Lack of diversity hurting Cyprus economy

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Cyprus’ economy is still characterised by large economic imbalances, which, unless addressed, may impede its medium-term prospects, the European Commission warns in its in-depth analysis.

It said Cyprus’ large imbalances are a legacy of the 2013 crisis and include high stocks of private, public and external debt and nonperforming loans.

“Cyprus has made limited progress in addressing the 2019 country-specific recommendations…Cyprus has made no progress on privatisations,” the Commission said.

Brussels urged Nicosia “to step up reforms in key areas to attract productivity-enhancing investments, diversify the economy and help foster inclusive and environmentally sustainable growth in the long term”.

“The long-term sustainability of the growth model of Cyprus is put at risk by rising external uncertainties and pending structural reforms.”

It also said, “the design of the Cypriot corporate tax residence rules, and the residence and citizenship by investment schemes, are a cause for concern”.

Cyprus economic growth is viewed as “resilient” but is expected to slow in the coming years with GDP growth projected at 3.2%% in 2019.

The economy is expected to continue growing — albeit at a slower pace — by around 2.8%% in 2020 and 2.5% in 2021, in view of the anticipated weakness of the global economy.

The headline budget balance is set to return to surplus in 2019 (above 3.5% of GDP) and to remain in surplus in 2020 and 2021, which would enable considerable debt reduction.

“To safeguard fiscal sustainability going forward expenditure developments should be carefully monitored, especially in the light of possible future risks to the robustness of revenues.”

Growth relies heavily on specific sectors, such as tourism, foreign-funded residential construction and services linked to foreign companies, which are vulnerable to potential negative external developments.

In mid-2019, the share of non-performing loans accounted for 33.5% of the total loans in the banking sector, which is still one of the highest proportions in the EU.

“The effective use of the legal framework, including for foreclosures and insolvency, is essential to reducing nonperforming loans further, enhancing the payment discipline and addressing strategic defaulters.”

Non-performing loans, including the growing proportion held outside of the banking sector, need to be resolved, said Brussels.

“This is, in particular, the case for the loans held by the state-owned asset management company (KEDIPES) where delays and organizational set-up challenges need to be addressed to ensure a successful performance. Strengthening the supervision of credit-acquiring companies is also important.”

The banking sector’s profitability remains under significant pressure.

While sales of non-performing loans are expected to reduce the proportion of bad loans held by the banks in 2020, low-interest margins, excess liquidity and high operating costs still dampen banks’ profitability.

Private sector debt remains high, although it is decreasing. Both households’ and nonfinancial corporations’ debt ratios are decreasing. (ESTIA scheme should help reduce the private sector debt and the housing market recovery could help reduce private debt).

Key challenges

Key challenges remain in relation to environmental sustainability and climate change.

“The country’s weak environmental performance is a major concern,” said the report.

“Despite some action, Cyprus remains vulnerable to climate change due to droughts and water scarcity. At the same time, Cyprus is among the Member States with the highest green-house gas emissions per person and the economy heavily relies on fossil fuels.”

It said the justice system continues to face serious inefficiencies that undermine the enforcement of contracts.

“Lengthy court proceedings and weak enforcement of judgements harm the business environment and hinder banks from using the available legal tools to reduce non-performing loans.

Addressing these inefficiencies would also help to strengthen the payment discipline in the country. Preparations for the justice system reform are advancing but there are still no tangible results.”

A need for reforms of the education and training systems were also highlighted.

“The relatively high public spending on education is not reflected in observed outcomes, as highlighted by the recent results from the Programme for International Student Assessment.”

“The weak support for early childhood education and care undermines potentially high long-term benefits of quality childcare and hinders people from working or looking for a job.”

Brussels said Improving educational achievements and skills, as well as increasing participation in adult learning and vocational education and training are “essential” for fostering sustainable growth in the future.

Inefficiencies in the public sector are also seen as harming the business environment.

“The impact of the efforts made to improve the governance and financial monitoring of state-owned enterprises remains to be seen.”

“Corruption is perceived as a problem by businesses, and adopting pending key anti-corruption legislation, as well as stepping up the implementation of the adopted action plan are essential for improving the business environment.”