IMF: Withdrawal of support measures should be gradual

An International Monetary Fund (IMF) mission met virtually with Cypriot authorities from March 8–29, 2021 to discuss recent economic developments and policy priorities on the island. In an interview with Kathimerini Cyprus, IMF mission chief for Cyprus, Anita Tuladhar, said the longer the period of recovery in tourism-related sectors, the higher the likelihood of permanent scarring in the economy. Tuladhar also noted the importance of state-sponsored programs to support the economy.

With regard to non-performing loans, the IMF mission chief for Cyprus said that given the risk of new NPLs, it will be prudent to preserve capital and use capital buffers flexibly to help ensure that the banking sector continues financing the real economy and has enough resources to absorb losses.

Tuladhar also emphasized that an effective foreclosure framework is critical to address strategic defaults and provide incentives for borrowers to enter restructuring negotiations or avail themselves of insolvency tools.

- It is said that the state financial support is necessary and it should not be revoked early or suddenly. Based on the financial potential of Cyprus as you evaluated it, for how long can the country have a good support program for companies and employees?

The economic outlook remains highly uncertain and will depend on the pace of vaccine rollout and new waves of infection. Withdrawal of support measures should therefore be gradual and conditioned on the durability of the recovery. Vulnerability to the COVID-19 pandemic shock is very high given nearly a third of the workforce is concentrated in tourism-related sectors (accommodation, food services, transport, and trade). The longer the period of recovery in these sectors, the higher the likelihood of permanent scarring in the economy. Currently, financing remains ample and risks to financing are outweighed by risks of wider bankruptcies and permanent scarring in the economy if the support is withdrawn too early. Policy priorities will thus depend crucially on the evolution of the pandemic and the vaccine rollout. Once the acute phase of the pandemic is over and broad relief spending can be scaled back, it will still be important for the government to spend on things like worker training to enable individuals to find employment in new sectors of the economy.

- In your report you state that you expected a smaller drop in foreign direct investment inflows due to the termination of the Cyprus Investment Program. Based on the structure of the Cypriot economy, where do you see foreign direct investments coming from to fill this gap?

Cyprus’s growth performance has been strong in recent years. While growth in construction and real estate sectors, fueled by FDI, has been a key driver, Cyprus has also seen rapid growth in other services sectors such as professional and administrative services, education and information and communication technology sectors. We expect these and other key sectors such as tourism, shipping, infrastructure and energy to continue to attract FDI. While Cyprus has maintained its cost competitiveness, addressing several bottlenecks such as access to financing, lengthy judicial processes, inefficiencies in public services, and skills mismatches will be key to attracting FDI flows.

- Given that a lot of money has come from investors in Cypriot banks and they have not given dividends in several year, what indicators do you see being necessary to give them again? For example, do you want a certain percentage of NPLS? Do you want a certain percentage of funds? What exactly?

Bank profitability in Cyprus has been under pressure because of the need to address legacy NPLs. In addition, high reliance on interest income in the current low interest environment and high operating costs are also weighing on bank profits. Addressing these challenges will be key to improving bank profitability and dividend distribution. At the current juncture, given the risks of new NPLs, it will be prudent to preserve capital and use capital buffers flexibly to help ensure that the banking sector continues financing the real economy and has enough resources to absorb losses. Hence, we consider it appropriate for banks to limit dividend distributions until uncertainties from the COVID-19 pandemic dissipate sufficiently. This is also consistent with the guidance provided by the European Central Bank and the Central Bank of Cyprus.

- From what you saw in Cyprus during your last evaluation, do we have the capacity and skills to achieve better supervision of the Credit Acquiring Companies (CAC) that operate on the island? Is it done with local potential or do we need to bring third parties and foreigners?

Oversight of Credit Acquiring Companies (CACs) should continue to be strengthened, given that they hold nearly two-thirds of the nation’s NPLs. Progress has been made in CAC supervision on several fronts such as data collection—for e.g., CACs were asked to adopt European guidelines on nonperforming and forborne exposures. Directives have been issued to strengthen the CBC’s authorization and supervisory framework on CACs, particularly on their governance frameworks. Off-site and on-site inspections have been conducted.

