Government should withdraw support schemes – Central Bank of Cyprus

The government should begin gradually withdrawing the support schemes it has promulgated during the pandemic crisis, the Central Bank of Cyprus said in its Annual Report and Financial Stability Report.

The two reports, released on Thursday, showed that in 2020, support needed to be the top priority, but that situation is changing in 2021.

“The most important matter in relation to the economy, for both Cypriot and European authorities, remains to limit the impact of the pandemic on economic activity and unemployment.

In Cyprus, the state has implemented fiscal measures to support the economy amounting to around €800 million (3,8 per cent of GDP) for 2020. Most of these measures are focused on supporting workers and businesses. The European Commission (EC) has also approved a loan to Cyprus with favourable terms within the Support to Mitigate Unemployment Risks in an Emergency (SURE) programme.

However, the Financial Stability Report emphasised that a transition should be achieved in 2021.

“While the economy of Cyprus in 2020 was affected by health developments, the 2021 support measures should be aimed at mitigating risks that have been created. The immediate reaction supervisory authorities and governments

2020 has largely contained the negative effects on the real economy. However, any further measures should be targeted to minimise the consequences, while reducing the impact on public finances,” the bank warned.

“On the one hand, it is necessary to avoid the early withdrawal of support measures, either in the economy as a whole or in individual sectors, before a sustainable recovery is achieved, causing further problems in the private sector, increasing unemployment and reducing the income of businesses and households.

On the other hand, if the support measures are extended for an unnecessary long time, this could act as a distortion to the restart of economic activity by sector and increase the number of unsustainable enterprises that remain in operation, harming productivity and delaying recovery.

At the same time, an unnecessary prolonged duration of the measures would pose a risk to the sustainability of public finances (public debt and budget deficit), with significant negative implications in relation to the determination of the investment grade of Cypriot bonds by the rating agencies, with everything that this entails for the country’s borrowing costs. Of course, safeguarding the investment grade should always be seen as a permanent criterion in shaping the country’s fiscal policy, not only in times of crisis, but even more so, in times of normal economic conditions in which fiscal consolidation is comparatively easier,” the report continues.

The country faces considerable uncertainty, the Financial Stability Report said, and the medium-term risks for financial stability are increased. “The CBC is monitoring them closely and is ready to intervene again with macroprudential policies and measures to reduce potential vulnerabilities in the system,” according to the report.

The banking system is at risk, the report continued, as a new wave of non-performing exposures (NPEs), provisions and losses should be expected after the end of support measures in 2021.

“However, this can be limited by the correct and rapid use of restructurings. Meanwhile, it is expected that credit institutions may be faced with a deteriorated credit quality and a reduced profitability prospect. At the same time, the structural problems already facing the banking sector should be resolved by streamlining the balance sheets of credit institutions.”

It is worth noting that reports on loan repayment at Cyprus banks indicate provisionally that the vast majority of borrowers who were protected by repayment suspension schemes are making payment again, and so there is less likelihood of a wave of NPEs.

The government must be extremely careful in its planning and management of the withdrawal of support measures to deal with the economic consequences of the pandemic (which correspond to around 9,7 per  cent of country’s GDP).

The recovery is expected to begin in mid-2021 due to the gradual increase projected in domestic and external demand. With risk factors from delays in the vaccine rollout taken into account, the recovery for 2021 should show 3.1 per cent growth, the report says.