IMF forecasts Cyprus economy growth to slow to 2.5 per cent in 2023

The economy of Cyprus is expected to experience a slowdown, with growth projected to reach approximately 2.5 per cent in 2023, according to a report released on Tuesday by the International Monetary Fund (IMF).

This forecast takes into account several factors, including a decline in household incomes, tighter financial conditions, and delayed effects resulting from sanctions imposed on Russia.

The IMF’s findings were published in a press release on Monday, following the conclusion of the Article IV consultation with Cyprus.

The IMF’s Executive Board acknowledges the resilience of Cyprus’s economy amidst the aftermath of Russia’s invasion of Ukraine. In 2022, the country’s output grew by 5.6 per cent, leading to a recovery in employment and a drop in unemployment rates, reaching a post-financial-crisis low.

However, high energy prices contributed to inflationary pressures and a larger current account deficit. On a positive note, Cyprus achieved a fiscal surplus equivalent to 2.3 per cent of its GDP, while also witnessing a significant decline in public debt.

The banking sector demonstrated strong liquidity and capital adequacy ratios, with improved profitability. Nevertheless, the IMF highlights that the slow resolution of legacy non-performing loans (NPLs) continues to impede private sector deleveraging.

Looking ahead, the IMF forecasts an average growth rate of around 3 per cent in the medium term, supported by both public and private investments, structural reforms, and further expansion in the information and communications technology (ICT) sector. However, high inflation is expected to persist, gradually receding due to elevated inflation expectations and wage pressures.

The IMF emphasised the importance of implementing a tight fiscal policy in the current year to mitigate price pressures arising from aggregate demand. It also notes that Cyprus’s public debt ratio is on a steady decline, while the external current account is expected to moderately improve but remain in a sizable deficit.

The IMF’s Executive Board recommends maintaining a moderately contractionary fiscal stance in 2023 to control price pressures and further reduce public debt. However, it advises that fiscal policy should remain flexible to respond if economic growth turns out weaker than anticipated.

When making decisions regarding wage indexation and support measures, the IMF suggests considering their macroeconomic impact holistically.

It cautions against implementing a mechanism that automatically adjusts wages to inflation, as it could potentially lead to persistent inflation, reduced competitiveness, and decreased fiscal capacity to respond to future shocks.

The IMF also recommends careful recalibration of the guaranteed minimum income programme, while strengthening its activation requirements.

Furthermore, the IMF underscores the importance of sustaining primary surpluses over time to reduce public debt, supported by a risk-based fiscal framework.

It recommends directing available fiscal space to productive investments for the green and digital transitions.

Additionally, it advises focusing on putting the National Health Service (NHS) on a sound fiscal footing, as well as strengthening governance and accountability of State-Owned Enterprises to stay on track with the planned fiscal path.

What is more, according to the IMF, despite notable improvements in bank resilience, risks persist within the banking sector.

The implementation of higher policy rates has thus far bolstered bank profitability, but the IMF cautions that credit risks are likely to increase due to financial tightening, particularly in light of the substantial private sector indebtedness. Close monitoring of these risks is necessary, the IMF adds.

To expedite the resolution of legacy non-performing loans (NPLs) and promote private sector deleveraging, the IMF emphasised the importance of resolutely implementing policies. It advocates for a forceful implementation of the foreclosure framework to tackle strategic defaulters.

The IMF further encourages banks to proactively employ all available tools to facilitate timely restructurings, taking advantage of recent legislative advancements. Additionally, sustained efforts are needed to advance the development of the newly proposed hybrid/out-of-court restructuring procedure.

While the Mortgage-to-Rent scheme is expected to contribute to NPL resolution for vulnerable borrowers, measures should be taken to minimise financial risks associated with the programme, as highlighted by the IMF.

The IMF also emphasised the need for strengthening the anti-money laundering and combating the financing of terrorism (AML/CFT) framework to address reputational risks.

In its press release, the IMF acknowledges Cyprus’s advantageous position to leverage its well-established professional services and strategic location.

However, it suggests that streamlining immigration procedures could address labour market shortages, while supply-side measures could tackle concerns related to housing affordability.

Reforms in the RRP (Recovery and Resilience Plan) are deemed crucial for overcoming structural bottlenecks, particularly through governance improvements and the future-proofing of workers’ skills via education system reforms, which could be expedited.

Furthermore, investments in digital infrastructure are highlighted as supportive of the digital transition.

The IMF also underscores the significance of adopting a greener growth model as a key component of reforms.

Finally, Cyprus’s integration into the regional electric grid, along with the expansion of renewable energy sources and the liberalisation of the domestic electricity market, are identified as crucial steps toward achieving carbon neutrality by 2050, while simultaneously enhancing energy security.

However, these objectives necessitate substantial public and private investments, according to the IMF’s conclusions.