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IMF: Ukraine fallout slows Cyprus growth

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Cyprus growth is hindered by the Ukraine war fallout, but partial recovery in exports and private consumption will see a 2% GDP rise in 2022, the International Monetary Fund forecasts.

It said Cyprus staged a strong recovery last year on the back of its successful management of the pandemic and sizeable policy support, adding that output returned to its pre-pandemic level and unemployment declined.

The current account deficit has remained elevated but narrowed to 7¼% of GDP with a recovery in exports, while inflation edged up, driven mainly by higher energy prices.

The fiscal deficit dropped to around 2% of GDP on a cyclical revenue recovery, while the public debt ratio has stayed high but declined to 104%.

“Liquidity in the banking sector has remained high and capital ratios broadly stable. Banks have made progress in offloading legacy non-performing loans. The effects of the pandemic on credit quality have been limited,” said the IMF.

“Growth this year will be set back by the fallout from the war in Ukraine and, with a partial recovery in exports and private consumption, is forecast at around 2%.

“It will also be supported by investment spending under Cyprus’ Recovery and Resilience Plan, which, combined with structural reforms, improves medium-term growth prospects.”

The current account is projected to worsen with a deterioration in trade temporarily, and higher imports and inflation will increase further before declining in the medium term.

IMF argues the slower recovery will stymie fiscal consolidation this year, but the fiscal deficit is still expected to narrow after the phase-out of Covid-related support, and the public debt ratio is set to remain on a firmly declining path.

“The outlook remains highly uncertain with risks from an escalation and prolonged duration of the war and sanctions, de-anchoring of inflation expectations in advanced economies, and uncontrolled and more severe Covid outbreaks.”

Policy response

The IMF commended the authorities for their policy response to the pandemic, which supported the recovery of output and employment.

“The outlook is subject to risks stemming from a prolonged war in Ukraine, uncontrolled COVID outbreaks, and abrupt monetary tightening in advanced economies.”

It stressed the need to calibrate a policy response to manage the pandemic and war-related shocks in the near term while pressing ahead with the financial sector and structural reforms to reduce vulnerabilities and improve growth prospects and resilience over the medium term.

IMF directors underscored the importance of fiscal discipline over the medium-term to place the public debt on a firmly declining path.

They encouraged further efforts to control public sector wage growth, address risks from the National Health System, and monitor the financial sector’s contingent liabilities.

Directors noted that the financial system has stayed resilient.

They agreed that the authorities should enhance monitoring and address asset quality given the worsened outlook.

“Resolving legacy non-performing loans requires more forceful implementation of existing tools, including further improving the working environment of credit acquiring companies and credit servicing companies”.

They underscored the criticality of an effective foreclosure framework for addressing strategic defaulters and providing incentives for borrowers to engage in restructurings.

“The planned Mortgage-to-Rent scheme should be well-targeted to minimise the fiscal cost and ensure transparency and accountability.

“Structural reforms are key to raising medium-term growth potential.”

Directors encouraged the authorities to continue to make progress in strengthening the AML-CFT and governance frameworks and tackling the skills, digital, and infrastructure gaps.

“Achieving the national climate goals can help Cyprus transition to a more resilient and sustainable growth model.

They recommended continued efforts to address the challenges to implementing the green agenda, including the planned green tax reform.

“Additional measures, including feebates, to enhance the emissions reduction could also be considered.”