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Fiscal watchdog warns Cyprus’s situation still “precarious” after programme exit (update)

 

The Fiscal Council, an agency set up to advise the government in an attempt to prevent fiscal derailment, said that it is concerned over the delay in the reforms process as the country’s economy remains in a “precarious situation” as a result of a high degree of indebtedness.

“The council stresses once more that Cyprus is in a difficult position because of its high public and private debt” seen at four times the annual economic output, the Fiscal Council said in its spring 2016 report. “A probable deterioration of external environment will have many times over and likely non-manageable consequences for the Cypriot economy compared with a country with less debt”.

“The delay in, or even the obstruction of, solving the non-performing loans problem prolongs Cyprus’s precarious situation,” the council said, adding that there is a need to focus on crucial issues to help avoid additional challenges. “Such issues include the planning and implementation of the national healthcare scheme and the Cyprus problem.

The fiscal watchdog said that Cyprus’s economy faces a plethora of risks, related to the cost of borrowing – both for the public and private sector – the delayed implementation of reforms such as the national healthcare scheme or containing the state’s payroll, or their ineffectiveness in reducing non-performing loans, the deferred modernisation of the public sector, the antiquated institutional framework of the pension system and the non-adherence to commitments included in Cyprus’s adjustment programme, such as the privatisation of the Cyprus Telecommunications Authority.

The state-owned telecom company risks being privatised “passively,” as happened in the case of Cyprus Airways, which ran out of cash in January 2015. This allowed the private sector to take over its operations without any financial benefit to the government, its main shareholder, the council said. As well, the government had to assume dozens of million euros in obligations.

In addition, the high stock of non-performing loans combined with the increased financing risk following the exit from the programme in March and external risks related to Greece, the UK leaving the European Union, the situation in the Middle East region and Russia are further risks for the economy.

On top come challenges related to a probable settlement of the Cyprus problem, the fiscal council said. A settlement will have to incorporate mechanisms that will preserve fiscal stability and the servicing of government debt, taking into account EU institutional frameworks, a comprehensive tax policy to avoid tax competition between the two federal states, and effective tax management to minimize tax evasion.

For the time being, as the island remains divided, the economy continues to have significant imbalances while it lacks competitiveness, the council said. The imbalances include a gap in the current account balance of 4.9 per cent of gross domestic product, a negative net investment position of almost 140 per cent of GDP, private-sector debt of 348 per cent of GDP, unemployment rate of 14.6 per cent, including 6.1 per cent of long-term unemployed.

Cyprus has already seen its borrowing cost rise following the programme exit -as reflected in the increased yields at recent auctions of treasury bills and on the secondary market for Cypriot government bonds-, the council said. External factors such as a negative market reaction following a possible Brexit could make things even worse via a negative impact on demand for bonds issued or guaranteed by the Republic of Cyprus, causing borrowing cost for the economy in general to rise further, the council said.

“The programme completion, the better than expected performance of the economy and the budget, and the beginning of the election campaign, have created an unfavourable environment for the continuation and completion of reforms, which are a fundamental precondition for economic stability and sound public finances,” the council said.

It added that as Cyprus’s sovereign credit rating continues to remain several notches below the investment-grade threshold, the high government debt, which was 108.9 per cent of the economy last year, combined with the pending short-term and medium-term refinancing needs makes the country’s position risky.

“Uncertainty over the future of public payroll remains,” while promotions based on non-meritocratic mechanisms in the government apparatus could further limit its effectiveness, the council said in an obvious reference to a draft legislation bundle submitted by Undersecretary to the President Constantinos Petrides in September.

With respect to non-performing loans, the council said that “despite a slight improvement” they remain high both as a percentage to overall bank lending and gross domestic product and, as a result, continue to threaten economic stability, the recovery process and fiscal consolidation.

“The return of the crisis in the relations of Greece, the International Monetary Fund and the European Commission is likely, while political and economic uncertainty in the region and Russia are likely risk factors for the Cypriot economy,” the council said in its report, adding that recent “terror attacks” could affect tourist destinations relying on airport traffic.

“It’s too early to evaluate the impact on Cyprus from the UK leaving the European Union but this would cause mostly negative than positive effects,” it said. A devaluation of the sterling vis-à-vis the euro is less likely to affect the number of arrivals than tourist spending.

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