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Brussels sees delays on key reforms in Cyprus

The Cyprus economy will continue to grow, fiscal performance is solid, but external headwinds are increasing and significant domestic vulnerabilities remain, while key reforms, including justice have been delayed, according to the Post Program Surveillance report on Cyprus released Friday in Brussels.

According to the report, despite the global economic slowdown, Cyprus posted remarkably strong growth for the third year in a row, reaching 3.9 per cent in 2018. Growth was driven by domestic demand and exports of services, particularly tourism, while inflation remained subdued. Domestic demand is expected to continue to perform strongly in 2019, on the back of rapidly declining unemployment and moderately rising wages.

Nevertheless, the growth momentum is forecast to subside, mostly reflecting the less favourable external environment. These challenges are further compounded by key vulnerabilities of the Cypriot economy, notably the still very high levels of non-performing loans as well as private, public and external debt in a context of low productivity growth, and high dependency on foreign capital flows”.

The European Commission noted that “underlying fiscal performance continued to be very strong in 2018 on account of buoyant revenues, even though the general government surplus turned into a deficit due to the one-off banking support measures related to the sale of the Cyprus Cooperative Bank (CCB).”

It also recognised that “last year Cyprus made significant progress in consolidating its banking sector and reducing non- performing loans (NPLs) held by banks, but important challenges remain.”

But it warned that “to continue with NPL resolution and private sector debt deleveraging, it is essential to enhance payment discipline and resolve unviable debt by fully using the amended insolvency and foreclosure frameworks”.

“Rigorously assessing the compliance with the eligibility criteria and swiftly triggering foreclosure procedures in the case of re-defaults will be critical for the performance of the forthcoming ESTIA scheme for NPLs collateralised with primary residences.

According to the EC the still-favourable economic conditions provide a window of opportunity to step up the pace of structural reforms to boost potential growth and a key priority is the effective implementation of judicial reform, “which is essential for the functioning of the economy”. This involves the establishment “of new specialised courts, in particular a commercial court, clearing the high accumulation of cases, including cases related to NPLs and revising the outdated civil procedure rules”.

“Strengthening the enforcement of judgments should become an essential element of the reform as it would also help improve debt repayment discipline”, the report said.

But the Commission warns that “notwithstanding the high political priority attached to judicial reform, progress in its implementation has been slow.” The implementation of e-justice — a key pillar of the reform — has also been postponed, but the review of the rules of civil procedures is on track.

The Commission states that it is also essential to improve the efficiency in the public sector, in particular the functioning of the public administration and of local governments. Furthermore, the business environment needs to be improved, including through the elimination of administrative barriers to investment, the opening up of the electricity market, and the completion of privatisation projects.

“These structural reforms would facilitate investment in Cyprus and help diversify it to sectors other than construction and tourism, currently the key drivers of growth. The implementation of the national healthcare system is expected to improve access to affordable health care services by reducing high out-of-pocket expenditure. At the same time, it will be important to contain related fiscal risks”, the report notes.

On the structural reforms the report states that “the opening up of the energy market and diversification of the energy mix are progressing, but are facing delays, the preparations for implementing the healthcare reform are progressing, while there are uncertainties surrounding its fiscal and economic impact and the legal framework to facilitate strategic investments is pending adoption.”

“The government’s efforts to explore and utilise hydrocarbons are on-going. The authorities expect the explorations in Cyprus’ exclusive economic zone to continue as planned. The agreement for the monetisation of the hydrocarbon reserves in Aphrodite field is expected to be concluded in the coming months, but implementation will take several years”, the report notes.

Transfers of title deeds also remain a key concern and a credible new system is long overdue and the simplification of the procedures for issuing building and planning permits is pending. Despite the withdrawal of the law on the governance of state-owned enterprises (SOEs), some steps are being taken to improve their governance and performance.

Furthermore revenue administration reforms are gradually progressing, but progress on individual privatisation projects remains limited. The draft bill on the corporatisation of the Cyprus Telecommunications Authority (Cyta) has stalled at the House of Representatives since 2017 and, for now, there is no intention of adopting this bill. No notable progress has been made on privatising other assets, such as the Cyprus Stock Exchange, although the reform of the local governments is gaining momentum. The horizontal reform of the public administration is still pending. Containing the public sector pay roll remains essential, the report said.