The challenges for Cyprus economy follow a downward trend, according to a working document of the European Commission that evaluates the reform program for Cyprus in 2014. As it notes, the economic adjustment program of Cyprus remains on track and implementation progress has been made in all key objectives, although there are still challenges.
According to the document, despite the fact that the recession has been severe, it was less pronounced than expected in 2013 (5.4%), thanks to the performance of tourism and professional services and the less than expected decrease in private consumption.
Employment has declined and the unemployment rate has increased significantly, however, the labor market has proved flexible, while the gradual adjustment of wages helped to contain the fall in employment, the report points out.
As the paper adds, the need for debt adjustment of the private and public sector from the current high level will continue to act as an obstacle to economic growth.
GDP is expected to decline further by 4.2% in 2014, and the economy is expected to return to modest growth of 0.4% next year, and then only gradually improved, as domestic demand is burdened by the need to reduce the very high levels of debt. However, the Commission considers that these challenges follow a downward trend.
The risks stem mainly from slower than anticipated recovery of non-performing loans, a possible prolonged period of tight lending conditions, any slower than expected deleveraging process for households, further deterioration in the labor market and the further increase in geopolitical tensions in Russia and Ukraine.
According to the Commission, the budgetary targets for 2013 have been achieved in a remarkable degree, both because of continued prudent budget execution and the less severe recession than expected. The public deficit in 2013 was finally about 2 percentage points below the target set, while the government deficit in 2014 is projected to be about ½ percentage point lower than expected, at 5.3% of GDP.
Regarding the banking sector, the Commission notes that there are emerging signs of stabilization, although there are still significant challenges. The challenges have to do with the need for consolidation of the balance sheets of banks from the high level of non-performing loans and to reduce the debt of the private sector, so as to restore credit and sustainable development.
A key element to this purpose is the development of a suitable framework for debt restructuring, the Commission points out, adding also the need to continue work on the implementation of the restructuring plans of domestic banks. It is also important to ensure that further relaxation of capital controls does not endanger financial stability. The Commission also notes the need to continue work against money laundering .
Regarding public finances, the Commission points out the strong financial performance thus far, stressing that the Cypriot authorities should continue to maintain a prudent budget execution. As agreed by the start of the program, it will be necessary an additional adjustment at the last years in order to achieve the long term goal for fixed primary surplus of 4% of GDP, which is necessary to place public debt on a sustainable downward trajectory.
Regarding structural reforms, the report says that their implementation has progressed, although some need to be accelerated. Progress has been made mainly in the areas of tax administration, the management of public finances, reform of taxation of real property and in improving activation policies in the labor market.
The report also notes that the top priority is the adoption of a welfare reform, to provide adequate social protection for vulnerable households in the current phase of economic downturn. At the same time a privatization plan should be rapidly implemented, as well as the establishment of a national health system.
Cyprus has received on March 2013 a €10 billion bailout from the EU and the IMF which prevented the meltdown of its financial system and covered the island`s financing needs.