Panayiotis Rougalas
In Cyprus, the European Commission consistently highlights the significant economic challenge of private debt through regular post-program or post-memorandum reports.
The Commission's latest report, released last Thursday, underscores that while the macro-economic environment remains stable, the private sector is still under pressure due to an exceptionally high level of debt. As of March 2023, the debt-to-GDP ratio is 163%, marking a decrease from 187% at the end of 2021. However, this reduction is primarily attributed to GDP growth rather than a substantial decrease in debt.
Despite the private sector creating a savings cushion during the pandemic, the burden of Non-Performing Loans (NPLs) transferred out of banks persists.
The impact of elevated private debt becomes more pronounced during periods like the present, with challenges in servicing for both households and businesses due to increasing interest rates and high inflation. According to the recent Economic Bulletin from the Central Bank, loans to households with fixed interest rates are below 10%, and for businesses, it's below 5%.
While acknowledging the private sector's creation of a savings cushion during the pandemic, the Commission emphasizes that non-performing loans transferred outside the banking system to loan acquisition companies continue to weigh on the economy through private sector debt.
Despite the adoption of new divestment bills on December 8, the Commission's report emphasizes the need for further progress in managing non-performing loans (NPLs) through an efficient divestment framework. Continuous postponements of the framework's implementation have weakened its efficiency, impacting efforts to reduce NPLs and the overall resilience of the Cypriot banking sector.
The effective implementation of the divestment framework is crucial for schemes like the Rent versus Rent scheme, designed to protect vulnerable households' homes. Ongoing discussions in Parliament to weaken the divestment framework may hinder efforts to find consensual solutions, particularly with strategic defaulters.
Despite the recent adoption of the revised divestment framework, the Commission conveys a clear message that any efforts to weaken its functionality undermine endeavors to reduce NPLs and send negative signals about the resilience of the Cypriot banking sector.
Moreover, the Commission explains that a weakened framework reduces lenders' ability to pressure uncooperative borrowers, eliminating the option of legal action for debt recovery. This lack of incentive for borrowers to move towards a consensual solution is detrimental.
In conclusion, the Commission stresses the vital role of a strong divestment framework for legal protection, maintaining discipline in payments, encouraging borrowers to participate in loan restructuring, and reducing moral hazard. It is also key to the sustainability and implementation of schemes like the Rent versus Rent scheme, aimed at protecting vulnerable households' main homes.
Anticipated challenges on balance sheets due to persistently high inflation and significant increases in lending rates are gradually impacting the private non-financial sector. The Central Bank of Cyprus notes potential declines in disposable income and profit margins, raising concerns about the debt repayment capacity of the private non-financial sector, particularly for vulnerable households and corporations.
On a positive note, economic growth, fiscal measures to mitigate high inflation effects, and precautionary savings are supporting the resilience of the domestic private non-financial sector, according to the Central Bank's Financial Stability Report.
The Central Bank emphasizes the importance of a stable legal framework for divestitures in managing legacy NPL volumes and potential new NPLs. The divestment framework should function seamlessly as an effective tool for dealing with strategic defaulters and as leverage to pressure creditors and borrowers for viable restructuring.
As of December 31, 2022, Credit Acquisition Companies (CACs) held loans with a book value of €8.1 billion, with 77.7% being NPLs. The Central Bank interprets this high NPL rate as suggesting a low risk of deterioration in the asset quality of ECAs. Nevertheless, it underscores the crucial role of both the restructuring tool and a stable divestment framework for managing NPLs and maintaining financial stability.
[This article was translated from its Greek original]
