Post-programme surveillance report : Cyprus, Spring 2018.
Date: 2018-09-07
Institutions: Directorate-General for Economic and Financial Affairs, European Central Bank
Subjects: Cyprus, economic development, economic forecasting, economic growth, economic policy, economic reform, financial aid, financial policy, fiscal policy, public debt, public finance, report, structural adjustment, structural policy

ISSN 2443-8014 (online)

Post-Programme
Surveillance 
Report

Cyprus, Spring 2018

INSTITUTIONAL PAPER 083 | JULY 2018

EUROPEAN ECONOMY

Economic and 
Financial Affairs

European  Economy  Institutional  Papers  are  important  reports  analysing  the  economic  situation  and 
economic  developments  prepared  by  the  European  Commission's  Directorate-General  for  Economic  and 
Financial Affairs, which serve to underpin economic policy-making by the European Commission, the Council 
of the European Union and the European Parliament.   

Views expressed in unofficial documents do not necessarily represent the views of the European Commission. 

LEGAL NOTICE 

Neither the European Commission nor any person acting on behalf of the European Commission is responsible 
for the use that might be made of the information contained in this publication. 

This paper exists in English only and can be downloaded from  
https://ec.europa.eu/info/publications/economic-and-financial-affairs-publications_en.  

Luxembourg: Publications Office of the European Union, 2018 

PDF          ISBN 978-92-79-77464-5       ISSN 2443-8014       doi:10.2765/831206      KC-BC-18-015-EN-N   

© European Union, 2018 
Reuse  is  authorised  provided  the  source  is  acknowledged.  The  reuse  policy  of  European  Commission 
documents is regulated by Decision 2011/833/EU (OJ L 330, 14.12.2011, p. 39). For any use or reproduction 
of material that is not under the EU copyright, permission must be sought directly from the copyright holders. 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
              
 
European Commission 
Directorate-General for Economic and Financial Affairs 

Post-Programme Surveillance Report  
Cyprus, Spring 2018 

EUROPEAN ECONOMY                                                                                    Institutional Paper 083 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
ACKNOWLEDGEMENTS 

The  report  was  prepared  in  the  Directorate  General  for  Economic  and  Financial  Affairs  under  the 
direction of Servaas Deroose, Deputy Director-General, Manfred Bergmann, Director, Moisés Orellana, 
Head  of  Unit  for  Cyprus,  and  Magdalena  Morgese-Borys,  Deputy  Head  of  Unit  for  Cyprus  at  the 
Directorate-General Economic and Financial Affairs. 

The main contributors were Filip Keereman, Mihai-Gheorghe Macovei, Emrah Arbak, Zivile Didziokaite, 
Angela  Droussiotou,  Nuria  Subirats-Rebull,  Milda  Valentinaite,  Pedro  Arevalo,  Stephanie  Pamies, 
Christos Koulouteris, Kristine Van Herck and Luigi De-Sanctis.  

The report was prepared in liaison with the ECB. 

Comments on the report would be gratefully received and should be sent by mail or e-mail to: 

Moisés Orellana   
European Commission 
Directorate General for Economic and Financial Affairs 
CHAR 12/006 
B-1040 Brussels, Belgium  
e-mail: moises.orellana@ec.europa.eu 

The  cut-off  date  for  the  data  and  policy  developments  included  in  this  report  is  15/05/2018.  This 
report is complemented by an Addendum.   

 
ABBREVIATIONS 

ALMPs: Active labour market policies 

EU-SILC: European Union Statistics on Income 
and Living Conditions 

AWG: Ageing Working Group 

CBC: Central Bank of Cyprus 

CCB: Cooperative Central Bank 

FDP: Field Development Plan 

FRBSL:  Fiscal  Responsibility  and  Budget 
System Law 

CET1: Common Equity Tier 1 

GDP: Gross Domestic Product 

CIT: Corporate Income Tax 

GMI: Guaranteed Minimum Income 

COLA: Cost of Living Allowance 

GVA: Gross value added 

CSE: Cyprus Stock Exchange 

HICP: Harmonised Index of Consumer Prices 

CSRs: Country specific recommendations 

IAS 39: International Accounting Standard 39 

CyTA: Cyprus Telecommunications Authority 

IDR: In-depth review 

DB: Draft Budget 

DBP: Draft Budgetary Plan 

DSA: Debt Sustainability Analysis 

DTA: Deferred Tax Assets 

EAC: Electricity Authority of Cyprus 

EC: European Commission 

ECB: European Central Bank 

EDP: Excessive Deficit Procedure 

IFRS  9: 
Standard 9 

International  Financial  Reporting 

IMF: International Monetary Fund 

LTD: loan-to-deposit (ratio) 

LNG: Liquefied Natural Gas 

MIP: Macroeconomic Imbalance Procedure 

MTO: Medium-term objective 

NEET:  Not 
training 

in  education,  employment  or 

EEZ: Exclusive Economic Zone 

NFC: Non-Financial Corporations 

EIOPA:  European  Insurance  and  Occupational 
Pensions Authority 

NHS: National Health System 

NPL: Non-performing loans 

ELA: Emergency Liquidity Assistance 

EPC: Economic Policy Committee 

OECD:  Organisation 
operation and Development 

for  Economic  Co-

ESA2010: European System of Accounts 2010 

PDMO: Public Debt Management Office 

ESF: European Social Fund 

PES: Public Employment Services 

ESI: Economic Sentiment Indicator 

PIT: Personal Income Tax 

ESM: European Stability Mechanism 

PPM: Post-programme monitoring 

 
PPPs: Public-private partnerships 

PPS: Post-programme surveillance 

PSPP: Public sector purchase programme 

RoA: Return on assets 

RoE: Return on equity 

SB: Structural balance 

SGP: Stability and Growth Pact 

SMEs: Small and medium-sized enterprises 

SOEs: State-owned enterprises 

SRB: Single Resolution Board 

SREP:  Supervisory  Review  and  Evaluation 
Process 

SSM: Single Supervisory Mechanism 

SWF: Sovereign Wealth Fund 

TSOCy:  Transmission  System  Operator  of 
Cyprus 

VAT: Value-added tax 

VET: Vocational and Educational Training 

 
EXECUTIVE SUMMARY 

This  report  presents  the  findings  of  the  fourth  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 19 to 23 March 2018, completing the assessment with the developments 
of the economy up to the cut-off date. An Addendum is included at the end of the report providing 
a  brief  overview  of  the  recent  developments  in  the  banking  sector,  namely  the  sale  of  the  second 
largest bank in the country (Cyprus Cooperative Bank, CCB). The mission was coordinated with the 
International Monetary Fund's (IMF) post-program monitoring (PPM) mission. Staff from the European 
Stability  Mechanism  (ESM)  also  participated  in  the  mission  on  aspects  related  to  the  ESM's  Early 
Warning System. The next PPS mission will take place in autumn 2018. 

Reducing the still high stock of non-performing loans (NPLs) should remain a high priority, as they 
weigh heavily on the profitability and the overall soundness of the banking sector. While NPLs are 
declining, the levels continue to be high, — close to 44% of gross loans at the end of 2017, down from 47 
% a year before. The main drivers for the decline in 2017 were cured restructured loans, write-offs and 
cash  repayments.  However,  loan  restructuring  is  becoming  more  challenging  as  the  pool  of  NPLs  for 
which negotiation is an option is dwindling. Following supervisory pressure by way of general and bank 
specific guidance, in 2017, the provisioning of NPLs has accelerated and together with shrinking interest 
margins,  has  led  to  losses  for  the  banking  sector  as  a  whole.  This  eroded  the  banks’  capital  buffers  by 
around 1 percentage point in 2017 (to Common Equity Tier 1 (CET1) ratio of 14.9 %), which was still 
above  the  EU  average  (CET1  of  around  13  %).  Deposits  were  stable  in  general  in  2017,  but  displayed 
some  variability  over  time  and  across  banks.  Outside  the  banking  sector,  no  progress  was  made  on 
integrating the insurance and pension fund supervisor. 

As  part  of  a  more  comprehensive  strategy  to  deal  with  NPLs,  additional  efforts  are  needed  to 
increase  the  implementation  and  use  of  the  new  insolvency  and  foreclosure  tools  and  more 
generally,  to  strengthen  the  payment  culture.  The  limited  use  of  insolvency  and  foreclosure 
frameworks hampers the deleveraging process and faster reduction of NPLs. The authorities are preparing 
a  package  of  targeted  legal  amendments  to  accelerate  NPL  resolution.  This  includes  increasing  the 
effectiveness  and  efficiency  of  the  insolvency  and  foreclosure  frameworks  as  well  as  the  sale  of  loans 
law,  though  the  work  has  not  been  finalised  yet.  The  authorities  aim  to  promote  these  amendments 
alongside a proposal of a government subsidy scheme addressed to vulnerable groups. It will be important 
that the design of this scheme follows international best practices and strengthens the payment culture in 
the country. It is also important that other policy measures considered by the authorities are also assessed 
in that light. The authorities have also started to identify the main deficiencies in the implementation of 
the insolvency and foreclosure frameworks as part of broader project, but the progress remains slow. The 
secondary market for NPLs is showing some positive signs, although the level of activity is quite small 
compared to the stock of NPLs. All of the main three domestic banks have recently set up arrangements 
with  external  servicers  to  facilitate  the  workout  of  NPLs,  which  may  also  speed  up  the  progress  in 
secondary market sales.  

The  macroeconomic  situation  and  outlook  remain  very  positive  although  the  risks  to  the  outlook 
have increased. After real growth of 3.9% in 2017, 3.6% is forecast for 2018 and 3.3% for 2019, fuelled 
by foreign-funded investment and solid private consumption. The current account deficit widened to 6.7% 
in  2017,  as  imports  increased  markedly,  outpacing  the  growth  of  exports.  The  widening  of  the  current 
account  deficit  is  expected  to  persist  reflecting  the  strong  economic  performance  and  the  high  import 
content of investment and consumption. Job creation gathered momentum. As a result, unemployment fell 
to below 10 % and is expected to continue falling, while labour market slack kept a lid on wage pressures. 
Inflation  remains  low  and  is  set  to  stay  subdued.  However,  recent  developments  in  the  financial  sector 
have widened downside risks to the outlook.  

Fiscal  performance  has  also  been  remarkably  strong,  although  the  latest  developments  have 
increased downside risks to the outlook, warranting a continuation of prudent fiscal policy. Fiscal 
performance  once  again  outperformed  projections  in  2017,  mainly  driven  by  buoyant  tax  revenues. 

7 

Expenditure increased at a slower pace than revenues. The general government is expected to continue to 
post  sizeable  budgetary  surpluses  in  2018  and  2019.  The  forecast  is  subject  to  uncertainties  mainly  in 
relation to the financial sector developments, in particular  on the budgetary impact of the government's 
transaction  related  to  the  CCB.  Additional  risks  to  the  fiscal  outlook  relate  to  the  fiscal  impact  of 
healthcare reform and the public payroll growth trend once the collective agreement expires. After falling 
significantly in 2017 to 97.5% of GDP, public debt is expected to rise to 105.7 % of GDP in 2018, mainly 
due to the authorities’ intervention in the banking sector, namely the issuance of government bonds, the 
proceeds  of  which  were  deposited  with  the  CCB.  However,  given  the  one-off  nature  of  the  CCB 
transaction and the assumed continuation of high primary surpluses as well as favourable debt dynamics 
mostly due to strong GDP growth, public debt is projected to steadily decline after that. Nevertheless, a 
continuous prudent budgetary policy remains essential, especially in view of increased downside risks; it 
is  crucial  to  ensure  that  temporary  revenue  windfalls  do  not  give  rise  to  permanent  increases  in 
expenditure and to safeguard fiscal sustainability in line with the requirements of the Stability and Growth 
Pact. 

Renewed  structural  reform  commitment  by  all  national  stakeholders  is  key  to  maintain  growth 
over  the  medium  term  and  safeguard  fiscal  sustainability.  A  swift  completion  of  the  justice  system 
reform is needed given its significant impact on the functioning of the economy and its strong link to the 
reduction of NPLs, including the establishment of a commercial court, the update of the civil procedure 
rules and the adoption of legislation on improving claim enforcement.  Moreover, the completion of the 
reform of the public administration would enhance the efficiency of the public sector and support fiscal 
sustainability. The mission also encouraged the authorities and other stakeholders to step up progress in 
other  essential  areas,  including  the  implementation  of  the  national  healthcare  system  in  a  fiscally-
sustainable way, the ongoing reform of the electricity market, and the establishment of an efficient title 
deeds  issuance  and  transfer  system.  Moreover,  the  mission  underlined  the  importance  of  continuing 
efforts  to  enhance  the  economy`s  growth  potential,  through  improving  the  business  environment  and 
attracting  further  growth-enhancing  investment,  as  well  as  prioritising  key  measures  included  in  the 
action plan for growth. 

Risks  to  Cyprus’  capacity  to  service  its  ESM  debt  have  increased  compared  to  the  previous  PPS 
report.  After  a  significant  improvement  in  2017,  borrowing  conditions  for  Cyprus  have  deteriorated 
somewhat  in  recent  months,  driven  by  factors  related  to  vulnerabilities  in  its  banking  sector  and 
uncertainties  related  to  the  ongoing  sale  of  the  CCB,  and  its  potential  repercussions  on  the  financing 
conditions for Cyprus. However, current medium-term fiscal and debt servicing financing needs under the 
baseline  scenario  are  moderate,  in  particular  due  to  Cyprus’  past  active  debt  management  operations, 
which  reduced  Cyprus’  annual  gross  financing  needs  in  coming  years  (2018-2021).  Continued  fiscal 
discipline, forceful reduction of NPLs and progress on growth-enhancing structural reforms will therefore 
play a vital part in consolidating and further improving investor confidence. 

8 

1. 

Introduction 

2.  Macroeconomic outlook 

3. 

Financial sector issues 

3.1.  Banking sector performance 
3.2.  Broader financial sector developments 

4. 

Budgetary outlook and fiscal policy stance 

4.1. 
4.2. 

Fiscal performance 

Fiscal outlook 

6. 

Structural issues 

6.1. 
6.2. 

Fiscal structural reforms 

Structural reforms 

7. 

Sovereign financing and ability to repay 

A1.  European Commission Debt Sustainability Analysis 

A2.  European Commission macroeconomic and fiscal projections (2018 Spring 

Forecast) 

Addendum 

LIST OF TABLES 

2.1.  Main features of macroeconomic forecast - European Commission Spring 2018 forecast 

3.1. 

Soundness indicators for the banking sector in Cyprus 

A1.1.  Sustainability indicators (in % of GDP) 

A2.1.  Selected economic indicators 

A2.2.  Use and supply of goods and services (volume) 

A2.3.  Use and supply of goods and services (value) 

A2.4.  Implicit deflators 

A2.5.  Labour market and costs 

A2.6.  External balance 

A2.7.  Fiscal accounts 

11 

13 

17 

17 
22 

25 

25 
25 

29 

29 
31 

35 

37 

41 

46 

16 

18 

39 

41 

42 

42 

42 

43 

43 

44 

9 

 
 
 
 
A2.8.  Debt developments 

LIST OF GRAPHS 

2.1.  Real GDP growth and contributions 

2.2.  Current account developments, SPEs and non-SPEs 

2.3.  Unemployment rate 

2.4.  HICP inflation and contributions 

2.5. 

Interest rates on mortgages 

3.1.  NPL ratio and its breakdown 

3.2. 

Loan restructuring developments 

3.3.  Quarterly NPL flows 

3.4.  Default rate on loans restructured within the last 18 months 

3.5.  Borrowing from the Eurosystem 

3.6.  Deposits developments 

4.1. 

Tax revenue contributions 

7.1.  Medium and long-term debt amortisation 

7.2.  Cyprus sovereign bond yield and spread vs. German sovereign bond 

7.3. 

Sovereign long-term ratings, Cyprus 

A1.1.  Debt projections 

45 

13 

14 

14 

15 

15 

17 

18 

19 

19 

21 

21 

26 

35 

36 

36 

38 

10 

 
 
 
 
 
 
 
1. 

INTRODUCTION 

Cyprus  implemented  an  economic  adjustment 
programme  from  April  2013  to  March  2016. 
The  three-year  programme  was  approved  by  the 
ECOFIN  Council  and  the  IMF  Board  in  March 
2013.  The  programme  provided  financing  by  the 
European Stability Mechanism (ESM) and the IMF 
of  about  EUR  7.8bn.  Its  objective  was  to  put 
Cyprus' public finances back on a sustainable path, 
ensure  financial  stability,  implement  structural 
reforms  to  restore  competitiveness,  and  regain 
international  capital  market  access  at  sustainable 
rates. 

the 
(PPS)  mission 

Staff  from  the  European  Commission  (EC),  in 
liaison  with  staff  from  the  European  Central 
Bank 
fourth  post-
(ECB),  undertook 
to 
programme  surveillance 
Cyprus  between  19  and  23  March  2018.  The 
mission was coordinated with IMF's post program 
monitoring (PPM) mission. The European Stability 
Mechanism (ESM) participated in the meetings on 
aspects  related  to  its  own  Early  Warning  System. 
PPS  aims  at  a  broad  monitoring  of  economic, 
fiscal  and  financial  conditions  with  a  view  to 
assessing  the  repayment  capacity  of  a  country 
having received financial assistance(1). While there 
is no policy conditionality under PPS, the Council 
can  issue  recommendations  for  corrective  actions, 
if necessary and where appropriate.    

