Cyprus needs to maintain its reforms momentum in the public sector reduce NPLs, and ensure labour market flexibility to strengthen its long-term growth potential and attractiveness as an investment destination, the annual European Stability Mechanism (ESM) report said on Thursday.
The text approved by the ESM board, also clearly mentions that the “reunification of the country, if ongoing talks succeed, would provide further opportunities for investment and growth”.
The ESM report said that Cyprus exited successfully from its adjustment programme on March 31, using in the end only 70 per cent of the €9 billion or so ESM package.
Over 2015 and early 2016, it continued reaping the benefits of the reforms undertaken since the start of the programme, it said.
In 2015, Cyprus exceeded targets in some key areas, such as on the fiscal side. And, while banks’ NPLs remained very high, the banking sector’s overall health continued to improve and capital controls were fully lifted in April 2015.
Structural reforms lagged, however. It is crucial that Cyprus actively manages the NPLs and continues pursuing sound policies post -program to improve long-term growth prospects further, the report said.
Cyprus returned to growth in 2015 after three years of recession. Annualized GDP grew at 1.6 per cent, slightly better than expected in the most recent forecasts. Domestic demand growth of 2.9 per cent largely drove this improvement. Net exports contributed negatively with 1.3 per cent as imports expanded at almost double the pace of exports.
The ESM also recognised that the labour market started to recover with the unemployment rate declining to 13.1 per cent in December 2015 from 16.8 per cent in December 2014, but still, unemployment remained “very high” and far above the 10 per cent registered in early 2012, the report said. Competitiveness continued to improve as unit labour costs fell again in 2015.
Cyprus was “broadly on track with fiscal adjustment and fiscal reform” measures in 2015. The general government headline deficit declined to approximately by 1 per cent of GDP versus 8.9 per cent in 2014.
The higher than expected primary surplus increased to 1.8 per cent in 2015 from a deficit of 6 per cent in 2014. The debt-to-GDP ratio reached 108.9 per cent in 2015, a marginal increase from 108.2 per cent in 2014. “Some of the reforms, however, fell behind schedule in late 2015, in particular those related to privatisation,” the report said.
The banking sector’s fundamentals improved further. An injection of additional capital in 2015 strengthened capitalisation, but excessively high NPLs weighed on profitability and outlook, the ESM added.
Although the NPL stock remained overly high in international comparison, it is expected to decline soon. The necessary legal frameworks aimed at reducing NPLs are now in place and banks have stepped up in pace and quality. “By maintaining the current pace NPLs could decrease at a faster pace than observed in other programme countries.”
Growth and fiscal performance helped Cyprus regain market access and allowed it to smoothly exit its ESM programme without any follow-up arrangement. Cyprus sovereign bond yields declined substantially. The 10-year yield reached around 3.8 per cent at the end of 2015. Over the programme period, Cyprus also built strong cash buffers. While Cyprus regained market confidence, its credit ratings remained below investment grade. To keep market perceptions positive and regain investment grade, the determined implementation of reforms remains essential, the report concluded. (CNA)