Commission: Cyprus retains the ability to service its debt to the ESM

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The Commission concludes that “Cyprus retains its ability to service its debt to the ESM, but the challenges have increased as a result of Covid-19” and warns that the risks to fiscal prospects have clearly worsened, including the effects of a recession. which is more pronounced than expected, of higher tax revenue elasticity and the possible cost of policy measures, including those involving possible liabilities, to address the impact of Covid- 19 “.

More specifically, according to the monitoring report after the program for Cyprus, which was approved today by the College of Commissioners, after several years of intense development, “the global escalation of Covid-19 throws the Cypriot economy into a deep recession in 2020.” .

The Commission notes that “Cyprus has experienced a period of strong growth since its banking crisis, with real GDP increasing by a quarter since 2014”, however, since mid-March 2020, “the pandemic of coronavirus, which has led At the border, closing, locking measures and shutting down all unnecessary businesses, including hotel and other tourist accommodation, have had a significant impact on the Cypriot economy. “

“The crisis is expected to affect in particular two key pillars of the economy, tourism and shipping. According to the Commission’s spring forecast, real GDP is projected to fall by about 7% in 2020,” the report said.

He notes that “exports of goods and services are expected to shrink significantly”. “Investment in construction may be somewhat better maintained, thanks to the fact that some major projects are already underway and due to many years,” and Cyprus has adopted a fiscal warming plan that will help mitigate the contraction, the commission said.

According to the report, “with exports falling sharply from imports, the current trade deficit is set to widen further (to about 11% of GDP).”

However, assuming a gradual exit from the lockdown in the coming months, it predicts “a return to strong growth in 2021 of about 6%, although production is not expected to return to 2019 levels,” the Commission said.

“At this time, there are significant risks to growth prospects, especially as the duration of the pandemic and the locking measures are still unknown,” the report warns.

More specifically, the report states that “the recession created by Covid-19 and the necessary political response are expected to significantly affect public finances in 2020.”

“After a strong fiscal performance in 2019, the key fiscal balance will be reduced to a significant 7% GDP deficit in 2020. This reflects significant expected revenue losses due to weaker economic activity and significant additional costs to mitigate its effects. The expansionary fiscal measures adopted represent about 4% of GDP, including revenue support systems for businesses and j of the additional costs for health care. The authorities are working on a large financial package of state guarantees for new loans to support liquidity availability to the private sector, “the report says.

“The risks to fiscal prospects are clearly negative. They include the consequences of a recession that is more severe than expected, tax revenue and the potential cost of policy measures, including those that involve possible obligations, to deal with the Covid impact.” 19 “, the Commission warns.

The stability of the banking sector “has improved significantly in recent years, but the economic impact of the pandemic may jeopardize tough progress.” Banks are on a “stronger footing” than in the past, following a “significant clearing of the balance sheet and leverage, with a significant reduction in non-performing loans (NPL) and a more unified banking system.”

However, the Covid-19 crisis “inevitably affects the banking system through its impact on profitability and credit risk”. In addition, it remains “the legal uncertainty over the amendments to the August 2019 sale law, for which the Supreme Court’s decision is pending. The NPL index stood at 28% in November 2019.

“Before the outbreak of Covid-19, further significant progress was expected in reducing NPLs in 2020, mainly due to high NPL portfolio sales from the two largest banks.”

However, “these sales have been postponed now, mainly due to the difficulty of determining the value of assets in the current environment and the growing uncertainty about the appetite of investors.”

“Furthermore, the economic collapse of the pandemic will likely lead to an increase in credit risk, generally and also in Cyprus, and will ultimately result in an increase in NPLs due to reduced revenues and net wealth,” the report said.

In addition, the report states that the lowest of the expected absorption of ESTIA – the state-sponsored NPL scheme provided by first homes – implies a much smaller than the targeted contribution to NPL reduction.

KEDIPES, the state-owned asset management company, has made some progress to become fully operational. However, further steps are needed to ensure that it can achieve its core mission of maximizing revenue from managing and disposing of its assets, including finalizing its organizational framework and governing it, reviewing the agreement at the service level. lender and starting the implementation of a business plan. Banks continue to operate at a significant surplus of liquidity, which is valuable in the face of global turmoil, and their capital reserves exceed the minimum regulatory requirements.

“However, we expect a prolonged impact of the pandemic on sensitive sectors (such as tourism, wholesale and retail activities, real estate and construction) and deteriorating asset quality could affect profitability and capital ratios,” he said. the Commission.

“Measures taken by the ECB, the Central Bank of Cyprus and the European Banking Authority are expected to support banks to maintain financing for businesses despite difficult economic conditions,” the report said.

Finally, the Commission concludes that “Cyprus retains the ability to service its debt to the ESM, but the challenges have increased as a result of Covid-19”.

“The first ESM repayment will not take place until 2025. The risks are expected to be gradually eliminated as soon as the recovery begins. Uncertainties and risks have been exacerbated, especially by the large projected budget deficit and the significant increase in gross public debt – It is expected to increase to 116% of GDP by the end of 2020 due to recent international and domestic bond issues to meet the highest financial needs of the state, “the report said.

“The vulnerabilities also come from the banking sector, which could see an increase in new NPLs. Although gross financial needs have increased significantly this year due to the pandemic, the government has secured funding early on in favorable market conditions. and therefore in a good position from a financing perspective for the immediate impact of health and the economic crisis. In the coming years, gross financing needs are expected to remain modest, “warns Kom. ision,

“In addition, the country continues to enjoy” investment grade “rating by the three main rating agencies. .