Despite the sizable and sustained improvement in the island’s economy, private sector indebtedness remained high, putting pressure on banks and limiting new lending, the International Monetary Fund said.
In its staff concluding statement of the second post-bailout program monitoring mission, the IMF urged Cypriot authorities to amend foreclosures and insolvency laws in a bid to tackle the high stick of non-performing loans (NPLs) and restart structural reforms.
The IMF, which along with the EU and the ECB, had financed Cyprus’ €10bn bailout in 2013, noted that economic growth continued to accelerate, supported by construction, tourism and professional services while unemployment dropped further.
“However, despite a sizable and sustained improvement in macroeconomic conditions, private sector indebtedness remains extremely high and continued weak payment discipline has kept nonperforming loans at very high levels,” the statement said. “The need for additional provisions and limited opportunities for new lending continue to weigh on banks’ profitability.”
The IMF said it expected the rapid pace of economic expansion to continue with GDP projected to grow by around 4 per cent during 2018-2019, “underpinned by a pipeline of mainly foreign-funded, large construction projects, notwithstanding somewhat slower growth in private consumption due to better compliance by households with regard to their contractual debt obligations.”
The statement said Cyprus is not expected to have problems repaying its debt, under a baseline scenario, although that could change if significant contingent liabilities from banks’ distressed assets materialise, an excess supply of luxury properties were to generate a new boom-bust cycle, or fiscal discipline were eroded by yielding to spending pressures.
“Strengthening payment discipline, avoiding pro-cyclical policies and adopting macro-critical structural reforms would help preserve financial stability, protect the downward trajectory of public debt, and support balanced and durable growth,” the fund said.
To achieve a sustainable and durable reduction in NPLs, Cyprus would have to strengthen its payment culture, the IMF said.
That would entail amending legal frameworks for insolvency and foreclosure to incentivize borrowers to engage with banks to reach mutually-agreeable restructuring solutions based on commercial terms.
Limited, well-targeted fiscal support to lower-income distressed borrowers can strengthen their financial viability and promote payment compliance throughout the duration of the loan.
Reliance on third-party loan servicing companies should continue and be made fully operational, and any NPLs transferred to nonbank entities should not be merely warehoused.
“The recently-announced search for strategic investors in the Cyprus Cooperative Bank is a welcome development and should proceed in a smooth manner.”
The IMF said the government should withdraw incentives supporting the construction sector and a durable mechanism for keeping the public-sector wage bill in check should be instituted.
It should also restart structural reforms; the effectiveness of commercial claims enforcement and the efficiency of the courts should be strengthened to improve the payment culture and investment environment.
Plans for expedited investment procedures while also phasing out incentives for construction could attract capital into innovative sectors and help diversify the sources of GDP growth.
Corporate governance and operational efficiency should be strengthened in key semi-governmental and private entities to modernize the economy and make it more flexible.