(1)  PPS  is  foreseen  by  Article  14  of  the  two-pack  Regulation 
(EU) N°472/2013. It started after the expiry of the EU/IMF 
financial assistance programme and lasts at least until 75% 
of the financial assistance has been repaid. 

11 

 
 
                                                           
2.  MACROECONOMIC OUTLOOK 

The cyclical  upswing  made  further headway in 
2017,  with  real  GDP  growing  by  a  remarkable 
3.9 %. This  was the  highest  growth rate  since the 
2013  crisis  and  makes  Cyprus  one  of  the  fastest 
growing economies in the euro area, for the second 
year  in  a  row.  Growth  was  driven  by  investment, 
consumption  and  exports  of  services.  The  labour 
market  continued  to  recover  at  a  fast  pace. 
Tourism, professional services and construction on 
the  supply  side  were  the  main  sectors  that  helped 
to accelerate growth.  

Growth  is  expected  to  remain  strong  in  2018 
and  2019,  albeit  easing  somewhat.  Early 
indicators of economic activity in Cyprus continue 
to point to a strong start to the year. For the year as 
a  whole  and  in  2019,  growth  is  expected  to  be 
driven  by  investment  and  private  consumption, 
with  public  consumption  also  making  a  positive 
contribution, although to a much lesser degree. Net 
exports are expected to be negative in the coming 
years, yet are not expected to be a substantial drag 
on growth.  

Graph 2.1: 

Real GDP growth and contributions 

Source: European Commission 

In  2017, 

Investment  has  become  the  main  driver  for 
investment  surged  again, 
growth. 
recording  a  28 %  annual  increase.  In  volume 
terms,  it  reached  levels  close  to  those  seen  in  the 
boom years (2005-2011), while investment to GDP 
ratio  has  more  than  fully  caught  up  with  the  EA 
average of 20 %. The rapid rise in investment was 
heavily  influenced  by  the  equipment  category, 
ship  acquisitions  or 
which 

is  driven  by 

registrations.  The 
tourism  boom  has  greatly 
increased  the  demand  for  accommodation  and 
other  tourism  infrastructure,  to  which  supply 
continues to respond. Recovering local demand for 
housing and particularly the citizenship scheme (2), 
which encourages foreigners to acquire property in 
Cyprus,  has  stimulated 
the  construction  of 
dwellings.  Some  investment  is  taking  place  in 
other  sectors,  including  education  and  energy, 
although  the  bulk  is  related  to  construction. 
Investment 
innovation  and  other 
productivity-enhancing  fields  holds  a  relatively 
small 
composition  of 
investment  hence  raises  questions  on  the  longer 
term impact on growth. At the same time, the risk 
of  a  new  boom  and  bust  cycle  in  construction 
cannot  be  fully  excluded,  warranting  a  close 
monitoring of developments in the sector.  

share.  The 

in  R&D, 

current 

The  investment  outlook  is  positive.  Several 
foreign-funded,  large-scale  projects,  focused  on 
tourism  infrastructure  (marinas,  hotels  and  other 
accommodation),  are  already  being  built  or  are 
about  to  be  start.  The  largest  among  these  is  the 
biggest  casino  in  Europe,  whose  construction  is 
envisaged to start later in 2018 and continue for 3 
years. The gradual revival in  new bank  lending is 
expected  to  boost  investment  further.  Business 
confidence  was  on  the  rise  in  the  first  quarter  of 
2018. Brexit might be an opportunity for Cyprus to 
attract  companies  from 
the  UK.  This  could 
possibly  create  an  additional  investment  stimulus 
in the short to medium term. 

by 

2.7 %.  Rapidly 

Consumption has accelerated and is expected to 
remain strong. In 2017, private consumption rose 
by  4.2 %  in  real  terms  and  public  consumption 
increased 
expanding 
employment  and  low  inflation  boosted  the  real 
disposable income of Cypriot households, creating 
positive  expectations  and  boosting  consumption. 
Consumer  sentiment  rose  further  in  the  first 
quarter  of  2018, 
its 
subcategories:  expectations  on 
financial 
situation,  employment,  savings  and  the  general 
economic situation. Consumption is expected to be 
solid in 2018 and beyond, although improved loan 
repayment  discipline  following  a  change  to  the 

improving  across  all 

the 

(2)  It requires to acquire a residence with a minimum value of 
EUR 0.5 million or to invest a minimum EUR 2 billion in 
other assets.  

13 

-12-8-40481210111213141516171819Net exportsInvestmentPriv. consumptionGov. consumptionInventoriesReal GDP (y-o-y%)forecastpps.  
 
                                                           
European Commission 

Post-Programme Surveillance Report 

insolvency and foreclosure frameworks could limit 
it somewhat. 

related 

The  current  account  deficit  is  widening.  For 
2017,  it  deteriorated  to  6.7 %  of  GDP,  as  imports 
increased  markedly,  outpacing  the  healthy  growth 
of  exports.  Net  trade  in  services  continued  to 
generate  ever  larger  surpluses,  driven  mainly  by 
tourism  but  also 
to 
the 
services 
telecommunications 
financial 
auxiliary 
and 
services. Meanwhile, the trade deficit in goods has 
been 
further 
rising  markedly,  with  exports 
contracting  and  imports  increasing  substantially. 
For  the  latter,  the  acquisition  and  registration  of 
ships  via  Special  Purpose  Entities  (SPEs)  has 
played  a  prominent  role.  In  2017,  the  current 
in  Cyprus,  excluding  SPE 
account  deficit 
activities, would have been much smaller, at 1.5 % 
of GDP. The current account is expected to worsen 
again  in  2018  and  2019  as  the  buoyant  economy 
with  strong  consumption  and  investment  is  likely 
to  be  accompanied  by  strong  import  growth  and 
more ships being registered. This is projected to be 
partially  offset  by  increasing  exports  of  services. 
On the export of tourism services, the first quarter 
of  2018  (low  season)  was  promising,  with  tourist 
arrivals up by nearly 20 %. 

substantial  increase  in  employment  in  2017,  with 
employment in construction accelerating in the last 
quarter.  The  reported  intentions  of  employers  in 
the  main  sectors  (construction,  manufacturing, 
retail sales and services) point to a continuation of 
this trend in 2018. Youth unemployment, which is 
still  very  high,  is  expected  to  fall  thanks  to 
activation  measures,  the  general  improvement  in 
the labour market and new openings offered by the 
temporary casino.  

Graph 2.3: 

Unemployment rate 

Graph 2.2:  Current account developments, SPEs and  

non-SPEs 

Source: Eurostat 

Wage pressures remain weak. Due to slack in the 
labour  market,  wage  pressures  continue  to  be 
weak.  Wage  rises  overall  were  generally  low, 
though  much  more  pronounced  in  the  public 
sector, where the wage indexation mechanism has 
kicked in and promotions that took place in 2012-
2016 have started to be remunerated. 

Inflation turned out lower than expected and is 
projected to remain low. Following a very  weak 
2017,  inflation  in  the  first  quarter  of  2018  dipped 
into  negative  territory.  This  was  a  rather  broad 
pattern.  Prices  of  non-energy  goods  fell  as  new 
import markets opened and competition increased, 
which  was  more  pronounced  during  the  sales 
season.  Unprocessed  food  prices  also  declined 
mainly due to a significant fall in vegetable prices, 
while processed food became cheaper on the back 
of  heightened  competition  among  supermarkets. 
Energy  prices  fell  slightly.  The  only  category  to 
buck  this  trend  was  services,  where  prices  picked 
up  from  February  onwards  as  the  tourism  season 

Based on running total of 4 quarters. 
Source: Central Bank of Cyprus 

The  labour  market  is  performing  strongly. 
Rapid  employment  growth  in  most  sectors  of  the 
economy has reduced unemployment in early 2018 
to below 10 %. All sectors except agriculture saw a 

14 

-10-8-6-4-20214Q415Q115Q215Q315Q416Q116Q216Q316Q417Q117Q217Q317Q4% GDPCA, excluding SPEsCA, SPEsCurrent account balance05101520253035404507Q208Q108Q409Q310Q211Q111Q412Q313Q214Q114Q415Q316Q217Q117Q4%TotalYouthLong-term 
 
 
2. Macroeconomic outlook 

resumed.  While  the  fall  in  prices  in  the  first  few 
months of 2018 is regarded mostly as a temporary 
phenomenon, inflation is expected to be below 1 % 
in  2018  and  only  slightly  higher  afterwards  amid 
remaining slack in the labour market.  

Graph 2.4:  HICP inflation and contributions 

Graph 2.5: 

Interest rates on mortgages 

Source: Central Bank of Cyprus, European Central Bank 

Source: Eurostat 

The  residential  real  estate  market  is  gradually 
recovering. Residential property sales were up by 
double-digit  percentages  in  2017,  boosted  by  a 
number  of  government  incentives.  Residential 
property prices have risen moderately, up 2.4 % in 
2017  (Eurostat).  Bank  lending  for  buying  real 
estate has also improved slightly, which could help 
local  demand.  Some  mortgages, 
stimulate 
reportedly, are granted with a loan-to-value ratio of 
fallen 
around  70 %.  Mortgage 
considerably 
lows; 
nevertheless, while the nominal interest rate keeps 
falling,  the  annual  percentage  interest  rate,  which 
better  reflects  the  full  cost  of  credit  (i.e.  it 
comprises  an 
interest  rate  component  and  a 
component  of  other  related  charges,  such  as  the 
cost  of  inquiries,  administration,  preparation  of 
documents, guarantees, etc.), has stabilised. 

rates  have 
at  historical 

and 

are 

demand 

although 

The  real  estate  supply  side  is  responding  to 
substantial 
increasing 
inefficiencies  remain.  Construction  activity  has 
considerably picked up in 2017 and the number of 
building  permits  issued  continued  to  increase. 
However,  real  estate  developers  report  extremely 
difficult  and  lengthy  procedures  (7  years  on 
average)  to  obtain  permits  for  a  large  project.  A 
very lengthy timespan between the initiation of the 
projects  and  their  execution  prevents  the  supply 
side  from  responding  swiftly  and  creates  inertia. 
The  creation  of  a  "single  window",  the  electronic 
submission  of  documents  and  the  setting  of  time 
limits for completing procedures necessary to issue 
a  permit  are  urgently  needed.  The  Ministry  of 
Interior  is  taking  some  steps  to  improve  the 
situation,  including  preparation  of  legislative  acts 
(see  Section  5.2  immovable  property  rights).  The 
attitude  of  banks  towards  financing  real  estate 
construction  has  become  slightly  more  positive, 
with  some  projects  starting  to  obtain  credit; 
however,  this  remains  very  limited  and  the  main 
sources  of  financing  are  still  the  pre-sales  and 
profits. 

15 

-2.5-2-1.5-1-0.500.511.5215Q115Q215Q315Q416Q116Q216Q316Q417Q117Q217Q317Q418Q1ServicesProcessed foodUnprocessed foodEnergyNon-energy industrial goodsHICP01234567804-0811-0806-0901-1008-1003-1110-1105-1212-1207-1302-1409-1404-1511-1506-1601-1708-1703-18%CY - floating rate and up to 1 year initial rate fixationCY - annual percentage rate of chargeEA - annualised agreed rate up to 1 year original maturity 
 
 
 
 
 
 
European Commission 

Post-Programme Surveillance Report 

The  balance  of  risk  to  the  economic  outlook  of 
Cyprus  has  widened  compared  to  the  previous 
PPS  report.  The  financial  sector,  which 
is 
unprofitable  and  burdened  by  non-performing 
loans  (NPLs),  remains  the  major  downside  risk. 
Tourism faces both downside and upside risks: the 
reopening  of  neighbouring  markets,  notably 
Turkey, increases competition, especially for some 
segments  of  tourists,  while  marketing  efforts, 
increased  air 
transport  and  accommodation 
capacity  brighten  the  sector’s  prospects.  At  the 
faster 
same 
currently 
implementation  of  projects 
envisaged, 
in  gas 
exploration,  are  the  upside  risks  to  the  outlook  in 
the short to medium term. 

than 
advancements 

investment  or 

including 

stronger 

time, 

Table 2.1: 

Main features of macroeconomic forecast - European Commission Spring 2018 forecast 

(1) Eurostat definition, % of labour force (2) % of GDP (3) National accounts term, % of GDP 
Source: European Commission 

16 

201420152016201720182019Curr. prices (EUR m)% of GDPGDP18.2100-1.42.03.43.93.63.3Private consumption12.669.00.72.63.34.23.42.9Public consumption2.715.0-7.2-2.6-0.42.71.53.3Gross fixed capital formation3.217.4-17.513.635.027.813.49.8Exports (goods and services)11.864.74.25.84.03.42.31.9Imports (goods and services)11.965.54.67.46.810.14.83.7GNI (GDP deflator)17.998.4-0.46.61.13.53.63.4Contribution to growth:Domestic demand-3.33.06.88.25.44.7Inventories2.1-0.1-1.70.10.00.0Net exports-0.1-0.9-1.7-4.4-1.8-1.3Employment-1.81.53.33.42.82.8Unemployment (1)16.115.013.011.19.07.1Compensation per employee-3.6-1.2-0.70.71.42.0Unit labour costs, whole economy-4.0-1.7-0.80.20.61.4Real unit labour costs-2.4-0.5-0.1-1.3-0.9-0.3GDP deflator-1.6-1.2-0.71.51.51.7Harmonised index of consumer prices-0.3-1.5-1.20.70.71.2Terms of trade0.5-0.50.11.50.70.5Trade balance (goods and services) (2)0.40.1-0.1-0.8-1.0-1.2Current account balance (3)-4.4-1.4-4.9-8.1-9.0-9.72016Annual percentage change 
 
 
 
 
 
 
3. 

FINANCIAL SECTOR ISSUES 

end-2017,  NPLs  in  local  operations  of  banks 
declined to around 44 % of all loans from close to 
47 % a year before (see Table 3.1) (5). The decline 
in  the  stock  of  NPLs  in  2017  has  been  above  the 
average  trend  since  the  end  of  2015  (see  Graph 
3.1).  However,  as  total  loans  continue  to  decline, 
progress  on  reducing  the  NPL  ratio  is  being 
somewhat  moderated  due  to  this  denominator 
effect. Overall, the large stock of NPLs underlines 
the 
importance  of  further  reforms  aimed  at 
improving the payment discipline.  

Graph 3.1:  NPL ratio and its breakdown 

3.1. 

BANKING SECTOR PERFORMANCE 

Overall situation 

solutions 

The  banking  sector  remains  fragile  due  to  its 
large, albeit  declining, stock of non-performing 
(NPLs)  and  negative  profitability. 
loans 
Progress  has  been  made  on  reducing  NPLs,  in 
terms of both volume and as a share of total loans, 
but they remain a significant challenge to financial 
stability. This has prompted the authorities to seek 
comprehensive 
to  accelerate  bank 
restructuring  and  balance-sheet  clean-up  (see 
Section 3.2).  Banks  continued  to  post  losses  in 
2017  due  to  low  interest  rates,  on-going  balance-
sheet  clean-up  and  a  further  building-up  of 
provisions,  partly 
to  supervisory 
pressure. Deposits were almost flat in the banking 
sector  in  2017,  although  with  divergent  trends 
among  banks.  Overall,  banks  maintain 
large 
liquidity buffers, which also weigh heavily on their 
profitability.  

in  response 

the 

In  the  spring  of  2018,  there  were  significant 
developments 
Cyprus 
concerning 
Cooperative  Bank  (CCB),  the  second  largest 
bank in the country. The bank is publicly owned 
and  has  an  NPL  ratio  of  close  to  60 %.  On  19 
March  the  government  initiated  the  sale  of  the 
bank  (3).  On  3  April,  Cyprus  issued  government 
bonds  with  a  total  value  of  EUR  2.35  billion  that 
were bought by the CCB. The funds raised through 
this transaction and a small cash addition from the 
government’s cash buffer (EUR 0.15 billion) were 
deposited  on  the  same  day  at  the  CCB  totalling 
EUR 2.5 billion. The situation was still evolving at 
the time of the mission and writing this report. 

