25 November 2013

IMF/Velculescu: "Cyprus on the mend?"

• Strong macro-economic policies are paramount to restoring confidence, macro-economic stability, and growth.

• First, the restructuring of the financial sector needs to be completed to allow a clean-up of the banks’ balance sheets and the eventual return of sustainable credit growth.

• The authorities will need to complete recapitalisation with state aid and the consolidation of the cooperative sector, while ensuring an adequate governance structure.

• Both banks and coops will need to implement their restructuring plans to address large and growing NPLs, in the context of the recently-established arrears framework and code of conduct, while putting in place incentives to facilitate voluntary negotiations and prevent strategic defaults.

• The new roadmap to relax capital controls provides an orderly and predictable framework to ease restrictions as key milestones in the bank strategy are reached. It is state rather than time contingent, and allows for flexibility in the face of changing circumstances.

• Second, fiscal policies need to balance short-run cyclical concerns with long-run sustainability objectives. Given the ambitious adjustment already underway, additional measures are envisaged for the outer years to place public debt on a sustained downward path.

• Third, the authorities have committed to complement these efforts with structural reforms to strengthen budget processes, improve revenue administration, privatise state-owned companies, and revamp the welfare system so as to better protect vulnerable groups during the downturn.

• In addition to strengthening macro-economic policies, an adaptation of the business model away from financial services and toward other services, where Cyprus has a comparative advantage, is also needed. Tourism and business services (legal, consulting, accounting) are expected to support the recovery and medium-term growth. These sectors benefit from a low corporate tax regime, educated labour force, strong institutions, and low structural barriers to growth. Prospects from the exploitation of gas reserves provide an upside for long-term potential growth.

To conclude, the authorities have a full agenda ahead. The difficulty of their task should not be underestimated, as the recession continues and large risks remain. Nevertheless, one should not forget that the most difficult decisions have been taken to address the root of the problems in Cyprus. The authorities have now a unique opportunity to use this momentum and turn their economy around.

Full speech

© International Monetary Fund