The Cypriot economy faces strong headwinds and downside risks due to financial turbulence in the euro area, the large exposure of Cypriot banks to Greece, and the need for substantial fiscal consolidation to stabilize public finances, the International Monetary Fund (IMF) has noted.
The IMF Executive Board, which concluded the consultation with Cyprus on November 18, urges the authorities to act forcefully to restore sound public finances and safeguard the stability of the banking system. Steadfast implementation of fiscal and structural reforms on several fronts would also be critical for a return to durable growth over the medium term”, IMF points out, adding that it supports the authorities’ plans to achieve fiscal balance over the next three years as an appropriate strategy for undertaking the necessary fiscal correction without unduly damaging growth prospects.
In addition, IMF Directors express concern about the vulnerabilities arising from Cyprus’s large banking sector.
In the conclusions, the Directors agree that an ambitious and credible fiscal adjustment is essential to regain access to the international capital markets and put the public debt ratio on a downward path.
They also consider that front-loading the adjustment with measures to reverse recent increases in public sector wages and poorly targeted transfers would provide a credible signal of the authorities’ commitment to medium-term consolidation and bolster investor confidence.
“Reforms of the cost-of-living allowance system would also be important for achieving the fiscal targets and improving real wage flexibility and competitiveness”, IMF notes.
Directors also underscore the importance of other fiscal reforms to underpin the consolidation efforts. Priorities should include the introduction of a medium-term budget framework and the adoption of fiscal rules consistent with EU directives.
Additionally, IMF Directors highlight the need for reforming the national pension and healthcare systems, which threaten to put unsustainable pressures on the budget as the population ages.
In the conclusions, IMF Directors express concern about the vulnerabilities arising from Cyprus’s large banking sector and the possibility of adverse feedback loops with the public finances and the real economy in the context of weakening balance sheets.
They also stress the importance of building prudent capital buffers and of ensuring adequate liquidity in the financial system.
“These actions should be supported by contingency planning and the immediate passage of legislation to provide the authorities with full powers to recapitalize or resolve banks, if necessary”, IMF adds.
Finally, the IMF points out that the Cooperative credit institutions should also be watched closely and brought under the same regulatory and supervisory frameworks as banks.
During the last visit of IMF delegation in Cyprus on October 12, 2011, the IMF concluded that Cyprus economy is expected to show little if any growth this year, and to register a small contraction in 2012. In addition, it predicted that the deficit in 2011 will be around 7% and in 2012 around 4%.