Asset quality  

The high NPL ratio despite the strong economic 
recovery  suggests  structural  problems  in  the 
financial  sector  which  so  far  had  not  been 
adequately tackled. NPLs stock has declined, but 
the NPL ratio (4) continues to remain very high. At 

(3)  http://www.ccb.coop/userfiles/93df4f45-33a6-4e45-9c09-

c01795656b98/news-19032018-en.pdf  

(4)  The  NPL  ratios  referred  to  in  this  report  are  based  on the 
Central  Bank  of  Cyprus’  data  and  definition.  Thus,  they 
differ  from  the  ratios  referred  to  in  the  2018  Cyprus 

Source: Central Bank of Cyprus 

Loan restructuring has slowed. The total stock of 
restructured  loans  (including  both  performing  and 
non-performing)  has  declined,  both  in  absolute 
terms  (to  EUR 11.8 billion  in  December  2017, 
from  EUR 13.4 billion  a  year  before)  and  as  a 
share of total loans, falling from 27.7 % to 26.6 %. 
The share of restructured loans to NPLs, including 
debt-to-asset swaps, increased slightly to 43.5 % in 

Country  Report,  which  is  based  on  the  ECB  data.  In 
particular,  exposures  of  banks  to  central  banks  and  credit 
institutions  and  the  overseas  operations  (branches  and 
subsidiaries  situated  abroad)  of  the  Cyprus  based  banking 
groups  are  not  taken  into  account  in  the  CBC  aggregate 
NPL ratios. 

(5)  Data for January 2018 show that the NPL stock and ratios 
have increased on a month-on-month basis. NPLs in local 
operations of banks increased to around 46 % of all loans. 
This  development  is  thought  to  be  mostly  driven  by  the 
introduction of the IFRS 9 standards on 1 January 2018. A 
more detailed assessment will be provided in the next PPS 
report  when  further  observations  and  bank-specific  data 
become available. 

17 

15%20%25%30%35%40%45%50%-4%-2%0%2%4%6%8%121314151617Denominator impact: deleveraging (+) or loan gr. (-)Numerator impact: change in NPL stock (+/-)NPL ratio, all loans (rhs) 
                                                           
 
 
                                                                                   
European Commission 

Post-Programme Surveillance Report 

Table 3.1: 

Soundness indicators for the banking sector in Cyprus 

The figures cover the Cyprus operations of all domestic and foreign credit institutions operating in Cyprus on a consolidated 
basis.  
*The local NPL definition was used until the end of 2014. From 2015, the EU NPL definition was used, as defined in Commission 
Implementing Regulation (EU) 2015/227, later amended by Commission Implementing Regulation (EU) 2015/1278. Figures 
exclude exposures to central banks and credit institutions. 
Source: Central Bank of Cyprus 

September  2017,  up  from  42.6 %  at  the  end  of 
2016  due  to  a  larger  reduction  in  NPLs  than 
restructured loans (see Graph 3.2).  

Graph 3.2: 

Loan restructuring developments 

the 

‘terminated 

The  slowdown  in  loan  restructuring  is  largely 
due  to  the  increasing  share  of  loans  for  which 
no  negotiation  option  exists.  According  to  the 
Central  Bank  of  Cyprus  (CBC)  aggregate  data, 
more  than  half  of  the  fixed-rate  NPL  stock  is 
classified  under 
accounts’ 
category,  where legal recourse is  seen as the  only 
option. (6) One potential explanatory factor for the 
unwillingness of these borrowers to renegotiate the 
terms  of  their  loans  is  the  dismal  foreclosure 
activity.  This  leads  to  a  very  large  stock  of  NPLs 
with no or very little prospect of workout. There is 
also  considerable  political  and  social  pressure  on 
banks  not  to  make  use  of  foreclosures,  especially 
for primary residences, to avoid households losing 
their homes. 

(6)  According to the Cypriot loan classification rules, a loan is 
moved  to  the  terminated  category  when  no  negotiation 
possibilities exist. 

18 

The figures were adjusted to take into account debt-to-asset 
swaps, which are recognised as restructured NPLs. 
Source: Central Bank of Cyprus 

The  restructuring  solutions  are  still  a  concern, 
but  are 
less  worrisome.  The  curing  of 
restructured  loans  and  its  impact  of  reducing 
NPLs, after declining in early 2017, has stabilised 
in  the  last  quarter  (see  Graph 3.3).  The  aggregate 
default  rate  on  loans  that  were  last  restructured 
over  the  last  18  months  rose  to  11.8 %  at  the  end 
of  2017,  up  from  5.8 %  a  year  before  (see  Graph 
3.4). However, this was mainly due to a reduction 
of  NPLs  (the  denominator  effect)  rather  than  an 
increasing stock of defaulted loans.  

Restruct. loans to households (lhs)Restruct. loans to NFCs (lhs)Other (lhs)051015202530354045500246810121416182006-1309-1312-1303-1406-1409-1412-1403-1506-1509-1512-1503-1606-1609-1612-1603-1706-1709-1712-17Restructured loans (% of all loans, rhs)Restructured NPLs (% of NPLs, rhs)EUR bn%DecDecDecDecMarJuneSepDecMarJuneSepDecNPLs*, all loans (EUR billions)15.626.027.326.725.724.724.123.823.222.421.520.6NPLs*, all loans (% of total)22.641.547.845.848.449.448.647.246.045.044.243.7NPLs*, loans to NFCs (% of total)....58.056.055.158.356.956.454.452.551.050.2  Restructered non-performing (% of total)..12.523.325.926.327.726.925.723.722.922.5..  Restructured performing (% of total)..12.25.37.57.89.19.19.49.910.69.9n.a.NPLs*, loans to households (% of total) ..43.352.756.256.456.356.655.955.755.754.653.9  Restructered non-performing (% of total)..6.713.918.019.019.720.320.020.020.119.9n.a.  Restructered performing (% of total)..10.48.96.76.26.77.27.78.18.18.2n.a.Coverage rate (Impairments / NPLs)*47.937.732.937.837.137.938.641.742.746.746.946.6Cost-to-income ratio55.653.440.444.154.252.452.352.551.348.448.753.6Net interest margin2.32.42.92.82.82.72.62.62.42.42.42.3Common Equity Tier 1 ratio ....14.215.615.315.716.015.915.814.915.014.9Return on assets-3.4-4.3-0.6-0.60.60.60.5-0.3-0.1-1.9-1.3-1.1201720122013201420152016 
                                                           
 
 
 
 
 
3. Financial sector issues 

Graph 3.3:  Quarterly NPL flows 

The figures are only for loans with fixed maturities, excluding 
revolving loan facilities such as overdrafts.  
* Cured loans cover restructured NPLs that transition into 
performing status.  
** Other includes NPL inflows on credit cards and overdrafts, 
interest accruals, unwinding of interest, and valuation 
changes due to currency fluctuations as well as error items. 
Source: Central Bank of Cyprus 

Graph 3.4:  Default rate on loans restructured within the 

last 18 months 

The data only covers fixed-term loans and up to 11 local 
credit institutions, representing over 90 % of domestic 
lending. For loans subject to multiple restructuring, latest 
restructuring date is taken into account. A loan remains 
classified as restructured, even if it fulfils the usual exit criteria 
(i.e. a probationary period of 24 months or more). The 
default rate therefore increases if a restructured loan is (i) 
repaid, de-recognised (i.e. written-off), or re-classified into 
“terminated” status (denominator effect); or (ii) goes into 
default by becoming more than 90 days past-due, 
(numerator effect).  
Source: Central Bank of Cyprus 

Single 

Owing to supervisory pressure, notably through 
the 
Supervisory  Mechanism’s 
Supervisory  Review  and  Evaluation  Processes 
(SREP),  the  provisioning  coverage  of  NPLs 
increased  to  46.6 %  at  the  end  of  2017  (up  from 
41.7 %  a  year  before).  The  coverage  level  of 
Cypriot banks is now in line with the EU average 
of  44 %  and  should  be  closer  to  reflecting  the 
market value of real estate collateral. In 2017, the 
SSM  and  the  national  supervisor,  the  CBC, 
required additional provisioning buffers to be built, 
partly to prepare for the gradual introduction of the 
International  Financial  Reporting  Standard  9 
(IFRS  9),  which  addresses  the  impairment  of 
financial  instruments.  Banks  with  sizeable  legacy 
issues  and 
loan 
those 
that  rely  heavily  on 
taken  on  board  additional 
restructuring  have 
provisioning charges, some of  which are reflected 
in 
results.  The  strong 
underlying  economic  conditions  and  current 
capital  positions  have  served  as  offsetting  factors. 
Nevertheless,  further  provisioning  is  expected  as 
banks continue to clean up their balance sheets and 
the introduction of the IFRS-9. 

their  2017 

financial 

Banking sector profitability 

Bank profitability has been mostly negative for 
6 years in a row. In 2017, it fell significantly due 
to a larger provisioning effort and a further decline 
in net interest income. For the locally active credit 
institutions,  a  net  loss  before  tax  of  around 
in  2017.  Net 
EUR 650 million  was  recorded 
interest income declined by around 13 % year-on-
year  (y-o-y)  to  EUR 1.2 billion.  By  contrast,  total 
operating  expenses  declined  only  marginally,  by 
3 %  to  EUR  960 million.  As  a  result,  total 
operating profit declined by around 17 % y-o-y. In 
addition,  a  significant  increase  in  provisions  of 
around  70 %  y-o-y  to  EUR 1.3 billion  tipped  the 
financial  results  into  deeply  negative  territory  in 
2017.  Overall,  the  banks’  capacity  to  generate 
profits  is  challenged  by  the  dwindling  interest 
margins  and  workout  of  the  extremely  high 
volume of NPLs.   

Bank profitability remains under pressure amid 
the  need  for  further  provisioning.  Increased 
provisioning  reduces  profits  directly,  but  also 
indirectly by reducing the non-provisioned part of 
NPLs  on  which  banks  accrue  interest  income.  As 
banks  register  accrued  interest  income  on  non-
provisioned NPLs, under-provisioning allows them 

19 

-2,500-2,000-1,500-1,000-50005001,0001,50016Q116Q216Q316Q417Q117Q217Q317Q4EUR mOther**Cures* due to restr. (gross)Cash repaymentsDebt-to-asset swapsWrite-offsNew NPLs (incl. restruct.)0%2%4%6%8%10%12%14%-4%-3%-2%-1%0%1%2%3%4%16Q116Q216Q316Q417Q117Q217Q317Q4Default rate (%)Default rate (q-o-q % change)Numerator effect: net default flowsDenominator effect: net loan flowsAggregate rate (rhs) 
 
 
 
European Commission 

Post-Programme Surveillance Report 

to  register  profits  without  corresponding  cash 
inflow and to bolster their net interest margin. As a 
result,  a  sharp  increase  in  provisions  in  2017 
interest 
negatively 
income. By continuing to work out a large amount 
of  NPLs,  banks  remain  subject  to  considerable 
pressure on their financial results. 

the  banks’  net 

impacted 

or 

employee 

in  Cyprus 

improving  profitability 

One  way  of 
is  to 
increase  the  efficiency  of  banks  by  reducing 
their  operating  expenses.  While  all  three  of  the 
largest banks made good progress in reducing their 
number of branches and employees since the crisis, 
several indicators point to the fact that they are still 
oversised. The amount of customers and assets per 
branch 
remains 
significantly lower than the euro area average. This 
is  also  impacted  by  the  larger  deleveraging  that 
took  place  in  Cyprus.  In  addition,  due  to  the 
decrease in income, the cost-to-income ratio fell by 
1 percentage point to 53.6 % in 2017. As a result, 
there  is  still  room  to  rationalise  the  capacity  and 
operations  of  Cypriot  banks  by  increasing  the  use 
of  ICT  technologies  and  online  products,  down-
sizing  units  that  operate  below  cost  recovery,  and 
diversifying  the  range  of  services  they  offer  in 
order to attract new business.   

Capitalisation, liquidity and lending 

impaired 

the  high  ratio  of 

The  Common  Equity  Tier 1  (CET1)  capital 
ratio  of  all  banks  declined  to  14.9 % 
in 
December  2017,  down  from  15.9 %  a  year 
before  due  to  recurrent  losses.  The  overall 
solvency ratio decreased by 0.5 percentage point to 
16.3 %  over  the  same  period.  While  the  CET1 
ratio is still higher than the EU average of around 
13 %, this reflects the large uncertainty associated 
with 
loans.  The 
acceleration of NPL  workout  has started to take a 
toll  on  the  banks’  capital  buffers.  The  banks  that 
are more advanced in terms of balance-sheet clean-
up have seen their CET 1 ratio fall well below the 
sector’s average. If banks continue to increase their 
provisioning levels and register losses, maintaining 
prove 
capitalisation 
current 
to 
likely 
challenging.  Some  of 
largest  banks  are 
therefore  planning  to  issue  additional  Tier 1  or 
Tier 2  capital  in  order  to  strengthen  their  capital 
for  a  successful 
buffers  as  a  prerequisite 
implementation of their NPL reduction targets. 

is 
the 

20 

The  CBC  designated  six  credit  institutions  as 
Other  Systemically  Important  Institutions  (O-
SIIs) (7). The imposed capital buffers to be phased 
in over 2019-2022 are: 0.5 % for Alpha Bank and 
Eurobank,  1 %  for  Hellenic  Bank  and  the  CCB, 
1.5 %  for  RCB  and  2 %  for  Bank  of  Cyprus.  The 
countercyclical  capital  buffer  requirement  is  still 
0 %(8).  

for  own 

Due  to  the  requirement  side  on  the  minimum 
requirement 
funds  and  eligible 
liabilities  (MREL)  banks  will  need  to  raise 
additional  funds  in  the  coming  years.  Cypriot 
banks  lack  of  non-deposit  funding,  therefore  they 
will need to raise additional eligible funds, such as 
non-preferred  senior  bonds,  to  meet  the  MREL 
requirements.  This  may  be  more  difficult  for 
Cypriot  banks  due  to  profitability  challenges  and 
weak  asset  quality  positions.  However,  they  will 
have a long transition period to adjust.  

Banks  reliance  on  central  bank 
funding 
stabilised and deposits declined at the beginning 
of  2018.  Banks  reliance  on  central  bank  funding 
stood at around EUR 0.9 billion in early 2018 (see 
Graph 3.5).  Deposits  from  residents  continued  to 
increase  in  2017,  especially  from  corporates, 
whereas deposits from non-residents declined (see 
Graph  3.6),  leading  to  overall  almost  flat  deposit 
base 
in  2017.  Deposits,  however,  declined 
significantly  in  the  first  quarter  of  2018.  In 
particular,  the  CCB  recorded  sizeable  deposit 
outflows linked to doubts about the viability of its 
restructuring  process.  More  recently,  outflows 
have eased, but remain volatile.  

Deleveraging  of  the  banks’  balance  sheets  has 
bottomed  out.  Total  consolidated  assets  of  the 
banking sector increased marginally by 0.6 % y-o-
y  in  2017  due  to  higher  cash,  deposits  and  assets 
available  for  sale,  while  the  stock  of  loans 
continued to contract. The contraction of the gross 
stock  of  loans  for  domestic  residents  stood  at 
almost 7 % y-o-y as of February 2018. 

(7)  Pursuant  to  Directive  2013/36/EU,  O-SIIs  are  institutions 
that,  due  to  their  systemic  importance,  are  more  likely  to 
create risks to financial stability and hence may be required 
to hold an additional capital buffer.  

(8)  The  CBC  also  introduced  borrower-based  measures  in 
2013,  which  were  streamlined  in  March  2016,  with  total 
debt servicing and the loan-to-value ratio capped. 

 
                                                           
3. Financial sector issues 

Graph 3.5: 

Borrowing from the Eurosystem 

2018,  the  fall  in  loan  interest  rates  for  NFC  loans 
continued, although it stalled for mortgage loans. 

Restructuring and resolution of banks 

The CCB continues to suffer from a high stock 
of  NPLs.  Despite  improving  economic  conditions 
on  the  island  and  progress  by  local  peers,  the 
volume  of  NPLs  has  declined  only  slightly.  The 
latest  development  was  mostly  due  to  a  one-off 
write-off in the second half of 2017, which also led 
to  de-recognition  losses.  The  NPL  ratio  has 
declined marginally from 60% at end-2016 to 59% 
in September 2017. The chief factor in explaining 
this  development  has  been  the  poor  quality  of  the 
restructuring solutions.  

Although the CCB has made significant steps to 
achieve operational requirements set forth in its 
restructuring  plan,  it  has  so  far  not  succeeded 
in meeting its privatisation objectives. Following 
two  capitalisation  injections  totalling  to  EUR  1.7 
billion in 2014 and 2015, the Cypriot government 
has a 77% direct ownership of the CCB, while the 
Recapitalisation  Fund (9)  holds  almost  all  of  the 
remaining  stakes.  According  to  its  restructuring 
plan, the CCB has to be gradually privatised within 
the  period  September  2018  to  March  2020. (10) 
in  early 
The  Cypriot  government  announced 
summer  of  2017  its  intention  to  distribute  freely 
the  relevant  amount  of  shares  to  clients  of  the 
group.  The  plan  was  abandoned 
following 
discussions with the European Commission. In late 
August 2017, the Cypriot government stated that it 
aims  to  fulfil  the  privatisation  requirement  by 
selling the bank to a strategic investor and to bring 
fresh capital to the bank. As already mentioned at 
the  beginning  of  this  chapter,  in  March  2018  the 
government initiated the sale of the CCB and then 
in  April  made  a  significant  financial  transaction 

(9)  To finance the second capital injection of EUR 175 million 
in  2015,  the  Cypriot  government  provided  a  loan  to  the 
Recapitalization  Fund.  The  loan  will  be  repaid  through  a 
special levy on bank deposits. 

