Post-programme surveillance report : Cyprus, Autumn 2017

This report presents the findings of the third post-programme surveillance (PPS) mission of European Commission staff, in liaison with staff from the European Central Bank (ECB), which took place in Cyprus from 25 to 29 September 2017. Given that Cyprus has been identified as experiencing excessive macroeconomic imbalances under the EU Macroeconomic Imbalance Procedure (MIP), this visit also served the purpose of specific monitoring under the MIP. The mission was coordinated with an International Monetary Fund (IMF) Article IV mission. Staff from the European Stability Mechanism (ESM) also participated in the mission on aspects related to the ESM's Early Warning System. The economic recovery in Cyprus has gathered further strength, but sustaining growth over the medium term will require renewed reform momentum, continued fiscal discipline and acceleration in the resolution of non-performing loans (NPLs). Growth should remain strong, albeit somewhat decelerating over the medium term. It has been increasingly driven by domestic demand, while tourism remains buoyant with positive spillovers to other sectors of the economy. Labour market conditions have continued to improve, with employment increasing across sectors. The real estate market has stabilised and the construction sector is rebounding. High private sector debt, which is being reduced only gradually, continues to weigh on growth prospects. In addition, the widening of the current account deficit needs to be closely monitored given the high level of external debt. Fiscal performance benefited from the favourable macroeconomic environment and from prudent expenditure policies, but important medium-term risks remain. Fiscal performance in the first half of 2017 was stronger than expected, mainly driven by buoyant tax revenues. Expenditure increased at a much slower pace than revenues. On this basis, the general government could record a higher primary fiscal surplus in 2017 than last year. Risks remain for the medium term, such as the uncertain fiscal impact of the recent healthcare reform and the lack of a mechanism to contain increases in the public wage bill beyond 2018. Containing expenditure growth, including in the payroll, remains essential for Cyprus to safeguard fiscal sustainability in line with the requirements of the preventive arm of the Stability and Growth Pact (SGP). If fiscal space materialises, it should be used to accelerate the reduction in the still elevated public debt and to increase public investment in productivity-enhancing projects to improve long-term growth potential.