Cyprus: Second Review Under the Extended Arrangement Under the Extended Fund Facility and Request for Modification of Performance Criteria
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Summary:
EXECUTIVE SUMMARY
Extended Arrangement: On May 15, 2013, the Executive Board approved a three-year
Extended Arrangement under the Extended Fund Facility in the amount of SDR 891
million (563 percent of quota; about €1 billion). Two purchases of amounts equivalent to
SDR 74.25 million (about €86 million) each have been made so far, and another
purchase of the same amount is proposed to be released upon completion of the
second review. The European Stability Mechanism has released €4.5 billion since the
program approval (of €9 billion committed).
Recent Economic Developments: The recession through September, though deep, has
not been as large as expected. Private consumption has been relatively resilient,
economic sentiment continues to improve, and exports, including tourism, have held up.
Nevertheless, the situation remains difficult, with unemployment on the rise and
disposable incomes falling. Banks are curtailing credit as asset quality continues to
deteriorate, and private sector indebtedness remains very high. In this context, the
growth forecast for 2013 has been revised upwards modestly, but a deeper contraction
in 2014 is now envisaged, consistent with a more gradual private sector deleveraging
process.
Policy Implementation: The program is on track. Fiscal performance continued to
exceed targets comfortably, and the 2014 budget is more ambitious than envisaged at
program approval. All structural benchmarks were met, albeit with a modest delay in
one case. Significant progress has been made in restructuring and recapitalizing the
banking sector, including with foreign participation in the share capital of one domestic
bank. Looking forward, efforts must concentrate on ensuring full implementation of
banks’ restructuring plans to clean up balance sheets and pave the way for a return of
credit to the private sector. Fiscal structural reforms are proceeding, but strong resolve is
needed to kick-start the privatization process. The program remains subject to large
uncertainty given lingering financial sector vulnerabilities and continued challenges to
policy implementation.
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