(10)  More  specifically,  CCB  has  to  list  25%  of  its  total  shares 
by September 2018, followed by two additional listing of at 
least  25%  of  total  shares  within  9  and  18  months  of  the 
initial sale. As an alternative to listings, the corresponding 
stakes  can  be  sold  to  known  international  or  domestic 
financial  institutions  as  well  as  renowned  institutional 
investors  active  in  the  financial  services  industry  with 
private offering. 

21 

Source: Central Bank of Cyprus 

Graph 3.6:  Deposits developments 

Source: Central Bank of Cyprus 

Interest  rates  on  both  deposits  and 
loans 
declined  further,  albeit  at  a  slower  pace.  In 
February  2015,  the  CBC  narrowed  the  maximum 
spread between Libor and the deposit interest rates 
that  banks  can  offer  from  300  to  200 basis  points 
(bps).  This  resulted  in  a  sharp  decline  in  deposits 
and, in particular, in lending rates, which increased 
pressure  on  the  banks’  net  interest  income.  In 
2017,  interest  rates  continued  to  fall,  albeit  at  a 
slower pace. Loan interest rates declined further by 
25 bps on longer-term mortgages and by 40 bps for 
longer-term NFC loans from the end of 2016 to the 
end  of  2017  (see  Graph  3.6).  At  the  beginning  of 

02468101214201220132014201520162017Lending to euro area credit institutions related to monetarypolicy operationsOther claims on euro area credit institutions (ELA)EUR bn-60-40-200204060800708091011121314151617From NFCs, CyprusFrom households, CyprusFrom NFCs, RoWFrom households, Rowy-o-y, % 
 
 
 
                                                           
European Commission 

Post-Programme Surveillance Report 

with the bank. Developments related to CCB were 
still ongoing at the time of writing. 

Bank  of  Cyprus,  the  largest  systemic  bank  in 
Cyprus,  has  made  notable  progress 
in 
implementing  its  restructuring  plan.  According 
to the bank’s 2017 results, the stock of NPLs  was 
reduced  by  EUR 2.01 billion,  or  around  20 %  in 
2017.  This  adds  to  the  steady  progress  that  the 
bank has made in reducing its NPL stock over the 
past  2  years.  Most  of  the  reduction  was  possible 
due  to  write  offs’  (€978m  or  48.5%  of  total 
loans, 
reduction).  The  curing  of  restructured 
representing  47  %  of  the  net  NPL  reduction  in 
2017.  The  rest  of  the  reduction  was  due  to  write-
offs  and  foreclosures  (mainly  consensual).  While 
the bank made some headway in selling foreclosed 
assets  in  2017,  the  overall  sales  figures  remain 
relatively low. The relatively high direct exposure 
of the bank to real estate due to the use of debt-to-
asset  or  equity  swaps  is  an  ongoing  concern.  The 
slower  pace  of  deleveraging  combined  with  the 
reduction  in  NPL  stock  brought  the  NPL  ratio  to 
47 % at the end of 2017, down from 55 % the year 
before.  Meanwhile,  the  bank’s  CET1  ratio  fell 
substantially to 12.7 % (transitional), mostly due to 
an  additional  provisioning  of  EUR 590 million  in 
the  first  half  of  2017  following  interactions  with 
the SSM. This additional provisioning brought the 
bank’s NPL coverage ratio to 48 %, up from 41 % 
the  year  before.  It  has  also  helped  reduce  the 
bank’s  net  loans-to-deposit  ratio,  which  came  to 
82 % at the end of 2017, down from 95 % the year 
before.  

The resolution of  Laiki reached its final  phase. 
The banking licence of Laiki’s Russian subsidiary 
was revoked in 2015, while the Ukrainian, Serbian, 
and Romanian  subsidiaries  were sold in 2016 and 
2017. After a long delay and various proceedings, 
a  deal  was  struck  with  the  Malta's  National 
Development  and  Social  Fund  in  March  2018  to 
buy  Laiki’s  stake  in  Malta’s  Lombard  Bank.  The 
sale  of  Laiki’s  shares  in  its  Greek  subsidiary  is 
expected to be finalised in July 2018. The Cypriot 
resolution  authority  sold  half  of  Laiki’s  Bank  of 
Cyprus  shares  in  May  2017  and  will  sell  the 
remaining shares when market conditions improve. 

The  liquidation  of  FBME  Bank  is  underway, 
but  may  be  delayed  due  to  international  legal 
challenges.  The  Cypriot  Deposit  Guarantee 
Scheme  has  started  making  payments,  although 

22 

only 1 600 claims had been received by April 2018 
out  of  a  potential  6 500  claims.  The  scheme  has 
paid  EUR 67 million  so  far.  However,  the  overall 
liquidation process has been halted as a Tanzanian 
senior  bond-holder  claims  that  liquidation  should 
take place in Tanzania.  

3.2. 

BROADER 
DEVELOPMENTS 

FINANCIAL 

SECTOR 

are 

A  decisive  and  durable  reduction  in  NPLs 
strengthening  Cyprus’s  payment 
requires 
culture. 
currently 
authorities 
The 
contemplating  a  more  comprehensive  strategy  to 
address the  high NPL stock in the banking sector. 
Work on a number of initiatives has been brought 
forward  in  the  past  few  months  and  should  be 
pursued as a matter of priority. It  will be key that 
any  new  measures  initiated  by  the  government 
contribute to strengthen the payment discipline and 
are in line with international best practices. 

including 

The  authorities  are  working  on  a  package  of 
legal amendments to accelerate NPL resolution. 
This  includes  increasing  the  effectiveness  and 
efficiency  of  the  insolvency  and  foreclosure 
framework as well as the sale of loans law. The 
targeted  amendments  build  on  input  from  various 
stakeholders, 
the  Cypriot  banking 
association  and  aim  at  removing  impediments 
identified  in  the  application  of  these  frameworks. 
The  proposals  are  awaiting  approval  by  the 
Council of Ministers, the aim being to submit them 
to the House of Representatives by June 2018. The 
authorities  aim  to  propose  these  amendments 
alongside  the  proposal  for  the  measure  addressed 
the  system-wide 
to  vulnerable  groups, 
government  subsidy  scheme  for  NPLs  secured 
with  primary  residences  below  a  certain  value, 
subject  to  certain  income  and  property  criteria. 
While  details  of  this  scheme  have  not  yet  been 
decided,  it  is  important  to  design  it  in  a  way  that 
does not provide wrong incentives for debtors and 
banks or undermines fiscal sustainability.   

i.e. 

the 

insolvency  and 

Use  of 
foreclosure 
frameworks  in  place  remains  limited  and  thus 
their  efficiency  has  not  yet  been  fully  tested. 
Foreclosure  auctions  under  the  current  legislation 
started  in  June  2016,  but  have  proved  rather 
unsuccessful  as 
the  majority  did  not  attract 
satisfactory  bids.  The  sale  of  foreclosed  assets 

 
3. Financial sector issues 

progress as it has only reviewed implementation of 
the DROs.  

On  new  legal  initiatives,  the  revised  draft 
securitisation  law  is  currently  being  vetted  for 
the  second  time  by  the  Attorney  General.  One 
amendment  that  has  been  incorporated  relates  to 
the  application  of  set-offs(12)  in  the  event  of 
liquidation,  for  which  the  borrower  is  given  more 
flexibility. Moreover, the draft law,  much like the 
foreclosure and loan sales framework, requires the 
originator  to  notify  the  borrower  prior  to  the 
inclusion  of  his  or  her  loan  in  the  securitisation 
pool.  The  ECB  has  issued  its  opinion  of  the  draft 
law in early  April 2018, highlighting a  number of 
concerns, including approval power granted to the 
CBC  and  the  requirement  of  notification  to  the 
borrowers,  collateral  providers  and  guarantors, 
well in advance in the event of a transfer or a sale. 

in 

the 
There  are  positive  developments 
secondary  market  for  NPL  sales.  Although  the 
newly  created  framework  for  a  secondary  market 
for  NPLs  is  still  not  used  enough,  Hellenic  Bank, 
Cyprus’ third-largest lender, sold EUR 145 million 
of  its  NPLs  (some  6 %  of  its  NPL  stock)  to 
Norway’s  B2Holdings  ASA  in  January  2018.  All 
major  banks  have  now  engaged  in  arrangements 
with external service providers for workout of their 
NPLs.  The  increased  use  of  loan  servicers  may 
serve as a first step towards more widespread loan 
sales.  The  government  has  also  shown  an 
increasing  willingness  to  amend  the  foreclosure 
and  insolvency  procedures  to  facilitate  collateral 
recovery,  which  may  improve  secondary  market 
valuations and facilitate sales. 

is 

limited,  which 

The  quality  of  financial  information  available 
on  borrowers 
is  being 
addressed to some extent. As agreed in the 2017 
National  Reform  Programme,  the  authorities  are 
improving  the  credit  registry  by  broadening  the 
information that is collected and made available as 
well 
reporting 
counterparties.  The  scope  and  quality  of  the 
financial  information  available  for  credit  risk 
assessment has been relatively limited but is in the 
process  of  being  improved  by  integrating  the 

expanding 

set  of 

the 

as 

remains  poor,  with  the  total  book  value  of  sold 
assets representing less than 0.05 % of NPLs in the 
second  half  of  2017.  On  implementation  of  the 
insolvency  framework,  the  main  bottleneck  is  the 
lack  of  interest  (i.e.  lack  of  applications)  among 
eligible borrowers. To promote the framework, the 
authorities  engaged  with  stakeholders  to  explain 
various  parts  of  the  2015  insolvency  reform  and 
made  an  effort  to  raise  general  awareness.  An 
interactive web tool was also set up to help debtors 
to create a restructuring plan of their own. Despite 
this, demand for the insolvency tools remains low. 
Debt relief orders (for relief from small unsecured 
debts,  up  to  EUR 25 000)  (DROs)  proved  to  be 
more  popular 
than  personal  repayment  plans 
(PRPs),  with  1 381  and  114  applications (11) 
respectively  by  the  end  of  April  2018.  PRP 
applications  only  took  off  in  2016  and  almost 
doubled 
in  2017.  The  backlog  of  untreated 
applications  by  borrowers  for  DROs  and  PRPs  is 
mainly generated by the Insolvency Service, since 
the  Courts  treated  majority of the cases submitted 
to them. The number of applications for corporate 
debt restructuring is also very low. 

framework 

the  regulatory 

Work  is  ongoing  to  improve  the  effectiveness 
and  efficiency  of  the  Insolvency  Service  and  to 
strengthen 
for 
insolvency  practitioners,  although  progress  is 
slow.  An  independent  review  of  the  operations  of 
the Insolvency Service has been finalised, resulting 
in  an  action  plan  lasting  3  years.  The  action  plan 
has yet to be approved by the Council of Ministers. 
The  project  to  improve  the  regulatory  framework 
for insolvency practitioners in the areas of training, 
technical 
supervision  and  discipline  with 
assistance 
for 
Reconstruction  and  Development  has  started,  and 
is  expected  to  be  finalised  by  around  the  end  of 
2019.  As  well  as  preparing  the  legal  amendments 
to  the  three  frameworks  mentioned,  there  is  a 
parallel  work  stream  in  which  a  working  group 
involving 
relevant  ministries, 
supervised  by  a  recently  established  ministerial 
committee,  assesses 
the 
insolvency and foreclosure frameworks, and which 
is  expected  to  give  a  political  steer.  So  far,  the 
working  group  did  not  yet  make  any  significant 

implementation  of 

European  Bank 

the  CBC  and 

the 

the 

of 

(11)  Source: 

http://www.mcit.gov.cy/mcit/insolvency.nsf/All/4502C8E1
D60C5CC0C2257F6100390460?OpenDocument. 

(12)  A set-off is where amounts are set off against each other to 
arrive at a single amount payable arising out of a series of 
mutual dealings between two parties. 

23 

 
                                                           
                                                           
European Commission 

Post-Programme Surveillance Report 

for 

physical 

island’s  second  largest  lender  the  CCB  into  the 
credit  register.  The  creation  of  a  credit  scoring 
been 
system 
commissioned, 
precise 
although 
implementation  timeline  has  been  announced  yet. 
The  credit  registry  needs  further  improvements 
regarding data quality, access and management, in 
line with international best practices.   

persons 

has 

no 

the  European 

Following 
Insurance  and 
(EIOPA) 
Occupational  Pensions  Authority 
study and the Ministry of Finance’s decision to 
proceed with the integration of the pension fund 
and insurance supervisors, the authorities have 
legal 
continued  to  work  on  drafting  the 
framework.  An  independent  supervisory  body 
will  be  set  up  as  a  separate  entity  outside  of  the 
government. The first draft of the legislation is still 
being  prepared  by  the  Ministry  of  Finance.  At 
present, there are delays in project completion due 
to  issues  related  to  the  status  of  the  staff  in  the 
planned new entity.  

24 

 
 
 
 
  
 
 
 
4. 

BUDGETARY OUTLOOK AND FISCAL POLICY STANCE 

4.1. 

FISCAL PERFORMANCE 

Fiscal  performance  was  remarkably  strong  in 
2017,  once  again  exceeding  expectations.  The 
general  government balance achieved a  surplus of 
1.8 %  of  GDP,  up  from  0.3 %  of  GDP  the  year 
before. The primary surplus increased to 5.0 % of 
GDP, (13)  up  from  3.6 %  of  GDP  in  2016,  and  is 
now  one  of  the  highest  in  the  EU.  This  is  a 
remarkable  turnaround  compared  to  a  headline 
deficit  of  5.1 %  of  GDP  when  the  economic 
adjustment  programme  started  in  2013.  Revenue 
collection  in  2017  was  buoyant  and  increased  by 
8.2 %,  while  expenditure  increased  at  a  much 
slower  pace,  by  4.3 %. The  fiscal  outturn  in  2017 
was  also  better 
the  Draft 
Budgetary  Plan  for  2018  and  the  Commission’s 
Autumn  2017  Economic  Forecast  (i.e.  up  by  0.8 
percentage  points  and  0.7  percentage  points  of 
GDP for the headline surplus respectively).  

than  expected 

in 

Increased general government revenue receipts 
in  2017  were  underpinned  by  the  strong 
economic  recovery  and  ongoing  improvements 
in the labour market. Tax receipts on production 
and  imports  increased  significantly  (VAT  receipts 
rose  by  15.9 %).  In  addition,  tax  revenues  on 
income  and  wealth  also  shot  up  despite  the 
negative impact of abolishing the temporary tax on 
wages  of  private  sector  employees  and 
the 
immovable  property  tax  (i.e.  corporate  tax  and 
income  tax  revenues  increased  by  10.3 %  and 
11.4 % 
social 
respectively).  Moreover, 
contributions  increased  by  a  similar  amount  (up 
10.5 %).  

General  government  expenditure  increased  in 
2017, albeit below the authorities’ projections in 
the Draft Budgetary Plan for 2018. The increase 
was  mainly  due  to  a  rise  in  investment  (up 
12.3 %),  followed  by  increases  in  intermediate 
consumption  (up  11.9 %;  partly  due  to  one-offs 
related  to  energy-related  expenditures  and  for 

(13)  Based  on  data  reported  to  Eurostat  in  spring  2018,  see 
April 2018 EDP notification. Discussions between Eurostat 
and  the  Statistical  Service  of  Cyprus  (Cystat)  are  ongoing 
regarding 
interest  expenditure  and 
intermediate  consumption.  Possible  future  changes  to  the 
recording  of  those  expenditure  items  would  not  have  an 
impact on the general government balance, but they would 
affect the primary balance and interest expenditure. 

the  recording  of 

desalinated water), compensation of employees (up 
4.0 %; including the hiring of additional personnel 
for  security  forces  and  the  abolition  of  the 
tax  on  wages  of  public  sector 
temporary 
employees) and social transfers (up 2.1 %; mainly 
due  to  payments  for  old  age  pensions).  However, 
expenditure  in  2017  was  somewhat  lower  than 
projected  in  the  Draft  Budgetary  Plan  for  2018. 
Most  savings  resulted  from  lower-than-budgeted 
expenditure  execution  on  social  transfers  (i.e. 
lower-than-projected 
Guaranteed  Minimum 
Income contributions and unemployment benefits), 
and  subsidies  (i.e.  front-loading  of  agricultural 
subsidies in December 2016). 

