IMF warns of 'increasing headwinds to sustained growth'

The International Monetary Fund called on Cyprus to mitigate the main vulnerabilities the economy is faced with, as headwinds are threatening sustained economic growth.

In a statement following the conclusion of the third post-programme motoring mission, released on Thursday, the IMF said real GDP growth is projected to reach a still-robust 3–3.5% in 2019–20, from 3.9% in 2018, led by foreign direct investment, but warned of “increasing headwinds to sustained growth.”

The IMF welcomed progress in addressing the high non-performing loans (NPLs), due to transferring sizeable NPL portfolio out of the banking system noting however continued efforts are need to reduce NPLs “which remain among the highest in Europe.”

According to the IMF Cyprus’s capacity to repay the Fund is adequate under this baseline, as strong economic growth and a sizable primary fiscal balance are expected to support a durable decline in gross public debt and continued favorable market borrowing terms.

“However, repayment capacity could be weakened if growth slows significantly or if some specific risks materialize from banks’ still weak asset quality; the realization of fiscal guarantees; or unexpected spending, including from court cases,” the fund said, adding this could be exacerbated in the event of weaker than expected growth in Europe, or a hard Brexit.

The IMF added, that economic growth has been strong, supported by construction, tourism and professional services, unemployment has declined further, while the underlying budget remains in a large surplus.

Furthermore, the Fund called for policies to mitigate Cyprus’ key vulnerabilities, mainly to reduce NPLS, limit public spending to maintain public debt on a downward path and to strengthen structural reforms.

On the banking sector, further efforts are needed to address the troubled legacy assets—which remain among the highest in Europe, adding that “steadfast implementation of the foreclosure framework, including e-auctions, is key to lowering debt.”

The IMF encourages banks to continue maintaining appropriate capital and provisioning levels and reducing NPLs and real estate property holdings to targeted levels and to address “the system’s inefficient cost structure.”

According to the IMF, that continued efforts to mitigate AML/CFT risks remains a priority to reduce risks to growth.

It also calls for an appropriate governance structure for the state-owned asset management company (KEDIPES) to maximize recovery and points out that ensuring ongoing compliance with the eligibility requirements for the Estia scheme is crucial to prevent abuse of taxpayer resources.

On the public finances, the IMF said spending growth should be firmly maintained at a pace below that of medium-term GDP and cyclical and windfall revenues should be saved, to ensure a neutral fiscal policy stance, build up buffers, and anchor public debt on a firmly downward path.

“Keeping growth of the wage bill below nominal GDP growth is particularly important given the gradual reversal of crisis-era public wage and pension cuts,” the IMF said, adding reforms aimed at making the public health sector more competitive and managing incentives for providers and patients adequately are crucial to mitigate fiscal risks from the introduction of a public health insurance system.

Moreover, it calls for the strengthening of structural reforms, referring to the ongoing judicial reform which would help address the legacy of the crisis and improve the investment climate.

It also said that improving corporate governance of commercial state-owned enterprises and reforming local government will help reduce contingent fiscal liabilities and raise productivity.