IMF happy with Cyprus bank stress tests

The IMF is happy with the quality of the bank stress tests carried out by the Central Bank of Cyprus on Cypriot banks, but the IMF mission head has cautioned that underlying risks remain, calling on banks to maintain high levels of capital in order meet the risks from a prolonged crisis or a further decline in property prices, to which Cyprus banks are particularly at risk.
The IMF urged Cyprus to cut a bloated state payroll feeding growing deficits it forecast could spike over the euro zone threshold of 3.0% this year. In a concluding report of an annual consultation, the IMF said it expected Cyprus's general government deficit to reach 3.9% in 2009, with growth at around 0.3%.
This is a sharp reversal from surpluses of 2007 and 2008, and a considerable divergence from official Finance Ministry forecasts of a 2.0-2.5% deficit this year, and 1.0% growth.
The state payroll accounted for about a third of Cyprus's public spending, a trend which would stoke an expansionary debt-deficit cycle if it were not intercepted, the IMF said.
The imbalance would not go away by collecting more revenues or raise taxes, said IMF Mission leader Angana Banerji.
“We think the most important element of current spending is basically the public payroll and we think the government should find ways to reduce it,” she told journalists.
An IMF interim report said Cyprus's deficit would need to fall by a rate of 0.25 to 0.75% of GDP growth per year to achieve the government's objective of structural fiscal balance over the medium term.
Cyprus, a member of the euro zone, has not detailed how it plans to correct deficits.
State finances in the last two years were largely propped up by a buoyant property market, which has since seen a decline in foreign buyers snapping up holiday homes.
A slowdown in economic growth was expected to expose underlying vulnerabilities which built up in an overheating economy in 2007 and 2008, the IMF said. The private sector was highly leveraged, with banks and households having large exposures to the property market.
But, Banerji said, the Mediterranean island had fared better than many European countries in weathering the global crisis.
The relatively benign impact of the crisis was partly due to conservative practices and strict supervision, and the elimination of exchange rate risk following euro adoption, the IMF said.