Public  debt  fell  significantly  in  2017,  dropping 
below  100 %  for  the  first  time  since  2013,  to 
97.5 % of GDP. Cyprus has accelerated its public 
debt  reduction  thanks  to  high  nominal  GDP 
growth,  a  sizeable  general  government  primary 
(5.0 %  of  GDP)  and  active  debt 
surplus 
management  operations.  The 
involved 
repaying  part  of  the  debt  from  the  accumulated 
cash balances. In particular, the government repaid 
part  of  the  debt  owed  to  the  CBC  (amounting  to 
EUR 615 million  or  3.2 %  of  GDP)  in  November 
2017.  For  other  active  debt  management 
operations in 2017, including early repayment of a 
part  of  the  IMF  loan,  see  Section  6  of  Cyprus’ 
Post-Programme  Surveillance  Report  of  autumn 
2017 (14).  

latter 

4.2. 

FISCAL OUTLOOK 

sizeable 

budgetary 

Fiscal  performance  for  2018  is  expected  to 
surpluses. 
maintain 
According  to  the  Commission’s  spring  forecast, 
the  general  government  headline  and  primary 
surpluses  are  projected  to  remain  high  at  around 
2.0 %  of  GDP  and  5.0 %  of  GDP  respectively  in 
2018,  both  well  above  the  euro  area  average  and 
among the highest in the EU. This is mainly due to 
the  positive  macroeconomic  outlook,  which  is 
driven by domestic demand, strong tourism and the 
improving  labour  market.  In  2019,  both  headline 
and  primary  balances  are  expected  to  increase 

(14)  European 

Commission 

Post-Programme 
Surveillance  Report  –  Cyprus  (autumn  2017),  European 
Economy,  Institutional  Paper  No  067,  Publications  Office 
of the European Union, Luxembourg. 

(2017), 

25 

 
                                                           
                                                           
European Commission 

Post-Programme Surveillance Report 

further to around 2.2 % of GDP and 5.1 % of GDP 
respectively,  mainly  on  account  of  an  increase  in 
social  security  contributions.  The  Commission 
forecast is based on a no-policy change assumption 
and  is  therefore  consistent  with  previous  policy 
orientations.  It  also 
into  account  new 
takes 
measures  that  are  sufficiently  detailed  and  have 
been  announced  by  the  authorities.  According  to 
the  2018  Stability  Programme  submitted  by  the 
Cypriot  authorities,  the  headline  and  primary 
balances are projected to reach 1.7 % of GDP and 
4.5 %  of  GDP  respectively  in  2018,  and  1.7 %  of 
GDP and 4.7 % of GDP respectively in 2019. The 
authorities  underpin  the  improving  fiscal  position 
going  forward  with  enhanced  economic  growth. 
Based on the authorities’ projections, the structural 
balance  is  expected  to  somewhat  deteriorate  to 
0.2 %  of  GDP  over  2018-2020,  followed  by  an 
increase to 0.5 % of GDP in 2021.  

in  2017 

However, this strong revenue performance may 
not last. The shares of VAT and income taxes (i.e. 
corporate  income  tax  and  personal  income  tax)  in 
terms  of  GDP  have  increased  in  recent  years.  In 
2017,  around  three  quarters  of  the  observed 
increase  in  total  tax  revenues  was  down  to  VAT 
and income taxes. However, corporate income tax 
is an inherently volatile source of revenue subject 
to relocation decisions by (large) companies, while 
the  sizeable  VAT  receipts 
largely 
benefitted  from  the  buoyant  construction  sector 
and,  to  a  lesser  extent,  from  wholesale  and  retail 
trade.  It  is  therefore  important  to  understand  the 
underlying  drivers  of  corporate  income  tax  and 
VAT  receipts  as  well  as  the  extent  to  which  they 
are driven by cyclical developments. As mentioned 
in  the  2018  Country  Report  for  Cyprus(15),  the 
Commission’s  analysis  points  to  significant  tax 
buoyancy  effects  for  corporate  income  tax  and 
VAT  in  Cyprus,  leading  to  revenue  windfalls  in 
2017.  Prudent  fiscal  policy  would  avoid  risks 
associated  with  using  the  additional  temporary 
revenue  generated  by  tax  buoyancy  effects  to 
finance increases in long-term expenditure.  

(15)  See  also  2018  Country  Report  for  Cyprus,  pages  26-28. 
https://ec.europa.eu/info/sites/info/files/2018-european-
semester-country-report-cyprus-en.pdf  

26 

Graph 4.1: 

Tax revenue contributions 

Source: Ministry of Finance and European Commission 

in 

fiscal 

including 

Fiscal  risks  remain  tilted  to  the  downside  and 
have  considerably  increased.  The  forecast  is 
subject  to  uncertainties  mainly  in  relation  to  the 
financial  sector  developments, 
the 
budgetary  impact  of  the  CCB  related  transaction. 
The high proportion of NPLs in the financial sector 
also  represents  a  contingent  risk  for  Cyprus. 
Furthermore,  there  are  fiscal  risks  associated  with 
public payroll growth. Compensation of employees 
may  suffer  upward  pressure,  which  may  have 
significant  budgetary  implications  and  potential 
spill-over  effects 
the  private  sector.  A 
permanent mechanism that regulates the growth of 
the  public  sector  wage  bill  would  avoid  any 
potential 
the 
slippage 
sustainability and predictability of public finances. 
Another major risk is linked to the fiscal impact of 
healthcare  reform,  which  might  create  additional 
budgetary  pressures.  The  study  on  the  fiscal  and 
economic  impact  of  the  reform  is  not  expected 
before the third quarter of 2018, while the potential 
cost  overruns  in  establishing  the  financial  and 
operational  autonomy  of  public  hospitals  are  still 
being assessed. Moreover, the government recently 
agreed  to  introduce  pay  rises  for  health-care 
professionals,  effective  from  2019. There  are  also 
uncertainties regarding the outcome of court cases 
on  the  constitutionality  of  the  public  sector  wage 
and benefit cuts during the crisis; rulings in favour 
of  claimants  could  significantly  impact  public 
finances.  

ensure 

and 

-5051015202530351011121314151617% GDPOtherOther direct taxesPersonal income taxSocial security contributionsCorporate income taxOther indirect taxesVATTotal taxes, with social contr. 
 
                                                           
 
the 

into 

account 

Taking 
government’s 
transaction with the CCB in April,  public debt 
is projected to increase from 97.5 % in 2017 to 
105.7 %  of  GDP  in  2018,  but  would  steadily 
decline after that. The increase in 2018 is mainly 
due  to  the  issuance  of  a  series  of  government 
bonds  on  3 April  2018  (worth  EUR 2.35 billion), 
the  proceeds  of  which  were  deposited  with  the 
CCB.  Based  on  the  no-policy  change  assumption, 
the deposit is not expected to be withdrawn by the 
end  of  the  forecast  horizon.  The  implications  of 
banking  support  for  the  State’s  balance  sheet  are 
particularly  relevant  in  the  Cypriot  context  where 
the size of the banking sector relative to that of the 
public sector is large. The transaction represents a 
shift  upwards  in  Cyprus’s  public  debt.  In  the 
absence  of  further  government  support  for  the 
banking sector, public debt is projected to decrease 
again  to  below  100 %  in  2019  owing  to  the 
projected  high  primary  surplus  of  5.1 %  of  GDP 
and favourable debt dynamics mostly due to strong 
real GDP growth (see also Section 6 and Annex 1 
for an analysis of debt sustainability, including the 
impact  of  the  government’s  transaction  with  the 
CCB of 3 April 2018). 

The  House  of  Representatives  has  resumed 
discussions on creating a sovereign wealth fund. 
The  draft  law,  which  sets  out  the  conditions  for 
collecting,  managing  and  using  future  resources 
from  hydrocarbon  exploitation  and  stipulates  that 
the  government  will  be  able  to  use  part  of  the 
revenue  to  reduce  government  debt,  is  set  to  be 
adopted 
to 
strengthening the long-term sustainability of public 
finances  and  to  ensure  the  sustainable  use  of 
revenue  generated  by  exploiting  hydrocarbon 
reserves.  

in  mid-2018.  This  fund 

is  key 

4. Budgetary outlook and fiscal policy stance 

27 

 
6. 

STRUCTURAL ISSUES 

The  favourable  economic  environment  offers 
the new government in place an opportunity to 
proceed  swiftly  with  much  needed  structural 
reforms.  Since  early  2017,  there  has  been  a 
noticeable  slowdown  in  structural  reforms.  The 
mission  stressed  that  renewed  structural  reform 
commitment by all national stakeholders is needed. 
It  also  encouraged  all  stakeholders  to  step-up  the 
reform  momentum 
in  key  areas,  which  are 
necessary  to  unlock  the  potential  growth  and 
safeguard  fiscal  sustainability,  given  the  country's 
ongoing important economic vulnerabilities. 

6.1. 

FISCAL STRUCTURAL REFORMS 

Public  financial  management  and  budgetary 
framework 

involved 

institutions 

Considerable  progress  has  been  made  on 
implementing  the  fiscal  framework,  although 
further  efforts  are  needed  on  the  appraisal  of 
public investment projects. Secondary legislation 
the  Fiscal  Responsibility  and  Budgetary 
for 
Framework  Law  has  been  fully  operational  since 
January  2018.  The  administrative  capacity  of  the 
key 
in  assessing  public 
investment  projects  is  being  further  improved.  In 
particular,  guidelines  and  templates  have  been 
finalised, several training courses are ongoing and 
a  software  management  system  is  being  acquired. 
However,  the  selection  process  for  including 
projects  in  the  budget  needs  to  be  assessed  and 
further  enhanced  based  on  the  pilot  of  the  new 
project selection process of the 2017-2019 budget. 
The establishment of a unit responsible for public-
the  Ministry  of 
private  partnerships  within 
Transport is still under discussion. 

State-owned enterprises 

the 

legal 

framework 

Only  individual  privatisation  projects  remain 
the  privatisation  unit  was 
active  after 
dismantled  and 
for 
privatisation  was  abolished.  After  the  House  of 
Representatives  rejected  budgetary  appropriations 
earmarked  for  privatisation  projects  in  the  2017 
budget,  the  government  effectively  dismantled  its 
privatisation unit and cancelled decrees to privatise 
the Cyprus Telecommunications Authority (CyTA) 
and the Cyprus Stock Exchange. In February 2018, 
the  Supreme Court upheld the law adopted by the 

House  of  Representatives  to  abolish  the  legal 
framework  for  privatisation.  As  a  result,  only 
individual  privatisation  projects  are  still  active, 
the  House  of  Representatives  closely 
with 
scrutinising  any  progress  made  on  these  files. 
These  developments  represent  a  reverse  of  one  of 
the  key  reform  commitments  made  under  the 
the 
programme.  Nevertheless,  progress  on 
individual  privatisation  projects  could  attract 
further  foreign  investment  in  Cyprus,  reduce  the 
state’s  exposure  to  contingent  liabilities  from 
public  companies  and  improve  the  economic 
governance  and  performance  of  state-owned 
enterprises (SOEs).  

to 

the  government’s 

legislative  proposal 

To  improve  the  efficiency  of  SOEs,  steps  could 
be taken in three areas. Following the withdrawal 
of 
to 
privatise CyTA in May 2016 due to strong political 
opposition,  the  government  now  proposes  the 
corporatisation  of  this  company.  The  government 
submitted  a  draft  bill 
the  House  of 
Representatives  in  November  2017,  in  which  it 
remains  the  majority  shareholder  and  a  strategic 
investor  is  in  charge  of  managing  CyTA.  An 
agreement  was  also  reached  to  sell  CyTA  Hellas, 
the  Greek  subsidiary  of  CyTA.  The  bill  for 
licensing the activities of the National Lottery to a 
private  investor  was  submitted  to  the  House  of 
Representatives,  with  an  investor  expected  to  be 
selected in 2018. The privatisation processes of the 
Larnaca  port  and  the  Troodos  residences  are 
underway,  with  both  subject  to  tender  procedures 
in 2018. By contrast, no notable progress has been 
made  on  the  privatisation  of  other  assets,  in 
particular  the  Cyprus  Stock  Exchange.  As  the 
experience  with  the  privatisation  of  the  Limassol 
port shows, smaller scale privatisation projects can 
also  yield  important  efficiency  gains  in  key 
strategic sectors of the Cypriot economy.  

The  law  on  SOE  corporate  governance  is  at  a 
standstill.  The  law,  which  aims  to  improve  the 
corporate  governance  of  SOEs,  was  submitted  to 
the  House  of  Representatives  in  2015,  and  no 
progress  has  been  made  since  then.  Even  though 
the  law  applies  to  companies  not  intended  for 
privatisation,  it  has  nevertheless  been  associated 
by  stakeholders  with  being  part  of  the  wider 
privatisation 
therefore  garners 
significant opposition.  

strategy  and 

29 

 
European Commission 

Post-Programme Surveillance Report 

Revenue administration 

Slow  progress  is  being  made  on  reforms  in  the 
area of revenue administration. Measures to step 
up  the  fight  against  tax  evasion  are  underway, 
which  aim  to  target  those  taxpayers  with  the 
biggest 
impact  on  public  revenue  collection. 
However, progress on implementing the integrated 
tax  administration  system  is  slow.  The  tender 
procedure  for  a  new  tax  IT  system  is  expected  to 
be  completed  by  the  end  of  2018,  although  full 
deployment of the new system is expected to take 
several  years.  In  the  meantime,  the  current  online 
system 
tax 
administration  (e.g.  e-payments).  Stakeholders  are 
currently being consulted on some of the chapters 
of the Tax Procedure Code, with these expected to 
be adopted in 2018 or early 2019. 

is  being  upgraded 

improve 

to 

Public administration reforms  

to  completing 

Renewed  commitment 
the 
horizontal  reform  of  public  administration  is 
needed. It consists of six pieces of legislation that 
aim 
to  modernise  public  administration  and 
enhance  its  productivity.  Legislation  on  mobility 
between  public  administration  and  SOEs  and 
among  SOEs  was  enacted  in  May  2017  and  is 
expected  to  improve  the  flexibility  of  public 
administration  on  resource  allocation.  Following 
their rejection by the House of Representatives, the 
draft  laws  on  modernisation  of  the  evaluation 
procedures 
recruitment  and  promotion, 
introduction  of  a  new  staff  appraisal  system  and 
the functioning of the Public Service  Commission 
were  amended.  The  government  intends  to  re-
submit  them  for  adoption  in  mid-2018  after 
the 
discussing  and  reaching  consensus  with 
relevant stakeholders.  

for 

The introduction of a permanent mechanism to 
safeguard  the  fiscal  sustainability  of  the  wage 
bill faces opposition. The draft law introducing a 
permanent  mechanism  to  contain  increases  to  the 
public sector payroll to the developments in fiscal 
conditions and  nominal GDP growth  was rejected 
by  the  House  of  Representatives  in  December 
2016  and  the  government  does  not  intend  to  re-
submit  it  for  adoption.  The  draft  law  provisions 
were 
introduced  be  means  of  a  collective 
agreement between the government and  the union 
of civil servants, which expires at the end of 2018. 
The  new  government  plans  to  start  negotiations 

30 

with  public  sector  unions  in  2019  to  renew  the 
agreement.  However,  a  legislative  mechanism  is 
still  needed 
long-term 
predictability of the evolution of the  public  sector 
wages. 

to  provide 

the 

for 

Local  government  reform  has  stalled.  The  draft 
law was submitted to the House of Representatives 
in 2015 and no progress has been made since then. 
The reform is  intended to streamline and improve 
local public services, in particular waste and water 
management.  It  is  expected  to  accelerate  the 
issuance  of  certificates  necessary  to  issue  and 
transfer title deeds, which face significant backlogs 
(see  Section  5.2  Immovable  property  rights).  The 
reform  also 
to  establish  a  common 
accounting  and  financial  reporting  framework  for 
all  local  governments,  which  could  improve  the 
public finance management.  

intends 

Reform of the welfare system 

The costs of the  Guaranteed Minimum  Income 
(GMI)  scheme  is  set  to  decline,  reflecting  the 
decreasing  number  of  beneficiaries.  The 
implementation  of  targeted  active  labour  market 
policies  and  the  improved  situation  of  the  labour 
market on the back of economic recovery led to a 
decrease  in  the  number  of  the  GMI  recipients.  In 
March 2018 there were about 45 000 beneficiaries 
of GMI declining from 47 000 in September 2017, 
and  46 000  in  December  2017.  GMI  costs  is 
therefore  expected  to  fall  to  EUR  220  million  in 
2018, as compared to around EUR 250  million  in 
2016 and 2017.  

Preliminary  analysis  of  social  indicators  shows 
that  GMI  has  a  positive  impact  on  reducing 
poverty.  A  study  of  the  GMI  scheme's  impact  on 
poverty is expected at the end of 2018 based on the 
2016  EU  Statistics  on  Income  and  Living 
Conditions  (SILC)  data.  In  the  meantime,  the 
preliminary  figures  on  the  at-risk  of  poverty 
indicator, the poverty gap and the impact of social 
benefits  on  poverty  reduction  for  2016,  (27.7% 
down  from  28.9%  in  2015)  suggest  that  the 
introduction  of  the  GMI  scheme  had  a  large 
positive impact on reducing poverty.  

