The International Monetary Fund (IMF) mission that wrapped up its fifth assessment of Cyprus` bailout programme, along with the European Commission and the European Central Bank, last week, has made its conclusions public, noting that an additional fiscal effort of permanent nature will be required to achieve and sustain the authorities’ primary surplus target of 4 percent of GDP by 2018, consistent with the objective of bringing public debt down to around 100 percent of GDP by 2020.
It also notes that there is scope to further reduce the public sector wage bill, complemented by reforming the pay structure to better link pay with performance and eliminate automatic increments before the wage freeze expires in 2016, and that further savings could be achieved by reforming the education sector and pensions.
`Looking forward, the authorities need to ensure that reforms are fully implemented and operations are not disrupted during the transition period`, it says.
The presentation was made during a teleconference by head of the IMF mission Delia Velculescu.
The last comprehensive review of Cyprus` economy had been made in late 2011.
The report says `Cyprus accumulated large imbalances, which were exposed in the crisis`, adding that `in the years preceding the crisis, significant foreign inflows led to a rapid expansion of the banking sector to eight times the size of the economy`.
`Easy credit fueled a housing boom and an increase in private-sector indebtedness to one of the highest levels in the Euro area. Surging imports relative to exports – exacerbated by an erosion of competitiveness as wage growth exceeded productivity – resulted in a steep rise in the current account deficit. And public debt swelled due to a loose fiscal policy after entry into the Eurozone in 2008. These imbalances were exposed in the crisis, which culminated in a collapse of the banking sector`, it points out.
The report refers to the measures taken by the authorities to address the crisis and points out that, `while significant progress has been achieved, overcoming the legacy of the crisis will be challenging`.
It also refers to Cyprus` achievements, which, `together with better-than-expected economic and fiscal performance, allowed Cyprus to re-access international markets earlier this year`.
`Still, public and private sector debt remain very large and the unemployment rate, at over 15 percent, is unacceptably high. Rising non-performing loans (NPLs) and tight capital and liquidity buffers limit prospects for the resumption of credit growth, output growth, and job creation, as well as for the removal of capital controls. Addressing these challenges successfully hinges on continued firm policy implementation. Continued euro area recovery and support from European policies will also contribute to restoring growth and stability in Cyprus` it says.
The report notes that `the economy is undergoing a deep but unavoidable adjustment, and the outlook is subject to risks`, adding that `the recession is projected to continue this year, with a modest recovery expected to take hold in 2015, and a gradual increase in growth toward 2 percent over the medium term`.
`Risks remain significant, related to uncertainty about the magnitude and pace of private sector deleveraging and the ability of banks to address NPLs, as well as to geopolitical tensions over Ukraine-Russia`, it says.
Furthermore, the report says that `a substantial fiscal consolidation has been implemented` and that `the authorities have put in place an ambitious package of measures of close to 7 percent of GDP in 2013-14, broadly balanced between revenues and spending`.
`The effort has helped to sustain tax revenues despite the deep recession and to unwind part of the increase in public sector wages and social transfers in the run up to the crisis. Moreover, the authorities executed the budget prudently, further tightening discretionary spending in the face of unusually high macroeconomic uncertainty. These efforts resulted in a decline in the fiscal deficit in 2013. This year, the primary deficit is expected to fall further, to about half its 2012 level`, it points out.
It notes, however, that `with public debt high and still rising, significant medium-term consolidation is needed`.
`An additional fiscal effort of permanent nature will be required to achieve and sustain the authorities’ primary surplus target of 4 percent of GDP by 2018, consistent with the objective of bringing public debt down to around 100 percent of GDP by 2020. The adjustment should be gradual and aim to balance short-run cyclical considerations with long-run sustainability objectives`, it says.
It adds that `a growth-friendly consolidation would need to focus on fully unwinding the spending increases preceding the crisis, while protecting capital expenditures`.
`There is scope to further reduce the public sector wage bill, complemented by reforming the pay structure to better link pay with performance and eliminate automatic increments before the wage freeze expires in 2016. Further savings could be achieved by reforming the education sector and pensions`, the report says.
The report says that, `with important structural reforms initiated, the focus needs to be on implementation`, adding that `the authorities have legislated sweeping reforms in many areas: (i) the pension system; (ii) the public sector wage-indexation mechanism; (iii) the welfare system; (iv) public financial management; and (v) revenue administration`.
`These initiatives are essential to ensuring the sustainability of the fiscal consolidation efforts. Looking forward, the authorities need to ensure that reforms are fully implemented and operations are not disrupted during the transition period`, it says.
It points out that `privatization efforts should also continue`, adding that, `given the ambitious agenda, additional medium-term reforms, such as of the healthcare system and public administration, would need to be implemented prudently, to minimize fiscal risks`.
Furthermore, it says, `they should also be carefully sequenced, to avoid capacity overload` and that, `finally, in developing their new growth-enhancing strategy, the authorities should focus on measures to address key bottlenecks and improve competitiveness`.
`Cyprus has come a long way in addressing the crisis. The financial sector has been stabilized, substantial fiscal consolidation has been implemented, and sweeping structural reforms are underway. The cost of the crisis has been large, and painful but necessary measures have imposed an unavoidable cost on the population. Looking forward, significant challenges remain, and they will not be resolved overnight`, it says.
It concludes that `the authorities will need to stay focused on and committed to adopting the necessary policies to advance their adjustment program in order to pave the way for sustainable growth`.
