ESM issues advice on Cyprus to follow through with the “implementation of envisaged reforms in the areas of local government, justice, and public administration”, that “would invigorate Cyprus’ economic potential”, in its annual report, endorsed today by its` board of governors, that convened earlier today in Luxemburg, where the Eurogroup will take place this month.

ESM notes on its Cyprus` chapter in the report that `the economic outlook for the Cypriot economy depends on the duration of the pandemic and continued policy support”.

“A persistent health crisis weighing on external and domestic demand would threaten businesses and employment, particularly in the tourism sector”, ESM notes.

“A premature end to public support schemes could lead to rising bankruptcies and unemployment. In addition, elevated household and corporate debt pose vulnerabilities to the economy given Cyprus’ high NPL ratios”, ESM warns.

More specifically the chapter on Cyprus under the 2020 ESM report notes that “Cyprus’ economy shrank in 2020 due to the pandemic, albeit by less than the euro area average and with only a moderate rise in the unemployment rate. Though public debt and government financing needs increased significantly, Cyprus enjoyed favourable financing conditions and maintained a large liquidity buffer. Decreasing, although still high, NPLs and the loan payment moratoria limited the pandemic’s drag on banks’ balance sheets. Structural reforms in sev- eral areas would help to boost the country’s longer- term growth potential.”

“Cyprus reported a large GDP drop in 2020, although smaller than the 6.6% euro area average decline. After expanding by 3.1% in 2019, real economic activity shrank by about 5.1% in 2020 largely because of the collapse in tourism. Domestic demand, however, remained relatively resilient, and government support schemes for the economy cushioned the impact of the crisis. The unemployment rate stood at 7.3% in December 2020, below the euro area average of 8.2%.”

“The fiscal deficit widened sharply in 2020, resulting in sizeable gross financing needs. The primary deficit stood at about 3.5% of GDP in 2020, about half the euro area average. More than half of the deficit was due to automatic stabilisers reacting to the fall in economic activity, while the remainder stemmed from discretionary measures designed to mitigate the economic effects of the pandemic. Public debt increased to above 118% of GDP in 2020 from 94% a year earlier, while limited contingent liabilities might arise from government guarantees granted in previous years to the private and public sector to sustain the economy. The main credit rating agencies, with the exception of Moody’s, continued to rate Cyprus’ debt at investment grade. Sovereign creditworthiness was constrained due to vulnerabilities stemming mainly from high private debt but also from relatively high public debt.”

“Despite the challenging economic environment, Cyprus enjoyed a positive market perception and advantageous financing conditions mainly thanks to the ECB’s monetary policy measures, and also the Next Generation EU programme. In this framework, Cyprus undertook a liability management operation fully substituting its IMF loan with market financing. Furthermore, Cyprus tapped the markets extensively in 2020 with favourable outcomes and yields broadly in line with euro area developments. As a result, the government built up a large cash buffer minimising liquidity risks for 2020; more than half the increase in the public debt-to-GDP ratio between end-2019 and end-2020 was due to a sizeable strengthening of the cash buffer.”

“Due to joint efforts by authorities and banks, NPLs declined substantially from their peak at the beginning of 2015. The NPL ratio remains in double-digit territory and the pandemic crisis could delay plans for further reductions. The loan payment moratoria have shielded banks’ balance sheets from new NPLs, although loan-loss provisions are already undermining results. To facilitate NPL workout and minimise the impact on banks’ capital, secondary market prices of NPLs need to be maximised, which requires a predictable and efficient contract enforcement procedure. New lending has been subdued, driven by banks’ capital constraints and the lack of a public guarantee scheme.”

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