Download The Cyprus economy exiting the economic adjustment programme

The Cyprus economy exiting the economic adjustment programme
Ioannis Tirkides, Senior Economist, Bank of Cyprus
Cyprus exited its economic adjustment programme in March of this year with considerable
success in terms of fiscal reform and banking sector restructuring. However, the continued
success and stability of the economy rests with continuing the reform effort and maintaining the
discipline and cohesion the country displayed in the programme period. In this article we take
stock of the position of the economy today, the risks and the challenges going forward and the
requirements for solidifying the gains, reducing the risks and enhancing the credibility of the
country in international capital markets.
Cyprus is coming out of a long and relatively deep recession, which, even if milder than initially
anticipated has left the country at a considerably lower level of output and income than when
the crisis had started; considerably higher unemployment; a high level of indebtedness both
public and private, relative to GDP; and a high level of non-performing loans that weigh heavily
on the banking sector. Growth returned in 2015 but it will take another five or six years on the
basis of current forecasts, to restore income to pre crisis levels. The International Monetary
Fund forecast growth between 2% and 2,5% annually to the end of the decade under certain
assumptions. Unemployment is high despite successive declines in recent quarters and income
inequality has risen.
There have been considerable advancements in the public sphere, the banking sector and
structural reform in the product and labour markets. As a result of growth performance and the
fiscal adjustment that accompanied the economic adjustment programme, the Cyprus
government regained access to capital markets. In October 2015 the government raised €1
billion by the issuance of a ten year Eurobond at yield of 4,25%. That was the third time the
government had accessed international capital markets since the start of the economic
adjustment programme.
On the strength of the economy’s performance and the strong implementation of required
measures and reforms, Cyprus exited its economic adjustment programme in March of this year
utilising only about 70% of the €10 billion funding that was made available by the European
Union and the International Monetary Fund. Its creditors noted the achievements and
highlighted what remains to be done in order to increase the resilience of the economy and
reduce its vulnerabilities.
The resilience of the economy, reflected in a milder recession than anticipated, rested with its
attractiveness as an international business centre, its strategic location in the eastern
Mediterranean, its flexibility reflected in price and quantity adjustments, its attractiveness as a
tourist destination and its ability to reach agreement on critical issues, even if with considerable
delays some times, in the implementation of a painful programme of economic adjustment, as
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the condition for the financial assistance of its creditors, the European Union and the
International Monetary Fund.
The growth outlook in the medium term remains positive but limited by vulnerabilities and
weaknesses that will need to be lessened as a matter of policy and strategy going forward
regardless of the government in power.
Weaknesses relate to the small size of the economy and its undiversified nature where a small
number of sectors drive growth. These weaknesses are enhanced by the high level of
indebtedness of both the public and the private sectors, and by the high level of non-performing
loans in the banking sector. Despite considerable restructuring this year, so far, and the last, the
regulatory requirements relating to non-performing loans ensure the reduction will be gradual.
At the same time the high level of indebtedness of almost every sector of economic activity
limits the scope for considerable further net credit expansion.
On the fiscal side there has been considerable consolidation in the context of the economic
adjustment programme. The €1 billion deficit of the general government in 2013 was almost
completely eliminated by 2015. The government’s budget performance has been strong.
Excluding costs relating to the recapitalisation of the credit cooperative sector, that amounts to
slightly more than 8% of GDP in 2014 and about 1% of GDP in 2015, the government budget was
near-balanced in the period and the primary surplus as a percent of GDP rose to 2,6% and 2,8%
respectively. The debt to GDP ratio may have peaked in 2015 at 108,9% and it is expected to
drop gradually toward 80% by 2020 according to the International Monetary Fund based on a
set of positive growth assumptions.
The affordability of debt remains an issue but at current levels and growth forecasts, debt is
affordable. Debt affordability is measured in terms of debt servicing costs as a ratio of gross
domestic product and total budget revenue. The low interest rate environment prevailing
ensures that debt servicing costs are within the abilities of the economy.
The institutional and regulatory framework in a post crisis scenario is greatly enhanced as a
result of the reforms that have been introduced and all the regulatory adjustments that have
taken place. Banking supervision for the systemic banks falls under the Single Supervisory
Mechanism of the European Central Bank. The foreclosure and bankruptcy laws have been
modernised. The government ranks high on effectiveness by the worldwide governance
indicators. The strengthened institutional framework ensures that with Cyprus’ exit from the
economic adjustment programme will not have material implications on funding access
provided fiscal prudence is maintained.
The stability of the country’s banking sector has been bolstered through restructuring and
recapitalisation. Capital buffers increased significantly, operations have been streamlined and
non-core activities overseas have been sold, and funding profiles improved markedly. Remaining
uncertainties relate to the large size of the sector and to the high level of non-performing loans.
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Regulatory changes and the reform of the foreclosure and insolvency framework coupled with
intensive restructuring work outs and are expected to improve gradually going forward.
Cyprus is now a more stable economy and set firmly on a path of modest growth at least, when
compared to historical standards. Growth prospects are weighed down by high total
indebtedness and the high level of non-performing loans. To successfully face the challenges
that lay ahead it is absolutely necessary to maintain the growth momentum by making sure that
the banking sector continues on the path of restructuring and deleveraging and that the public
sector remains committed to fiscal discipline. Credibility especially now that the country has
exited its economic adjustment programme is fundamental.
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