IMF says no to CoLA rise, warns of NPLs

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The International Monetary Fund (IMF) warned the government against increasing the Cost-of-Living Allowance while pointing to threats posed by a possible rise in Non-Performing Loans due to hiking interest rates.

The IMF made the written recommendations in the context of the 14th post-bailout audit of the economy and the banking system.

In its concluding notes after meeting Cypriot authorities from March 16–28 to discuss economic developments and policy priorities, the IMF advised against any upward revision to the automatic CoLA adjustment, arguing it would weaken economic resilience and competitiveness.

“For the public sector, further increases in the relatively high wage bill would reduce fiscal space, while a stronger automatic link between wages and inflation would also make fiscal policy more pro-cyclical,” said the IMF report.

For the private sector, the IMF argued that CoLA does not account for productivity developments and reduces the ability to adjust to adverse shocks, weighing on resilience and competitiveness.

“Moreover, higher CoLA would deepen duality in the labour market, as it mostly benefits public sector employees and around a third of private sector employees covered by collective agreements”.

The IMF recommendations come as the Labour Ministry is carrying out consultations with the social partners to renew the CoLA collective agreement.

The unions are asking for a substantial increase in the rate currently granted (50%), with the government appearing willing to discuss an increase, but this is not the case with the employers’ associations.

Interest rates

IMF staff also sent warning signals to the banking authorities on risks posed by the increase in interest rates, which could challenge borrowers’ capacity to meet their obligations.

This could push up Cyprus banks’ Non-Performing Exposure, notes the IMF.

As the IMF team notes, significant progress has been achieved in improving banks’ resilience, but vulnerabilities remain.

“Banks remain highly liquid, and capital ratios are comfortably above regulatory requirements; higher interest rates, as well as progress in lowering fixed costs through voluntary staff exits, helped raise traditionally low profitability.

“The strong capital position is encumbered by still-high NPL ratios, and household and corporate sector indebtedness, although on a declining trend, remain among the highest in the euro area, pointing to borrower-side vulnerabilities”.

It said high inflation and gradually rising borrowing costs are likely to increase credit risk amid elevated private sector debt levels, “while significant exposure to the real estate sector exposes banks and credit acquiring companies (CACs) to collateral revaluation risks”.

Echoing earlier calls by Cyprus’ central banker, Constantinos Herodotou, the IMF urged banks to proactively use all available tools to enable timely loan restructuring of viable businesses in financial difficulties.

IMF said an effective foreclosure framework remains key to resolving legacy NPLs. However, the effectiveness of the Foreclosure Law has been hindered by repeated suspensions.

The report welcomed the House’s decision to end a freeze on the foreclosure law, noting that state plans to introduce “a mortgage-to-rent scheme for vulnerable households—with safeguards to minimise fiscal risks—may help resolve socially-sensitive NPLs”.

The IMF appears satisfied with the fiscal policies implemented related to pressures from the war in Ukraine, with the right balance achieved between providing the necessary support to citizens and ensuring fiscal sustainability.

According to the report, measures to address the cost-of-living crisis were mostly well-targeted and came at a limited cost to the budget (below 1% of GDP).

“Thanks to higher-than-projected revenue collection and contained expenditures, the primary balance reached 3.8% of GDP (from 0.1 in 2021), and public debt declined to below 87%  of GDP”.