Cyprus outlook points to a gradual, uneven recovery: IMF
The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with Cyprus and endorsed the staff appraisal without a meeting on May 18, 2021. The COVID-19 pandemic has interrupted Cyprus's strong economic growth over the past few years.
At end-April 2021, Cyprus was in the midst a third wave of new COVID-19 infections, leading to a renewed lockdown, and the vaccination rate stood near the European average level. Reflecting strict containment measures and the high dependence on tourism services, the economy contracted by 5.1 percent in 2020 while the current account deficit widened to 11.9 percent GDP.
Weaker demand and declining energy prices led inflation to turn negative. To cushion the impact of the crisis, the authorities rapidly introduced a targeted set of fiscal and financial policy support measures. These crisis-related fiscal measures and the adverse macroeconomic developments led the overall general government fiscal balance to swing to a deficit of 5.7 percent of GDP in 2020 and public debt to increase to 119 percent of GDP.
These support measures and balance sheet buffers that were built up before the COVID crisis have helped limit loan defaults and job losses, enabling a rapid, albeit uneven, recovery. GDP is projected to grow by 3 percent in 2021 as the vaccine rollout gathers pace and international tourism gradually recovers.
The current account deficit is expected to narrow moderately. While fiscal support measures are being maintained, with the recovery of the economy, fiscal balances are expected to improve, allowing the public debt ratio to start declining from 2021. However, the outlook remains highly uncertain with risks tilted to the downside, due to the high uncertainty of the path of the pandemic and the pace of vaccine rollout.
Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. In concluding the Article IV consultation with Cyprus, Executive Directors endorsed the staff's appraisal as follows: Cyprus has managed the COVID-19 pandemic shock relatively well.
Swift implementation of containment measures and high testing rates have kept hospitalization and mortality rates at relatively low levels. Despite the economy's dependence on tourism and the high private and public debt levels, wide-spread defaults and high unemployment have largely been avoided so far, thanks in part to timely policy support and balance sheet buffers accumulated before the COVID-19 crisis.
The near-term outlook points to a gradual but uneven recovery, with significant risks on the downside. Growth is projected to recover moderately to 3 percent in 2021 after output fell by 5.1 percent in 2020.
However, the pace of the vaccine rollout and potential new waves of infection are key uncertainties. A weakening of the underlying fiscal position leading to increased risk premia and a larger than expected drop in foreign direct investment inflows due to the termination of the Cyprus Investment Program could further dampen the recovery.
Given the large economic exposure to tourism and related sectors, risks of wider bankruptcies and loan repayment difficulties leading to permanent scarring are high if policy support is withdrawn prematurely or if the economic recovery, particularly in the tourism sector, lags.
Policy priorities depend crucially on the evolution of the health and economic crises. Near-term policies should focus on mitigating the impact of the crisis and ensuring rapid distribution of vaccines, and the withdrawal of broad support measures should thus be gradual. As recovery takes hold, policies should shift towards achieving sustainable and inclusive growth, with policies aimed at supporting the efficient reallocation of resources to minimize scarring and enhance growth potential.