 
 
6. Structural issues 

Healthcare reform 

6.2. 

STRUCTURAL REFORMS 

Implementation of the long-standing healthcare 
reform is gaining  momentum. In June  2017, the 
House of Representatives adopted the legislation to 
establish  a  universal  healthcare  system  in  Cyprus 
by 2020 (National Health System NHS). This was 
an  important  achievement,  signalling  compliance 
with a long-standing programme commitment and 
recurrent country-specific recommendation as part 
of  the  European  Semester.  The  government  has 
reaffirmed its commitment to proceeding with full 
implementation  of  the  NHS.  Progress  on  key 
implementation  milestones  is  being  made,  in 
particular  on  implementing  the  IT  system  and 
reforming  primary  healthcare.  Furthermore,  the 
the 
negotiations  between 
representatives  of  medical  professionals  are 
ongoing in a constructive way. The outcome of the 
negotiations  will  have  an  impact  in  particular  on 
the  participation  rate  of  private  sector  health 
professionals  in  the  NHS.  Progress  is  also  being 
made 
operational 
financial 
autonomisation  of  hospitals,  which  is  set  to  be 
completed by June 2020.  

the  authorities  and 

and 

the 

on 

impact  on 

incurred  by 

Implementation of the new healthcare system is 
expected to significantly lower the out-of-pocket 
medical  costs  currently 
the 
population,  although  efforts  to  safeguard  fiscal 
sustainability  need  to  continue.  Out-of-pocket 
medical costs currently account for more than half 
of  the  total  healthcare  expenditure.  The  reform  is 
expected  to  reduce  these  costs  to  15%,  with  a 
positive 
the  household  disposable 
income. However, the fiscal costs of the reform is 
still  unknown  —the  results  of  the  study  on  the 
hospitals' costs, which could help identify possible 
costs overruns, will only be available in mid-2018. 
Furthermore, 
study, 
results 
commissioned by the Ministry of Finance, on how 
including 
the 
identifying potential fiscal risks are  only expected 
at the end of 2018. Implementation of the reform, 
in  particular  autonomisation  of  public  hospitals, 
entails  significant  investment  needs,  including 
human  capital,  health  technology,  and  a  new  IT 
system. In this respect, it is important to strengthen 
safeguards  against  possible  costs  overruns  and 
implement 
fiscally 
sustainable way.  

the  economy, 

this  major 

impacts 

reform 

reform 

in  a 

the 

the 

of 

Justice system reform 

to 

thanks 

in  particular 

Preparations  for  comprehensive  reform  of  the 
justice  system  continue,  with  some  progress 
expected in 2018. The gradual implementation  of 
the  reform  is  expected  to  be,  to  a  great  extent, 
in  2020,  with  preparations  gaining 
finalised 
momentum, 
technical 
assistance  provided  by  the  European  Commission 
(Structural  Reform  Support  Service).  The  law 
establishing  an  administrative  court  to  deal  with 
asylum seekers has been submitted to the House of 
Representatives and it is expected to be adopted by 
mid-2018.  The  law  establishing  a  commercial 
court,  which  will  handle  cases  of  over  EUR  2 
million  is  under  legal  vetting  and  should  be 
submitted to the House of Representatives by mid-
2018.  This  court  is  expected  to  make  the  system 
more efficient, in particular for cases related to the 
non-performing  loans  (NPLs),  which  is  much 
needed in order to allow banks to proceed swiftly 
with  cleaning  up  their  balance  sheets.  These  two 
courts  will  also  help  reduce  the  large  backlog  of 
cases  accumulated  over  the  years  due  to  the 
inefficiencies  of  the  judicial  system.  In  addition, 
the training school for judges is also due to be fully 
operational  by  the  end  of  2018.  While  the 
transition  to  an  IT  system  is  still  a  long  way  off, 
preparations  are  advancing.  Amendments  to  the 
civil procedure rules are still at an initial stage.  

to 

An independent  review of court operations has 
been finalised. A study on court operations, which 
was  commissioned  by  the  Structural  Reform 
Support  Service,  was  presented  in  March  2018.  It 
makes  a  series  of  recommendations,  including 
creating  a  task  force  to  clear  the  large  backlog  of 
cases,  making  changes 
the  management 
structure of the courts, improving the efficiency of 
case management and more effective judicial time 
management.  The 
recommendations  will  be 
reviewed by the Cypriot authorities. Reform of the 
judicial  system  is  deemed  necessary  given  its 
the 
strong 
enforcement  of  contracts  as  well  as  the  business 
environment 
conditions. 
Successful  implementation  of  the  reform  requires 
more  staff  in  the  Supreme  Court  office  dealing 
with the reform initiatives and a close cooperation 
between  the  Supreme  Court  and  the  Ministries  of 
Finance and Justice. 

the  NPLs  and 

investment 

issue  of 

link 

and 

to 

31 

 
European Commission 

Post-Programme Surveillance Report 

Energy 

Recent  gas  exploration  results  reconfirmed  the 
promising  geological  characteristics  of  the 
(EEZ). 
Cyprus’  Exclusive  Economic  Zone 
Following  a  successful  exploration 
licensing 
procedure  in  2017  with  well-known  companies 
(ExxonMobil,  Qatar  Petroleum,  Eni  and  Total), 
drillings  in  the  Cyprus’  EEZ  were  stepped  up  in 
the  second  half  of  2017,  in  particular  the  one  of 
ENI  in  Block  6  Offshore  Cyprus  at  the  end  of 
2017.  This  last  exploration  reconfirmed  very 
promising  gas  reserves  in  Cyprus’  EEZ.  More 
exploratory  drillings  by  Eni  in  Block  3,  which  is 
closer  to  Cyprus’  coast,  were  blocked  by  Turkish 
ships.  This  military  incident  created  uncertainty 
complex 
and  highlighted  once 
geopolitical  situation.  In  March  2018,  President 
Anastasiades 
the  European  Council 
about  the  incident,  which  called  on  Turkey  to 
cease these actions and respect the sovereign rights 
of  Cyprus  to  explore  and  exploit  its  natural 
resources in accordance with EU and international 
law(16).  On  a  positive  note,  Exxon  is  advancing 
with  the  necessary  environmental  studies,  and  is 
expected to start drilling in mid-2018.  

informed 

again 

the 

The  Cypriot  authorities  are  continuing  with 
negotiations  to  monetise  potential  reserves  of 
gas  at  the  Aphrodite  field  and  confirmed  their 
intention  to  take  part  in  the  EastMed  Pipeline 
Project. The development and production plan for 
the  Aphrodite  field  is  still  being  discussed  by  the 
Cypriot  authorities  and  the  Aphrodite  consortium. 
On  the  prospects  of  gas  supply  to  the  EU  from 
Eastern  Mediterranean  sources,  Cyprus  —  along 
with  Israel,  Italy  and  Greece  —  signed  a 
Memorandum  of  Understanding  to  confirm  their 
intention 
in  developing  and 
implementing the EastMed Pipeline Project (2 000 
km long pipeline to channel offshore reserves from 
the Eastern Mediterranean to Greece and Italy. An 
intergovernmental  agreement  is  expected  to  be 
signed in 2018.       

to  cooperate 

The  plan  on  importing  liquefied  natural  gas 
(LNG) to Cyprus is being implemented. The two 
tenders - one to supply LNG by way of a long-term 

(16)

http://www.consilium.europa.eu/en/press/presseleas

es/2018/03/23/european-council-conclusions-22-march-
2018/ 

32 

contract and the other to build the infrastructure to 
distribute  LNG  over  the  energy  network  -  are 
about to be launched. The project received funding 
of  around  EUR  100  million  from  the  Connecting 
Europe Facility, which amounts to around 40 % of 
the total costs.  

The  Cypriot  authorities  are  committed  to 
opening  the  electricity  market  as  of  July  2019. 
The  three-stage  review  of  the  implementation  of 
the  functional  unbundling  is  advancing;  the  first 
review has been completed, the second is currently 
under way and the third is expected by the end of 
2018.  Accounting  unbundling  is  also  advancing 
with  Separated  Regulatory  Accounts  being 
prepared for the years 2015 and 2016. If functional 
and  accounting  unbundling  are  successful  and 
provided that political backing by all stakeholders 
continues,  full  ownership  unbundling  is  expected 
as  of  1  July  2019.  In  the  meantime,  an  important 
stepping  stone  towards  increasing  competition  in 
the  electricity  market  is  the  fact  that  a  new 
electricity supplier has been licensed — F. E. First 
Electric  Supply  Ltd  —  who  will  interact  with 
producers  and  consumers  based  on  bilateral 
contracts. It is the first time an electricity supplier 
other  than  the  Electricity  Authority  of  Cyprus  is 
allowed  to  enter  in  the  market.  Two  additional 
licences are expected to be granted soon. 

Immovable property rights  

Progress  is  slow  on  reducing  the  backlog  of 
transfers  and 
issuance  of  title  deeds.  The 
backlog of unissued titles fell to around 26 000 in 
March  2018,  down  from  28  000  in  September 
2017. The authorities believe that the main reason 
for the delay lies with local governments and their 
reluctance  to  issue  the  necessary  certificates.  This 
is due in particular to small infrastructure projects, 
where the developers did not complete the required 
works and the local government needs to complete 
them and bear the costs before the certificates can 
be  issued.  Pending  local  government  reform  is 
expected  to  address  these  difficulties.  Limited 
progress  has  also  been  made  on  legacy  cases  e.g. 
the  transfer  of  title  deeds  to  their  final  buyers  for 
sales  registered  before  2015.  Some  4  000  out  of 
15 600 transfer applications have been completed, 
The 
resolution 
with 
constitutionality  of  the  trapped  buyers'  law  is  still 
subject to a decision by the Supreme Court. A new 
law that could remedy the situation is at the Legal 

expected. 

quicker 

 
                                                           
 
6. Structural issues 

study is expected to be launched by the University 
of Cyprus on the effectiveness of ALMPs.  

Collective agreements have been renewed or are 
in place for most sectors of the economy. In the 
construction  sector,  discussions  are  still  ongoing 
on  legislating  certain  provisions  of  collective 
agreements, including  wage floors, working hours 
and provident fund contributions in an effort to set 
minimum  standards  for  the  construction  industry. 
The  main  reason  for  this  action  is  to  have  a 
comprehensive  coverage  as 
trade  union 
membership rate in this sector has fallen to below 
50  %,  and  the  extension  of  an  agreement  reached 
between  minority 
be 
representative of  the needs of the entire  sector. In 
the  financial  sector,  the  collective  agreement  for 
the  Bank  of  Cyprus,  the  largest  bank  in  the 
country,  is  still  being  negotiated  to  better  link 
wages to profit and performance.       

unions  might 

not 

the 

Service for vetting and is being discussed with the 
stakeholders. The reform, which would streamline 
and  shorten  the  long  and  cumbersome  procedures 
for  issuing  building  and  spatial  planning  permits, 
is  still  under  preparation  with  technical  assistance 
from the Commission (see Section 2 on the impact 
of the real estate supply side).  

Action Plan for Growth 

Implementation  of  the  National  Strategy  for 
Tourism  is  underway.  Following  consultation 
with stakeholders, the strategy was adopted by the 
Council  of  Ministers  and  has  entered 
the 
implementation phase. However, the setting  up of 
the Deputy Ministry for Tourism has been delayed 
in  the  House  of  Representatives,  with  no  timeline 
announced.   

adoption 

the  House 

The  framework  for  strategic  investments  is 
of 
by 
pending 
Representatives.  Preparation  of  a  key  element  of 
the Action Plan for Growth — setting up of a fast-
track  mechanism  for strategic investments  —  was 
completed,  with  the  House  of  Representatives 
expected to adopt it. Efforts are under way to make 
it  easier  for  small  and  medium-sized  enterprises 
(SMEs)  to  access  finance,  including  two  projects 
under the European Fund for Strategic Investments 
(EFSI  SME  window).  Implementation  of  e-
government projects is gaining momentum.  

Labour market structural issues  

Public  employment  services  (PES)  are  not  yet 
well  equipped,  although  some  measures  (PES 
peer support, IT platform) are being taken. The 
recruitment  of  30  extra  employment  counsellors 
has  been  further  delayed  and  is  now  expected  to 
take place in May 2018.  

targeting  young  people  under 

The  assessment  of  the  effectiveness  of  active 
labour  market  policies  (ALMPs)  has  started 
since  the  beginning  of  2018.  ALMPs  include 
measures 
the 
National  Action  Plan  for  Youth  Employment  as 
well  as  measures 
targeting  other  vulnerable 
groups, such as the long-term unemployed, persons 
with disabilities, but also GMI recipients. The new 
ALMPs  monitoring  and  evaluation  system  has 
been in place since the beginning of 2018, but still 
needs  some  time  to  deliver  results.  In  addition,  a 

33 

 
 
 
7. 

SOVEREIGN FINANCING AND ABILITY TO REPAY 

situation 

financing 

Sovereign 
remains 
comfortable  in  the  baseline  scenario,  although 
significant  risks  related  to  the  financial  sector 
have  recently  come  to  the  front.  As  a  result  of 
active debt management in recent years, there will 
be no more debt amortisation peaks in the medium 
term.  In  2018-2021,  the  annual  debt  principal 
repayments will not exceed EUR 1.4 bn or 7 % of 
GDP  (see  Graph 7.1).  In  addition,  total  debt 
redemptions  and  fiscal  needs  will  be  contained  in 
the  medium  term  owing  to  the  long  maturity  of 
ESM  loans  and  projected  government  surpluses. 
Excluding Treasury bills (T-bills), financing needs 
for  2018  are  estimated  at  around  EUR 0.5 billion 
(consisting  of  EUR 0.9 billion  of  debt  redemption 
needs,  which  are  partly  offset  by  EUR 0.4  billion 
of  revenue  from  the  projected  headline  surplus). 
As  the  CCB  sale  was  still  evolving  at  the  time  of 
writing,  there  are  major  uncertainties  regarding 
in 
potential  financial  sector  financing  needs 
relation  to  the  sale.  Excluding  these  potential 
additional  needs  up  to  mid-2019,  the  financing 
needs  are  lower  than  the  cash  buffer,  even  after 
excluding  the  funds  deposited  with  the  CCB  of 
EUR 0.9 billion available in April 2018.  

Graph 7.1:  Medium and long-term debt amortisation 

funds 

raised 

through 

Eurobond  of  EUR 0.85 billion  (4.4 %  of  GDP) 
with  a  yield  of  2.8 %.  The  issuance  was  almost 
five  times  oversubscribed.  So  far  in  2018,  the 
the 
government  has 
transaction involving a private placement with the 
CCB  in  April.  This  transaction  comprised  the 
issuance  of  9  domestic  government  bonds  for  a 
total  nominal  amount  of  EUR 2.35 billion,  with 
maturities  of  15-20  years  and  yields  of  2.45-
3.05 % (17), the proceeds of which and a small cash 
addition from the  government’s cash  buffer (EUR 
0.15  billion)  were  deposited  with  the  CCB. 
to  Cyprus’  Annual  Financing 
According 
Programme  2018 (18)  and 
the  2018  Stability 
Programme,  Cyprus  also  plans 
issue  an 
international bond of around EUR 1 billion later in 
2018,  subject  to  market  developments  and  the 
actual financing needs of the sovereign.  

to 

the 

following 

improvement 

in  2017, 
After  a  significant 
Cyprus’  sovereign  bond  yield  has  deteriorated 
somewhat 
recent  CCB 
developments.  Cyprus’  7 ½ year  sovereign  bond 
yield  declined  substantially  in  2017,  to  1.5 %  in 
December 2017, and then increased  with peaks in 
February and April, amounting to around 2.3 % in 
the middle of May 2018. The spread to the German 
sovereign  bond  had  a  similar  decline  in  2017  and 
stayed  broadly  at  that  level  before  increasing 
somewhat  since  the  second  half  of  March  2018 
(see  Graph  7.2).  The  deterioration  in  Cyprus’ 
sovereign  bond  yield  in  2018  mainly  reflects 
country-specific factors, likely related to the recent 
developments in relation to the banking sector and 
in particular the CCB. The most recent spike in the 
yield  may  be  down  to  a  Fitch  report  of  13 April 
2018  stating  that  banks  in  Cyprus  (as  well  as  in 
some  other  EU  countries)  may  need  to  build  up 
further 
riskier  market 
characteristics. The yield somewhat fell again after 
followed. 
the  rating  upgrade  by  Fitch 

reserves,  given 

that 

the 

Source: Ministry of Finance —- Public debt management 
office and own calculations 

access 

While  Cyprus  maintained 
to 
international  capital  markets  at  favourable 
rates  in  2017,  uncertainties  have  increased  for 
2018  linked  to  the  ongoing  sale  of  the  CCB.  In 
June  2017,  when  the  previous  international  bond 
issuance  took  place,  Cyprus  issued  a  seven-year 

(17)  The  government  bonds  include  a unilateral  call  option  for 
an early buyback of all or any part of the bonds from any 
holder  at  nominal  value.  See  also  for  further  information: 
http://www.mof.gov.cy/mof/pdmo/pdmo.nsf/All/01EC129
A8453C1D4C225826B002D5117/$file/Announcement%2
0bond%20issuance%20through%20private%20placement.
pdf. 
(18)  Source: 

http://www.mof.gov.cy/mof/pdmo/pdmo.nsf/All/E633CAF
2CA92B6AFC22581FD003753A7/$file/Announcement%2
0for%20AFP%202018%20EN.pdf?OpenElement. 

