The high ratio of corporate debt in Cyprus, accumulated before the culmination of the banking crisis four years ago, has a strong and negative effect on investment and thus on economic output and therefore its expedient reduction could help economic recovery, the International Monetary Fund said in a working paper.
Corporate indebtedness in Cyprus, which peaked in 2012 at 275 per cent of economic output, is also reflected in the “very high level of impaired loans” which account for roughly half of the banks’ loan portfolio, Sophia Chen and Yinqiu Lu, said in their paper posted on the website of the IMF on Tuesday. The views in the paper reflect those of the authors, the IMF said.
“Before the Cypriot banking crises, flushed with easy money and accommodated by regulatory forbearance, banks relaxed lending conditions and overly relied on collaterals in lending,” the paper said.
The two authors said that they estimate that a 10 per cent change in indebtedness “measured by total debt-to-assets ratio” over the last decade, is associated with a 3 to 6 per cent change in investment rate in the opposite direction.
“Extrapolating these results to macroeconomic developments suggests that the increase in corporate leverage may account for one sixth to one third of the decline in corporate investment from its 2008 peak,” they said. “Our results are consistent with recent evidence on the impact of financial distress on investment documented in other European countries”.
The enriched toolbox available to banks to address non-performing loans via loan restructurings, including revised insolvency legislation, can help companies repair their balance sheets, in turn helping the economy, which exited in 2015 a prolonged recession and is projected to grow in 2017 3 per cent, almost as much as in 2016, the paper concluded.