Cyprus experiencing excessive macroeconomic imbalances

The European Commission said Wednesday that Cyprus continues to face excessive macroeconomic imbalances, particularly in view of the country’s very high percentage of non-performing loans that continue to plague the financial sector, but also in light of high private sector, government, and external debt.

According to the Cyprus chapter of the Commission’s Alert Mechanism Report for 2021, the updated scoreboard that includes figures until 2019, the current account deficit, the net international investment position (NIIP), private sector debt, and the government debt ratio indicators exceed the indicative threshold.

The relevant recommendations issued in 2019 and 2020 are broadly related to fiscal-structural policies, private sector debt, non-performing loans and the business environment. In addition to the policies needed to address the pandemic, the actions taken in 2020 to address the imbalances relate to the justice system, public administration, local government and access to finance, the Commission said.

Real GDP growth is projected to decline significantly as a result of the coronavirus crisis, from 3.1% in 2019 to -6.2% in 2020. Real growth is projected to reach 3.7% in 2021, leaving the nominal GDP level 0.7% lower than in 2019.

External vulnerabilities remain a concern, as the NIIP index is significantly negative, despite the 2019 improvement, which mainly reflects the activities of special purpose entities.

The current account showed a large deficit of 6.3% of GDP in 2019 and is expected to deteriorate sharply in 2020 with the sharp decline in tourism.

The corporate debt ratio continued to decline in 2019, although it remained increased. Domestic debt amounted to about 90% of GDP in 2019, above the limits of prudential supervision. In 2020, private sector debt ratios are expected to increase due to declining nominal GDP. The downward trend is expected to continue in 2021.

While the government debt-to-GDP ratio declined in 2019, it is projected to increase by 20 percentage points in 2020, reaching almost 113% of GDP, taking into account fiscal support measures, additional bond issuance and GDP shrinkage.

The stability of the banking sector has improved in recent years with significant reductions in NPLs during the period 2018-2019. In 2020, increases in the NPL index were limited due to sales and write-offs of assets, but may increase further in 2021 with the lifting of the debt repayment moratorium.

The Commission noted that Cyprus entered the coronavirus crisis with vulnerabilities related to external, private sector and public debt and high non-performing loans, in a context of moderate potential growth.

With the coronavirus crisis, the current account deficit has worsened, debt ratios have risen, and the repayment of non-performing loans by banks has slowed.

Overall, the Commission "considers it appropriate, also taking into account the detection of excessive imbalances in February, to further examine the persistence of macroeconomic risks and to monitor progress in overcoming excessive imbalances".