35 

012318202224262830bn EURIMFESMloans (other)loans (Russia)bonds (to beissued, technicalassumptions)bonds(outstanding) 
 
                                                           
European Commission 

Post-Programme Surveillance Report 

However,  it  is  worth  noting  that  the  Cyprus 
sovereign  bond  market  is  relatively  small,  which 
tends  to  exacerbate  volatility  in  yields.  At  the 
shorter  end  of  Cyprus’  yield  curve,  the  yield  for 
the  primary  market 
three-month  T-bills  on 
remained  negative. 
the 
outstanding T-bill stock stood at EUR 300 million, 
within the target range set out in the Medium Term 
Debt Strategy (1-4 % of total debt).  

In  February  2018, 

Graph 7.2:  Cyprus sovereign bond yield and spread vs. 

German sovereign bond 

agencies.  The  upcoming  sovereign  rating  reviews 
are scheduled for 25 May 2018 by DBRS, July by 
Moody’s,  September  by  Standard  &  Poor’s  and 
October by Fitch. 

Graph 7.3: 

Sovereign long-term ratings, Cyprus 

Source: European Commission 

Uncertainties about Cyprus’ capacity to service 
its ESM debt have increased since the previous 
PPS  report,  while  financing  needs 
in  the 
baseline  scenario  remain  moderate  at  present. 
Uncertainties and risks have increased in particular 
due to the significant increase in gross government 
debt associated with the placement of government 
bonds  with  the  CCB.  At  the  time  of  writing, 
developments  on  the  CCB  were  still  ongoing.  On 
the  other  hand,  current  medium-term  fiscal  and 
debt  servicing  financing  needs  are  moderate 
mainly  due 
to  Cyprus’  past  active  debt 
the 
management  operations.  Until  mid-2019, 
financing needs in the baseline  scenario are lower 
than 
this 
the  current  cash  buffer.  Against 
background,  continued  fiscal  discipline,  forceful 
reduction  of  NPLs  and  progress  on  growth-
enhancing  structural  reforms  will  be  of  critical 
importance in consolidating and further improving 
investor confidence.  

Source: Bloomberg and own calculations. 

Cyprus’  sovereign  credit  rating  was  recently 
upgraded  by  Fitch,  although  it  remains  below 
investment  grade.  On  20 April  2018,  Fitch 
upgraded  Cyprus  by  one  notch  to  ‘BB+’  from 
‘BB’,  keeping  its  outlook  positive,  due  to  the 
country’s  strong  cyclical  economic  recovery  and 
prudent  fiscal  policy.  This  upgrade  occurred 
around 2 weeks after the government’s transaction 
with the CCB. In March 2018, Standard & Poor’s 
kept  Cyprus’  sovereign  credit  rating  one  notch 
below  the  investment  grade  (at  ‘BB+’)  with  a 
positive  outlook,  citing  the  risks  to  the  economy 
from 
therefore 
currently  rated  one  notch  below  investment  grade 
by  two  rating  agencies  (Standard  &  Poor’s  and 
Fitch)  and  three  notches  below  investment  grade 
by Moody’s and DBRS, with a positive outlook by 
the  four rating agencies (see Graph 7.3). The high 
level of NPLs combined  with high public, private 
and  external  debt  hold  back  further  upgrades  by 
the  credit  rating  agencies.  This  suggests  that  a 
marked reduction in NPLs in the banking sector is 
likely  to  be  viewed  positively  by  the  rating 

the  banks’  NPLs.  Cyprus 

is 

36 

00.511.522.533.5401-1702-1703-1704-1705-1706-1707-1708-1709-1710-1711-1712-1701-1802-1803-1804-1805-18CY 7.5 YTM bond spreadCY yield (Nov'25)-214710131619May-11Nov-11May-12Nov-12May-13Nov-13May-14Nov-14May-15Nov-15May-16Nov-16May-17Nov-17Fitch RatingsS&PMoody'sDBRSNon-investment gradeInvestmentgradeAa/AAABaa/BBBBa/BBBCaa/CCCC 
 
 
ANNEX 1 

European Commission Debt Sustainability Analysis 

The  Commission  spring  2018  forecast  and  the  debt  sustainability  analysis,  based  on  standard 
Commission  methodology,  imply  an  increase  of  the  government  debt-to-GDP  ratio  in  2018  and  a 
steadily declining path afterwards over a 10-year period. After a significant fall in 2017, public debt is 
projected to increase to 105.7 % of GDP in 2018 due to the  issuance of a series of government bonds on 
3 April 2018 (totalling EUR 2.35 billion), the proceeds of which were deposited with the CCB. However, 
in the baseline scenario public debt is projected to steadily decline thereafter and to reach 66.9 % of GDP 
in  2028.  This  debt  sustainability  analysis  uses  the  Commission  spring  2018  forecast  (2018-2019)  as  a 
starting point to ensure consistency across EU Member States.  After 2019, the analysis is based on the 
following  standard  assumptions  in  the  Commission  methodology:  (i)  the  structural  primary  balance, 
before  the  cost  of  ageing,  is  kept  at  a  surplus  of  3.3 %  of  GDP  under  the  ‘no  fiscal  policy  change’ 
assumption; (ii) inflation converges to 2.0 % by 2022 and remains stable after that; (iii) the real long-term 
interest rate on new and rolled-over debt converges linearly to 3 % (5 % in nominal terms) by the end of 
the 10-year projection period, in line with the assumptions agreed with the Economic Policy Committee’s 
(EPC) Ageing Working Group; (iv) real GDP grows at the rate projected according to commonly agreed 
methods  with  the  EPC’s  Output  Gaps  Working  Group  until  t+10,  and  then  grows  according  to  the 
European  Commission  -  Ageing  Working  Group’s  projections  (average  rate  of  around  1.5 %  in  2018-
2028); and (v) ageing costs develop according to the 2018 Ageing Report projections (19). 

However,  there  are  significant  adverse  risks  to  the  baseline  stemming  mainly  from  the  financial 
sector  and  the  large  share  of  non-performing  loans.  In  the  baseline,  potential  additional  financial 
sector financing needs are not taken into account, since uncertain at this stage. In particular, in the short 
term, there are uncertainties surrounding the CCB sale and possible negative feedback effects on interest 
rates and GDP growth. Moreover, a weaker fiscal performance could seriously undermine the favourable 
projected  trend  in  the  baseline.  In  order  to  illustrate  the  possible  indirect  impact  from  financial  sector 
developments  as  well  as  deviations  from  the  fiscal  path,  three  adverse  scenarios  are  considered  (see 
Graph A1.1). The first adverse scenario is a standard macro shock that assumes a decrease in real GDP 
growth (by 0.5 percentage point (pp.) compared to the baseline) over the forecast period. This keeps the 
debt trajectory on a steadily declining path, but at a slower pace compared to the baseline scenario, with 
the public debt being higher by 1.5 % of GDP in 2020 and 4.9 % of GDP in 2028. The second  adverse 
scenario  assumes  a  fiscal  shock  of  the  structural  primary  balance  gradually  converging  towards  its  15-
year  historical  average  (a  surplus  of  0.8 %  of  GDP).  In  this  second  scenario,  public  debt  declines  at  a 
much slower pace, ending up 18.2 % of GDP higher in 2028 compared to the baseline. The third adverse 
scenario  assumes,  in  addition  to  the  fiscal  shock,  negative  feedback  effects  on  interest  rates  and  GDP 
growth,  both  sustained  over  the  entire  projection  period  (20).  In  this  scenario,  public  debt  —  after 
declining in the first few years (until 2023) —starts rising again, reaching around 100 % of GDP by 2028, 
as higher interest rates feed through new and rolled-over debt. By 2028, public debt is therefore higher by 
around 33 % of GDP compared to the baseline. Given Cyprus’ high level of public debt and uncertainties 
about  the  CCB  sale,  continued  fiscal  discipline  and  sustained  structural  reform  efforts  are  necessary  to 
firmly anchor the debt-to-GDP ratio on a sustainable downward path. 

(19)  European  Commission  and  the  EPC/Council,  ‘The  2018  Ageing  Report.  Economic  and  budgetary  projections  for  the  EU 

Member States (2016-2070)’, European Economy 79/2018.  

(20)  In  this  scenario, the  structural  primary  balance  is assumed to  linearly  decrease  until  2023  (and  remain constant  after  that)  to 
reach its historical average (a lower value of 0.8% of GDP, compared to the 2019 forecast value). In addition, negative feedback 
effects  on  interest  rates  (a  sustained  shock  of  +200  basis  points)  and  on  real  GDP  growth  rate  (a  sustained  shock  of  -1  pp. 
compared to the baseline)  are assumed. A sustained shock of +200 basis points (+2 %) on market interest rates can be deemed 
significant in the current benign market environment. This scenario is more adverse than those assessed in the previous  Post-
Programme Surveillance reports due to greater uncertainties and downside risks, in particular in relation to the CCB sale.  

37 

 
                                                           
European Commission 

Post-Programme Surveillance Report 

Graph A1.1:  Debt projections 

Source: European Commission 

The  indicator-based  analysis  does  not  signal  high  fiscal  sustainability  risks  in  the  short  term,  but 
there  are  clear  indications  that  the  economy’s  macroeconomic,  financial  and  competitiveness 
aspects pose significant challenges. In the short term, considerable vulnerabilities have been identified, 
based  on  the  Commission’s  early  detection  indicator  of  fiscal  stress  (the  S0  indicator).  Cyprus  has  the 
highest  value  among  the  EU  countries,  remaining  below  —  albeit  close  to  —  its  critical  threshold  (see 
Table A1.1). Furthermore, the financial-competitiveness S0 sub-index is above its critical threshold.  

Given the initial high public debt  stock  and potential contingent liabilities related to the financial 
sector,  there  are  risks  to  medium-term  sustainability.  Based  on  standard  Commission  methodology, 
Cyprus is deemed to be at medium sustainability risk in the medium term due to medium risks attached to 
the debt sustainability analysis (21). The medium-term fiscal sustainability risk indicator S1, at -0.6 % of 
GDP, points to low risks in the medium term (a negative value indicates that no upfront fiscal adjustment 
effort is needed to reduce the debt to below the 60% of GDP reference value by 2032). Despite the high 
level  of  government  debt  at  present,  under  the  baseline  scenario  it  would  decline  noticeably  given  an 
assumed continuation of the structural primary surplus. This indicator has slightly improved compared to 
the  third  PPS  review  (based  on  the  Commission  autumn  2017  forecast).  The  long-term  fiscal 
sustainability risk indicator S2, being negative, points to low fiscal sustainability risks, under the baseline 
scenario.  This  is  mainly  due  to  the  strong  initial  budgetary  position  in  terms  of  the  projected  structural 
primary surplus in 2019. A marginal deterioration in the indicator compared to the Commission autumn 
2017  forecast  is  due  to  higher  projected  pension-related  ageing  costs,  not  fully  offset  by  the  stronger 
initial  budgetary  position.  However,  this  methodology  does  not  account  for  risks  related  to  potential 
contingent liabilities stemming from the financial sector.  

Overall, the debt sustainability analysis shows that in the baseline scenario the debt-to-GDP ratio 
declines after the peak in 2018. However, there are large uncertainties surrounding these projections. In 
particular, public debt would still be high and remain vulnerable to unfavourable macroeconomic, fiscal 
and financial market shocks. As illustrated above, a scenario that combines these various adverse shocks 
could result in the debt ratio no longer being on a declining path over the projection period. In addition, 
significantly  higher  than  currently  expected  fiscal  costs  related  to  the  ongoing  sale  of  CCB  could  also 

(21)  This assessment also includes sensitivity analysis, i.e. several deterministic debt projections, as well as stochastic projections 

(for more details, see Debt Sustainability Monitor 2017). 

38 

606570758085909510010511020122013201420152016201720182019202020212022202320242025202620272028Baseline no-policy change scenarioMacro shock: standardised (permanent) negative shock (-0.5 pp.) on GDP growthFiscal shock: structural balance converging to historical average (0.8% of GDP)Combined negative macro, fiscal and interest shock: fiscal shock, +2 pps. on the real long-term interest rate and -1 pp. on GDPgrowth 
 
                                                           
1. European Commission Debt Sustainability Analysis 

have  a  negative  impact  on  debt  dynamics,  especially  if  they  lead  to  increased  refinancing  costs  for  the 
sovereign and, thus, higher gross financing needs. These risks underscore the importance of maintaining 
fiscal discipline over the medium to long term in order to underpin/safeguard a declining trajectory of the 
debt-to-GDP  ratio  going  forward.  In  addition,  the  baseline  debt  reduction  path  hinges  on  medium  and 
long-term economic growth, which points to the need to persevere with the implementation of structural 
reforms in order to improve competitiveness and boost the potential GDP of the Cypriot economy. 

Table A1.1: 

Sustainability indicators (in % of GDP) 

[1] The S0 indicator, which captures short-term fiscal challenges, aims at the early detection of fiscal stress associated with 
fiscal risks within a one-year period To estimate these risks, S0 uses a set of fiscal, financial and competitiveness indicators 
selected and weighted according to their signalling power. S0 is therefore a composite indicator whose methodology 
fundamentally differs from the S1 and S2 indicators, which quantify fiscal adjustment efforts. The critical threshold for the 
overall S0 indicator is 0.46. For the fiscal and financial-competitiveness sub-indexes, the thresholds are 0.36 and 0.49* 
respectively. 
[2] Debt sustainability analysis is performed based on the ‘no fiscal policy change’ scenario in a manner that tests the 
response of this scenario to different shocks presented as sensitivity tests and stochastic projections*. 
[3] The S1 indicator is the medium-term sustainability gap; it measures the upfront fiscal adjustment effort required to reduce 
the debt-to-GDP ratio to 60 % by 2032. This adjustment effort corresponds to a cumulated improvement in the structural 
primary balance over the 5 years following the forecast period (i.e. from 2020); it must then be sustained, including financing 
for any additional expenditure until the target date arising from an ageing population. The critical thresholds for S1 are 0 and 
2.5, a value between which indicates medium risk. If S1 is below 0 or above 2.5, it indicates low and high risk respectively*. 
[4] The S2 indicator is the long-term sustainability gap; it shows the upfront and permanent fiscal adjustment required to 
stabilise the debt-to-GDP ratio over the infinite period, including the costs of ageing. The critical thresholds for S2 are 2 and 6, 
a value between which indicates medium risk. If S2 is below 2 or above 6, it indicates low and high risk respectively*. 
* For more information, see the Fiscal Sustainability Report 2015 and Debt Sustainability Monitor 2017. 
Source: European Commission 

39 

Time periodShort-term0.19LOW risk0.19LOW risk0.57HIGH risk0.57HIGH riskMedium-termDSA [2]S1 indicator [3]-0.6LOW risk0.0MEDIUM riskDebt requirementof whichPensionsHealthcareLong-term careOtherLong-termS2 indicator [4]Required adjustment given IBРRequired adjustment due to CoA of whichPensionsHealthcareLong-term careOtherMEDIUM riskNo-policy-change scenarioPPS third review (autumn 2017)LOW riskLOW riskS0 indicator [1]0.44Fiscal sub-indexFinancial & competitiveness sub-indexMEDIUM risk0.60.3MEDIUM riskMEDIUM riskof which-3.5-2.43.02.7-0.1-0.2of which0.10.10.00.0-0.7-0.61.90.3LOW riskLOW risk-1.3-1.8-2.2-1.20.9-0.50.44Required adjustment given initial budgetary position (IBР)Required adjustment due to cost of ageing (CoA) 0.30.20.20.2-1.4-1.2 
 
 
 
 
European Commission 

Post-Programme Surveillance Report 

40 

 
 
ANNEX 2 

European Commission macroeconomic and fiscal projections 
(2018 Spring Forecast) 

Table A2.1: 

Selected economic indicators 

(1) Net of the one-off recapitalisation of the cooperative banking sector amounting to 8.6% of GDP in 2014. 
Source: European Commission 

