Cyprus growth is above most European peers, inflation is close to 2 percent and fiscal performance continues to be strong, significantly reducing public debt, Alex Pienkowski, IMF mission chief for Cyprus, has said, noting at the same time that the authorities should resist further extending poorly-targeted excise and VAT reductions.
In an IMF statement it is noted that an International Monetary Fund (IMF) mission met with the Cypriot authorities during March 19-29, 2024 to discuss recent economic developments, the outlook and risks, and policy priorities. At the conclusion of the visit, Mr. Alex Pienkowski, IMF mission chief for Cyprus, said that “supported by robust policies, Cyprus recovered swiftly from the pandemic, and has proved broadly resilient to multiple adverse shocks. Growth is above most European peers, and inflation is close to 2 percent. Fiscal performance continues to be strong, significantly reducing public debt”.
IMF notes the key policy priorities, which are: Fiscal surpluses should per
sist until debt falls comfortably below 60 percent of GDP, the authorities should resist additional indexation of public sector wages and avoid further extending poorly-targeted excise and VAT reductions, the financial sector appears resilient but requires continued vigilance, including in the non-bank financial sector, following recent amendments, the foreclosure framework should be left to work without further changes, further improvements are needed in the judiciary and education to strengthen long-term growth prospects and additional climate mitigation and adaptation policies are needed to achieve emission targets and reduce climate risks.
The Staff Concluding Statement of the 2024 Article IV Mission notes the robust growth, receding inflation, and strong fiscal performance, saying that economic diversification has supported growth.
“Despite headwinds from higher interest rates and weak activity in trading partners, growth in Cyprus was above most peers in 2023. Despite a steep drop in visitors from Rus
sia, the tourism sector has continued its post-pandemic recovery. At the same time, the information and communication technology (ICT) sector is growing strongly, and financial services are becoming more diversified. Growth is expected to be around 2½ percent in 2024, as rising real incomes support consumption, and foreign direct investment (FDI) and EU Recovery and Resilience Program (RRP) financing inflows support investment. Labor markets are expected to remain strong” it adds.
Inflation, it says, has normalized, adding that led by falling energy prices and tighter monetary policy, headline inflation has fallen to around 2 percent. “Core inflation remains slightly higher, with some stickiness persisting from robust domestic demand. Nevertheless, inflation is expected to remain contained going forward”.
Strong fiscal policy remains a key anchor for macroeconomic stability, it continues, noting that ‘on the back of robust revenue performance, the primary surplus increased in 2023 to 4.4 percent of GDP. Thi
s, along with strong growth, reduced public debt to 77 percent of GDP, back to the favorable pre-pandemic trend. Among other factors, fiscal discipline, falling debt, ample cash buffers, and recently demonstrated economic resilience have supported credit rating upgrades and improved market sentiment”.
Risks, it adds, have declined but remain to the downside. “Short-term risks include a downturn in major tourism markets and an escalation of regional conflicts that could slow Cyprus’s efforts to reorient its services exports. Over the medium- and long-term, there are adverse risks from climate change, while accelerated rebalancing of the growth model has upside potential”.
Moreover, it says that fiscal discipline should be maintained while strong primary surpluses-which underpinned the post-crisis recovery-should be maintained. “In the near-term, budget targets for a continued large primary surplus remain appropriate. Further out, the overarching fiscal anchor should be to reduce debt to comfortably below 60
percent of GDP. To achieve this, it is important that fiscal space is preserved to address sizable long-term spending pressures, including from aging and climate change” it says.
Further wage indexation should be avoided, and temporary tax exemptions should be phased out, it says. “Public sector wages should reflect macroeconomic and productivity developments, implying that further upward revisions of the cost-of-living adjustment (CoLA) should be avoided. The authorities should also resist any further expansions or extensions to poorly targeted VAT exemptions. Similarly, the electricity subsidy and fuel excise suspension should be allowed to expire, as planned. Capital expenditures should be prioritized in line with full absorption of RRP funds”.
Furthermore, it notes that finalizing the roll-out of the National Health Service (NHS) and governance reforms of State-Owned Enterprises (SOEs) remain critical, adding that after delays associated with the pandemic, efforts to ensure that public hospitals achieve
financial self-sufficiency are welcome. And efforts to strengthen the financial oversight of SOEs should continue.
As regards the banking sector, it says that it has large capital and liquidity buffers, and financial sector risks appear to have eased. “Banks are well capitalized and remain resilient under stress tests. Despite higher interest rates, asset quality does not appear to have deteriorated, supported by robust economic growth, declining unemployment, and rising property prices. Nevertheless, continued vigilance is required, including close monitoring of the recent uptick of loan renegotiations”
Noting that macro-prudential policy is appropriately set, but the real estate sector requires careful monitoring, it says that “the increase in the positive neutral Counter-Cyclical Capital Buffer is welcomed and will build policy space in the face of future shocks. Real estate plays an important role as collateral in the financial system. While property prices appear in line with fundamentals, risks remain
, including in the non-bank financial sector. Careful regulatory vigilance is required, including through continuous and comprehensive assessment of real estate risks in the financial sector”.
In addition, it notes that the foreclosure framework should be allowed to work without further changes. “The large stock of legacy nonperforming loans (NPLs) remains a drag on private sector balance sheets and the efficient allocation of credit; uncertainty over collateral recovery inhibits new lending. As such, resolving NPLs-supported by measures such as the mortgage-to-rent scheme-remains a key priority”.
Moreover, it says that strengthening the judicial and education sectors is critical for long-term growth. “Ongoing efforts to reduce the backlog of court cases are welcome, but more is needed to simplify procedures, enhance physical and technological infrastructure, and address staffing needs. The education system should better focus on digital skills, which would allow more Cypriots to benefit from ICT job opport
unities”.
A robust anti-money laundering (AML) framework reduces reputational, regulatory, and business risks, it says adding that “Cyprus has made good progress on AML issues, especially in the banking sector. However, the authorities should continue to strengthen the effectiveness of the framework by creating a single supervisory agency to oversee self-regulation by accountants and lawyers, and by strengthening AML/CFT efforts in real estate. The creation of a national sanctions enforcement unit will reduce risks from potential sanction evasion”.
IMF says that greater energy integration and diversification will enhance energy security and support the green transition. “Plans to connect the electricity network with neighbors, import LNG, increase the share of renewable energy sources, and introduce competition in the energy market are critical. But progress on these fronts has been slow, and efforts are needed to implement these plans more decisively”.
It expresses the view that further measures are neede
d to reach Cyprus’s ambitious climate objectives, noting that “the introduction of the green tax will bring Cyprus closer to its climate targets. However, more effort is needed, particularly in sectors not covered by the EU Emission Trading System (ETS), other than transport. Hence, the scope of the tax should be widened. IMF analysis suggests that the growth and distributional effects of such an expansion will be manageable”.
IMF says that an adaptation strategy is needed to limit the cost of climate change. “Extreme heat, drought, and sea level rise pose risks to the Cypriot economy. Contingency planning, early warning systems, and careful planning of coastal development and protection are important elements of a strategy to manage these risks. Public investments and reforms to boost private sector climate adaptation are needed” it concludes.
Source: Cyprus News Agency