNewswire Policy/ -- European Commission staff, in liaison with staff from the European Central Bank (ECB), visited Cyprus from 25 to 29 September to conduct the third post-programme surveillance (PPS) mission and undertake specific monitoring of macroeconomic imbalances under the Macroeconomic Imbalances Procedure (MIP). The mission was coordinated with an International Monetary Fund (IMF) Article IV mission. Staff from the European Stability Mechanism (ESM) also participated in the mission on aspects related to the ESM's Early Warning System.

The economic recovery has gathered further strength, but sustaining growth over the medium term will require renewed reform momentum, continued fiscal discipline and acceleration in the resolution of non-performing loans (NPLs). Growth exceeded expectations and should remain strong, albeit somewhat decelerating over the medium term. It has been increasingly driven by domestic demand, while tourism remains buoyant with positive spillovers to other sectors of the economy. Labour market conditions have continued to improve, with employment increasing across sectors. The real estate market has stabilised and the construction sector is rebounding. Despite these positive developments, high private sector debt, which is being reduced only gradually, continues to weigh on growth prospects. In addition, the widening of the current account deficit needs to be closely monitored given the high level of external debt.

Fiscal performance benefited from the favourable macroeconomic environment and from prudent expenditure policies, but important medium-term risks remain. Fiscal performance in the first half of 2017 was stronger than expected, mainly driven by buoyant tax revenues. Notwithstanding the electoral calendar, expenditure execution has thus far remained prudent. On this basis, the mission expects the general government to record a higher primary fiscal surplus in 2017 than last year. Uncertainties and risks remain for the medium term, such as the fiscal impact of the recent healthcare reform and the lack of a mechanism to contain increases in the public wage bill beyond 2018. Containing expenditure growth, including in the payroll, remains essential for Cyprus to safeguard fiscal sustainability in line with the requirements of the preventive arm of the Stability and Growth Pact (SGP). If fiscal space materialises, it should be used to accelerate the reduction in the still elevated public debt and to increase public investment in productivity-enhancing projects to improve long-term growth potential.

The very high level of NPLs remains the key vulnerability of the Cypriot economy, rendering it pressing to significantly accelerate the NPL resolution across all banks. The stock of NPLs is declining but remains high, and continues to weigh on bank profitability. Strengthening confidence has contributed to the ample availability of liquidity. New lending is picking up, supported by the improving macroeconomic environment. Increases in provisioning for NPLs, while welcome, exert pressure on profitability in a low interest rate environment. NPLs are declining in the banking sector as a whole, but remain among the highest in the EU. NPL restructuring is becoming more challenging, highlighting difficulties in working out retail and SME loans as well as tackling strategic defaults. This also reflects the uneven efforts across banks to resolve NPLs in a sustainable manner, highlighting the pressing need to step up NPL resolution in banks that are lagging behind. The mission underlined the need to make insolvency and foreclosure-related legal proceedings more efficient. Swift approval of the securitisation law would help create the secondary market for loans, which could accelerate balance sheet repair. Moreover, it will be important to proceed swiftly with the integration of the supervisor of the pension funds and insurance companies.

Maintaining robust growth and safeguarding fiscal sustainability require a renewed commitment by all stakeholders to accelerate the structural reform momentum. In terms of the significant reform of the national healthcare system it will be important to strengthen safeguards against possible cost overruns. Given its overarching impact on the functioning of the economy, a swift reform of the judiciary is needed, including by establishing a commercial court, updating the civil procedure code and adopting legislation on improving claim enforcement. Moreover, the completion of the reform of the public administration would enhance the efficiency of the public sector and support fiscal sustainability. The mission also encouraged the authorities and other stakeholders to make material progress in other essential areas, including the privatisation of major state-owned enterprises, the reform of the electricity market, the creation of the sovereign wealth fund and the reform of the title deeds issuance and transfer system. The mission also highlighted the benefits of a more determined implementation of the action plan for growth.

The mission would like to thank the Cypriot authorities for their constructive and open discussions and IMF and ESM staff for their cooperation. The next PPS mission will take place in spring 2018.