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Sustained reform key to mitigating Cyprus’ economic risks, ESM warns

Cyprus regained an investment grade rating in 2018 thanks to strong economic growth, a prudent fiscal policy, and a more resilient financial sector, and the winding down of the Co-op Bank (CCB) alleviated a major risk to financial stability by removing a large share of NPLs from outside the banking sector, according the 2018 report by the European Stability Mechanism (ESM).

The report said this one-off operation, however, adversely affected public finances in 2018 and banks still remained burdened by a sizeable NPL stock. “Sustained reform momentum is key to mitigating the domestic and external risks that could unravel efforts made over recent years”.

“Despite Cyprus’ solid recovery in recent years, the country needs to safeguard the robust fiscal performance to relieve the public debt burden. And while the financial sector has made important progress, the high level of NPLs remains a key vulnerability for banks”, the ESM chapter on Cyprus warned.

It said the Cypriot economy posted another consecutive year of strong growth. GDP grew close to 4 per cent in 2018, primarily driven by private consumption. Productivity growth reached the pre-crisis level, reflecting efforts to remove barriers in the service market.

Economic activity helped to reduce the unemployment rate to close to 8 per cent. “Yet Cyprus’ economy remains exposed to external risks, which may lead to a sharper-than- expected slowdown of GDP growth that could, for example, reduce tax receipts and put a halt to the downward trend of unemployment,” the report said.

“Excluding the CCB transaction and its one-off impact on public finances, a combination of favourable economic conditions and prudent fiscal policy kept public finances on the virtuous path,” it added.

The Commission projects that the general government surplus should still exceed 2.5 per cent of GDP in the medium-term. The government’s support of the CCB partial sale temporarily interrupted the reduction of public debt, which had fallen below 100 per cent of GDP at the end of 2017.

The CCB deal would also lead to increased financing needs in the coming years, the report said. Cyprus currently faces no major risks in meeting its loan service payments. “The reform momentum should, however, continue, particularly in areas related to public administration law”, the annual report said. “Cyprus’ banks made important progress, but the sector remains vulnerable”.
It also said NPL ratios in the banking sector declined significantly but remain among the highest in Europe.

In 2018, several NPL portfolio sales took place. Banks advanced in their restructurings but suffer from low profitability and additional provisioning pressures, the ESM said.

The report registers that the strong economic performance and the accelerated clean-up of banks’ balance sheets led to several rating upgrades. Cyprus now enjoys an investment grade rating from three of the four major agencies, and sovereign bond yields declined substantially during the year. Taking advantage of these developments, Cyprus issued a 10-year bond at a yield of 2.4 per cent in September 2018 but “going forward, the high private and public debt levels will remain the major burden on the country’s creditworthiness.”

 


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