As for the Cyprus AMC, safeguards should also be strengthened to ensure sound corporate governance, operational arrangements, and transparency. In the past, the Fund advised that in order to avoid just accumulating these distressed assets and to maximize returns, the entity should have a clear mandate accompanied by operational targets, a supervisory board consisting of a majority of independent members acting in the interest of the company first and one that is run by skilled management, whose compensation should be based on performance. Operational independence should be balanced with public accountability such as transparent reporting.

- You mentioned in the Cyprus Article IV concluding statement about the ESTIA Loans Scheme, for loans that failed to enter the ESTIA and loans that need a support plan. What are the characteristics of these loans to be included in the category of support, in order to avoid moral hazard? Do you have in mind loan categories, such as amount, type, etc.?

One of the strategies for a difficult-to-resolve NPL portfolio has been the state subsidy scheme (Estia), which aims at supporting restructuring and repayment of the NPLs collateralized by primary residences. However, the applications filed represented a very small share of the potentially eligible amount with many applications still incomplete or needing to be assessed. The authorities suggested economic difficulties facing borrowers and strategic defaults as two reasons for the lackluster take-up rate.

A new scheme—possibly a mortgage-to-rent scheme—will likely be offered to vulnerable applicants who did not qualify for Estia. In our view, such a social safety net scheme to support the vulnerable applicants could be considered, provided support is timebound support, and there are strict eligibility criteria and full transparency on fiscal costs. Importantly, safeguards should be in place to identify and address willful defaults and non-cooperative borrowers so that they are not in the scheme and are addressed as part of the legal enforcement framework. Spending scarce fiscal resources to protect these borrowers would be unfair and would undermine the repayment culture.

- Given the current state of foreclosures in Cyprus today, do you find there is any room for relaxations? And if so, in what direction to satisfy the Parliament of Cyprus, which is seeking them? Are there guidelines?

Progress with claims enforcement and collateral recovery has been uneven in Cyprus. In the past, NPL resolution was difficult, given the long time taken for foreclosures. However, following the 2018 amendments to the foreclosure legislative framework, the number of cases of foreclosure/auctions picked up. More importantly, the threat of foreclosure incentivized greater cooperation for cash repayment and bilateral restructurings. These reforms also enabled banks to sell NPL portfolios to credit acquiring companies, helping to strengthen banks’ balance sheets. The 2019 amendments to the foreclosure legislation, which became effective in 2020, following the Supreme Court decision, while limited to non-terminated NPLs with primary residence as collateral, have introduced uncertainties on the foreclosure process. The priority now should be to resume foreclosures and speedily address uncertainties in the scope and implementation of these amendments. In addition, to facilitate timely restructuring, obstacles to using insolvency tools such as an examinership process should also be addressed.

An effective foreclosure framework is critical to address strategic defaults and provide incentives for borrowers to enter restructuring negotiations or avail themselves of insolvency tools. Current proposals under discussion in Parliament risk reducing the threat of foreclosures and create uncertainties by weakening prospects for collateral recovery necessitating additional provisions and capital increases for banks. Reversal of the reforms by weakening the framework is a risk for financial stability.

- When Covid-19 will be an end era, will leave an impact on tourism. What adjustments are needed to be made to the Cypriot tourism product so that it is compatible with what the post-Covid-19 era will leave? Will the Cypriot tourism model of 2019 be enough to be implemented in 2021 and onwards?

The Cypriot economy is highly dependent on tourism, making it more vulnerable to the impact of pandemic shock. Looking ahead, Cyprus fares relatively well in terms of prospects for recovery given the tourism structure, health sector indicators and recovery in the main source countries. Lower dependency on business travel, better progress on vaccination in source countries and the relatively good health conditions of Cyprus would help to attract tourists once travel restrictions are lifted. The tourism sector in Cyprus is competitive compared to euro area peers. There has been progress in diversifying the source markets of tourism, although the share of its top three markets remains very high, making it vulnerable to developments in these countries. Improvements will need to focus on environmental sustainability and opening to different types of market such as cultural resources. We believe that continued targeted support measures to the tourism sector are warranted in the short term given its systemic importance to the economy. The longer-term policy challenge is to steer the sector toward sustainable tourism, that focuses on regionally more diverse, higher-end tourism and is more strongly based on environmental sustainability, quality of services, and non-price competitiveness.