The International Monetary Fund insists on additional public sector wage bill reduction in 2016, despite objections by the Cyprus government.
As part of a €10 billion bailout, Cyprus has implemented so far fiscal measures amounting to 9% for the period of 2012-2016, including 9-15% public sector wage cuts. The MoU stipulates that in Q2-2016, the Cypriot authorities will present the programme partners with a provisional list of measures to attain a primary surplus of 2.5% of GDP in 2017 and 4% of GDP in 2018.
In the staff report issued for Cyprus under the article IV consultation, the notes that these measures should “rely on permanent measures, and be focused on unwinding the spending increases preceding the crisis.”
“The adjustment should start in 2016, be growth-friendly and balanced over time, and focus on reversing the statutory spending increases that took place before the crisis,” the IMF notes, adding that “to prevent a rapid rise in public-sector wages following their expected unfreezing after the program period, the wage bill needs to be further rationalized, including by revising current wage levels and pay scales, eliminating automatic increases, reducing employment in overstaffed areas and rationalizing public-pension lump-sum payments.
However the Cypriot authorities, according to the report, say they expected a better fiscal outturn in 2014 and considered that a more modest fiscal effort will be required to attain the 2018 primary-surplus target, given the over-performance to date and a likely stronger economic recovery.
“While (the Cypriot authorities) they saw merit in reforming the public wage-setting framework to better link wages with productivity, they did not agree with further reducing wage levels,” the IMF notes.
The IMF projects that following three years of consecutive recession, the Cypriot economy will show a modest 0.4% growth in 2015 followed by a growth of 1.6% of GDP 2016. Growth is projected to continue albeit a modest pace until 2020.
The Fund however notes that risks remain to the downside, pointing out that the main challenge is addressing the Non-performing loans in the island`s banking system.
According to the IMF, NPLs spiked to 57% by July 2014 with corporate loans at at over 73% and primary residences NPLs reaching 40%.
“This reflects not only the severe recession, but also increasing strategic default. Indeed, NPLs exceed what could be explained by unemployment, especially given the large and positive asset position of households,” the fund notes.
“Reforming the debt-restructuring legal framework is urgent”
The Fund points out that the inability to reach restructuring solutions is largely due to a lack of incentives for borrowers and lenders to negotiate, including a foreclosure process that takes 10–15 years and outdated corporate-restructuring and personal-bankruptcy procedures.
“The authorities need to implement without delay foreclosure legislation allowing for a balanced but swift process without interference from government agencies,” IMF says.
Despite a recent GDP revision by the EU Statistical Service (Eurostat) the Fund maintains the same projections for the public debt trajectory. Cyprus public debt is projected to reach 117.4% this year and will peak at 126.0% in 2015 and will gradually decline to 100% levels by 2020. However the government believes that as a result of the GDP revision , the public debt will peak at 105% the current year and will start its downward path next year before decline below 100% by 2017.
“The revision was the largest among euro-area countries, and significantly larger than the euro-area average of 3 percent,” the IMF says.