41 

2013201420152016201720182019Real economy(percent change)  Real GDP-5.9-1.42.03.43.93.63.3    Domestic demand incl. inventories-9.4-1.22.95.18.35.24.5    Total consumption expenditure-6.4-0.91.62.74.03.12.9        Private consumption expenditure-5.90.72.63.34.23.42.9        Government consumption expenditure-8.1-7.2-2.6-0.42.71.53.3    Gross fixed capital formation-12.9-17.513.635.027.813.49.8    Exports of goods and services1.94.25.84.03.42.31.9    Imports of goods and services-4.94.67.46.810.14.83.7Contribution to growth(percentage points)    Domestic demand (excl. inventories)-7.4-3.33.06.88.25.44.7    Foreign trade3.7-0.1-0.9-1.7-4.4-1.8-1.3    Changes in inventories-2.22.1-0.1-1.70.10.00.0Inflation(percent change)    GDP deflator-1.1-1.6-1.2-0.71.51.51.7    HICP0.4-0.3-1.5-1.20.70.71.2Labour market(percent change, unless otherwise stated)    Unemployment rate (% of labour force)15.916.115.013.011.19.07.1    Employment-5.9-1.81.53.33.42.82.8    Compensation per employee-5.4-3.6-1.2-0.70.71.42.0    Labour productivity0.00.40.50.10.51.10.9    Unit labour costs-5.4-4.0-1.7-0.80.20.61.4Public finance (1)(percent of GDP)    General government balance-5.1-9.0-1.30.31.82.02.2        Total revenue36.739.839.338.939.939.639.6        Total expenditure41.948.840.738.638.137.637.3    General government primary balance-1.3-5.52.53.65.05.05.1    Gross debt 102.6107.5107.5106.697.5105.799.5Balance of payments(percent of GDP)  Current external balance-4.9-4.4-1.4-4.9-8.1-9.0-9.7    Ext. bal. of goods and services1.82.00.8-0.8-4.0-5.0-5.8        Exports goods and services58.662.164.564.763.862.861.8        Imports goods and services56.860.063.765.567.867.867.5    Balance of services18.018.017.520.419.520.020.0    Balance of  goods-16.2-16.0-16.7-21.2-23.5-25.0-25.7    Balance of primary income-4.6-3.70.7-1.6-1.9-1.9-1.9    Balance of secondary income-2.1-2.8-2.9-2.5-2.1-2.0-2.0Memorandum item(EUR bn)    Nominal GDP18.117.617.718.219.220.221.2 
 
 
 
 
European Commission 

Post-Programme Surveillance Report 

Table A2.2:  Use and supply of goods and services (volume) 

Source: European Commission 

Table A2.3:  Use and supply of goods and services (value) 

Source: European Commission 

Table A2.4: 

Implicit deflators 

Source: European Commission 

42 

percent change unless otherwise stated20132014201520162017201820191. Private consumption expenditure-5.90.72.63.34.23.42.92. Government consumption expenditure-8.1-7.2-2.6-0.42.71.53.33. Gross fixed capital formation-12.9-17.513.635.027.813.49.84. Domestic demand excl. inventories-7.4-3.33.06.88.25.44.75. Changes in inventories (contr. to growth)-2.22.1-0.1-1.70.10.00.06. Domestic demand incl. inventories-9.4-1.22.95.18.35.24.57. Exports of goods and services1.94.25.84.03.42.31.97a. - of which goods-12.52.11.7-9.0-4.9-2.5-0.57b. - of which services7.84.97.17.95.43.52.48. Final demand-5.50.84.04.76.44.13.59. Imports of goods and services-4.94.67.46.810.14.83.79a. - of which goods-15.35.16.611.08.36.74.99b. - of which services11.43.98.41.812.42.52.210. GDP at market prices-5.9-1.42.03.43.93.63.3(Contribution to change in GDP)11. Final domestic demand-7.4-3.33.06.88.25.44.712. Changes in inventories-2.22.1-0.1-1.70.10.00.013. Net exports3.7-0.1-0.9-1.7-4.4-1.8-1.3percent change unless otherwise stated20132014201520162017201820191. Private consumption expenditure-5.90.20.82.05.04.34.22. Government consumption expenditure-12.4-11.6-3.1-0.74.53.15.13. Gross fixed capital formation-12.7-19.912.237.827.914.611.24. Domestic demand excl. inventories-8.1-4.81.56.38.86.25.85. Changes in inventories (contr. to growth)-0.20.10.2-0.1-0.1-0.1-0.16. Domestic demand incl. inventories-10.0-3.22.14.38.86.25.87. Exports of goods and services2.12.74.83.04.03.43.57a. - of which goods-10.73.52.5-9.9-4.5-1.60.87b. - of which services7.42.45.67.36.44.74.18. Final demand-5.8-1.03.13.86.95.25.09. Imports of goods and services-3.72.57.05.59.25.24.79a. - of which goods-13.7-0.64.110.58.37.05.89b. - of which services12.16.210.30.210.23.03.310. Gross national income at market prices-8.5-2.05.30.45.05.25.111. Gross value added at basis prices-6.7-4.30.92.24.65.55.512. Gross domestic product at market prices-6.9-2.90.82.75.55.25.1percent change20132014201520162017201820191. Private consumption expenditure0.0-0.5-1.8-1.30.70.91.32. Government consumption expenditure-4.6-4.8-0.6-0.41.81.61.83. Gross fixed capital formation0.2-2.9-1.22.1-0.51.11.34. Domestic demand incl. inventories-0.6-1.9-0.8-0.80.51.01.35. Exports of goods and services0.2-1.5-0.9-0.60.81.11.56. Final demand-0.3-1.8-0.8-0.70.61.01.47. Imports of goods and services1.3-2.0-0.4-1.0-0.90.41.08. Gross domestic product at market prices-1.1-1.6-1.2-0.71.51.51.7     HICP0.4-0.3-1.5-1.20.70.71.2 
 
 
 
 
 
 
 
 
 
 
 
 
2. European Commission macroeconomic and fiscal projections (2018 Spring Forecast) 

Table A2.5: 

Labour market and costs 

(1) Eurostat definition, % of labour force. 
Source: European Commission 

Table A2.6: 

External balance 

Source: European Commission 

43 

Percent change unless otherwise stated20132014201520162017201820191. Labour productivity0.00.40.50.10.51.10.92. Compensation per employee-5.4-3.6-1.2-0.70.71.42.03. Unit labour costs-5.4-4.0-1.7-0.80.30.31.14. Total population-0.2-1.1-0.60.50.90.60.75. Population of working age (15-64 years)-0.8-2.1-1.6-0.10.30.30.36. Employment-5.9-1.91.53.33.42.82.87. Unemployment rate (1)15.916.115.013.011.19.07.1EUR bn unless otherwise stated20132014201520162017201820191. Exports of goods (fob)2.72.82.92.62.52.42.52. Imports of goods (fob)5.75.65.86.57.07.57.93. Trade balance (goods, fob/fob) (1-2)-2.9-2.8-3.0-3.9-4.5-5.1-5.53.1 p.m. (3) as % of GDP-16.2-16.0-16.7-21.2-23.5-25.0-25.74. Exports of services7.98.18.69.29.810.210.75. Imports of services4.74.95.55.56.06.26.46. Service balance (4-5)3.33.23.13.73.84.04.26.1 p.m. 6 as % of GDP18.018.017.520.419.520.020.07. External balance of goods and services (3+6)0.30.40.1-0.1-0.8-1.0-1.27.1 p.m. 7 as % of GDP1.82.00.8-0.8-4.0-5.0-5.88. Balance of primary and secondary incomes-1.2-1.1-0.4-0.7-0.8-0.8-0.88.1 - of which, balance of primary income-0.8-0.60.1-0.3-0.4-0.4-0.48.2 - of which, balance of secondary income-0.4-0.5-0.5-0.5-0.4-0.4-0.48.3 p.m. 8 as % of GDP-6.7-6.4-2.2-4.1-4.1-4.0-3.99. Current external balance (7+8)-0.9-0.8-0.3-0.9-1.6-1.8-2.19.1 p.m. 9 as % of GDP-4.9-4.4-1.4-4.9-8.1-9.0-9.710. Net capital transactions0.30.00.00.00.10.10.111. Net lending (+)/net borrowing (-) (9+10)-0.6-0.8-0.2-0.9-1.5-1.7-2.011.1 p.m. 11 as % of GDP-3.5-4.6-1.1-4.7-7.6-8.6-9.3 
 
 
 
 
 
 
 
 
European Commission 

Post-Programme Surveillance Report 

Table A2.7: 

Fiscal accounts 

* Net of the one-off recapitalisation of the cooperative banking sector amounting to 8.6% of GDP in 2014        
(1) This includes an annual interest saving of EUR 30m related to the CBC asset-debt swap, which is subject to a decision of 
the CBC board in full respect of the independence of the CBC, the Treaty and the rules and procedures of the Eurosystem.         
(2) For 2013, this includes compensation of pension funds amounting to 1.8% of GDP in 2013.        
(3) For 2013, this includes signing fees for gas exploration amounting to 1.1% of GDP, which are treated as negative capital 
expenditure (disposal of non-produced assets).  
Source: European Commission 

44 

20132014*20152016201720182019levels, EUR mTaxes on production and imports2,4752,6002,6082,7403,0413,2003,334Taxes on income and wealth1,8741,8121,7611,7551,8351,9152,003Social contributions1,3621,4451,4831,5451,7071,7901,950Other current resources7931,0281,0241,0059981,0091,026Total current revenue6,5046,8846,8767,0447,5827,9148,313Capital transfers received16013010143898989Total government revenue6,6647,0146,9767,0877,6718,0038,402Compensation of employees2,5942,3412,2712,2602,3502,4452,571Intermediate consumption645575548531594628663Social transfers2,4842,4692,4682,5642,6182,6902,777Interest payments (1)696607674604611615605Subsidies95807297555656Other current expenditure403395463398462495521Total current expenditure6,9116,4626,4916,4496,6856,9227,187Total capital expenditure (2) (3)6782,125718574637678736Total government expenditure7,5958,5927,2137,0287,3287,6067,928General government balance-931-1,577-23659344397473General government primary balance-235-9714386639551,0111,078% of GDPTaxes on production and imports13.614.814.715.015.815.815.7Taxes on income and wealth10.310.39.99.69.69.59.4Social contributions7.58.28.48.58.98.99.2Other current resources4.45.85.85.55.25.04.8Total current revenue35.939.138.838.739.539.239.1Capital transfers received0.90.70.60.20.50.40.4Total government revenue36.739.839.338.939.939.639.6Compensation of employees14.313.312.812.412.212.112.1Intermediate consumption 3.63.33.12.93.13.13.1Social transfers13.714.013.914.113.613.313.1Interest payments (1)3.83.43.83.33.23.02.8Subsidies0.50.50.40.50.30.30.3Other current expenditure2.22.22.62.22.42.52.5Total current expenditure38.136.736.635.434.834.333.8Total capital expenditure (2) (3)3.712.14.03.23.33.43.5Total government expenditure41.948.840.738.638.137.637.3General government balance-5.1-9.0-1.30.31.82.02.2General government primary balance-1.3-5.52.53.65.05.05.1Nominal GDP18.117.617.718.219.220.221.2 
 
 
 
 
2. European Commission macroeconomic and fiscal projections (2018 Spring Forecast) 

Table A2.8:  Debt developments 

* Net of one-off recapitalisation cost of the cooperative banking sector amounting to 8.6% of GDP in 2014. 
Source: European Commission 

45 

20132014*20152016201720182019Gross debt (% of GDP)102.6107.5107.5106.697.5105.799.5Real GDP growth (% change in PYP)-4.2-2.40.42.23.25.24.9Nominal GDP (EUR bn)18.117.617.718.219.220.221.2General government balance (% of GDP)-5.1-9.0-1.30.31.82.02.2Change in gross debt ratio (pps change)22.94.90.0-0.9-9.18.2-6.1Contribution to the change in stockPrimary balance1.35.5-2.5-3.6-5.0-5.0-5.1Snow-ball effect9.86.62.90.5-2.3-1.7-2.2of whichInterest expenditure3.83.43.83.33.23.02.8Real growth effect5.11.5-2.1-3.6-3.9-3.3-3.4Inflation effect0.91.71.30.7-1.5-1.4-1.7Stock-flow adjustments11.9-7.2-0.52.2-1.815.01.3 
 
 
 
 
 
 
ADDENDUM 

1. Introduction  

This  addendum  to  the  PPS  report  aims  at 
providing  a  brief  overview  of  the  significant 
developments  in  the  Cypriot  banking  sector  that 
materialised  in  June  2018,  after  the  report  was 
drafted  and  discussed  at  the  Economic  and 
Financial Committee.   

On  15  June  2018, 
the  Cypriot  government 
endorsed  an  agreement  in  principle  with  Hellenic 
Bank for the sale of part of the assets of the Cyprus 
Cooperative Bank (CCB). As already mentioned in 
the  PPS  report,  the  sale  of  the  CCB  the  second 
largest bank in the country and which was publicly 
owned was initiated on 19 March. On 17 June, the 
government of Cyprus notified to the Commission 
for assessment under EU State aid rules their plans 
to  support  the  orderly  liquidation  of  the  CCB, 
including  the  sale  and  full  integration  of  some  of 
the CCB’s assets and deposits into Hellenic Bank. 
On 19 June, the Commission approved the Cypriot 
measures  to  facilitate  the  liquidation  of  the  CCB 
under national law. On 25 June, a business transfer 
agreement was signed between Hellenic Bank and 
the  CCB.  However,  finalising  the  transaction  is 
still  subject  to  a  number  of  approvals  by  the 
relevant EU and national authorities, as well as the 
conclusion  of  a  capital  raise  by  Hellenic  Bank. 
Therefore, the transaction may take several months 
to be finalised.  

These  are  the  final  steps  in  the  restructuring 
process  of  the  CCB,  which  was  initiated  by  the 
Cypriot authorities in February 2014 and modified 
in December 2015. Contrary to expectations at the 
time, the CCB was unable to return to viability: it 
failed  to  recover  much  money  from  its  very 
significant  portfolio  of  non-performing 
loans 
(NPLs),  partly  because  of 
the  CCB’s  own 
governance failures and partly because of obstacles 
created  by  the  Cypriot  legal  framework  to  work 
out NPLs.  

When  completed,  the  transaction  is  expected  to 
remove around EUR 6 billion of NPLs (25-30% of 
all NPLs) from the Cypriot banking sector, shifting 
them  and  the  associated  financial  costs  and  risks 
via  a  newly  created  asset  management  company, 
i.e.  ‘Residual  entity’  to  the  state.  Given  the 
significance  of  this  development,  this  addendum 
updates  the  PPS  report  by  providing  a  brief 
overview  of  the  State  aid  decision  of  19  June  as 

46 

well as an initial assessment of the likely impact of 
the  sale  on  the  financial  sector  and  the  fiscal  and 
macroeconomic outlook.   

2. Sale of the CCB 

2.1. Overview of the sale process and State aid 
measures decision  

The  sale  agreement  entails  that  parts  of  the 
CCB’s  assets  and 
liabilities  will  be  fully 
integrated  into  Hellenic  Bank,  while  the  rest 
will remain in the CCB’s Residual entity, to be 
owned  and  financed  by  the  state  and  wound 
down over time. No bidder was ready to take over 
the CCB’s assets and liabilities at a positive price. 
Therefore, public financial support measures were 
deemed  necessary  to  support  the  sale  of  certain 
assets  and  the  customer  deposits.  These  measures 
mainly  consist  of  (i)  an  injection  by  the  State  of 
around  EUR  3.5  billion  in  the  CCB  (which  will 
absorb  losses  made  by  the  Residual  entity),  of 
which EUR 2.5 billion was already provided on 3 
April, and (ii)  a counter-guarantee  by the State of 
the  guarantees  provided  by  the  CCB  to  Hellenic 
Bank, including a large asset protection scheme on 
a  portfolio  of  the  transferred  assets  (which  will 
cover  a  large  share  of  losses  made  by  Hellenic 
Bank on specific assets purchased from the CCB).   

legacy.  It  started  before 

The  restructuring  of  the  CCB  is  part  of  the 
banking  crisis 
the 
application of the post-crisis European Union legal 
framework  on  Bank  Recovery  and  Resolution 
(Directive 
The 
responsibility  to  deal  with  such  legacy  cases  lies 
with the Member States concerned and is governed 
by  national  law  preceding  the  transposition  of  the 
BRRD and needs to comply with in particular the 
EU State aid rules. 

2014/59/EU22, 

BRRD). 

The  Commission  concluded  that  the  public 
support  measures constitute State  aid, which is 
compatible  with  the  internal  market  under 

(22)  Directive  2014/59/EU  of  the  European  Parliament  and  of 
the Council of 15 May 2014 establishing a framework for 
the  recovery  and  resolution  of  credit  institutions  and 
investment 
firms  and  amending  Council  Directive 
82/891/EEC,  and  Directives  2001/24/EC,  2002/47/EC, 
2004/25/EC,  2005/56/EC,  2007/36/EC,  2011/35/EU, 
2012/30/EU  and  2013/36/EU,  and  Regulations  (EU)  No 
1093/2010  and  (EU)  No  648/2012  (OJ  L  173,  12.6.2014, 
p. 190). 

 
                                                           
In  particular, 

State  aid  rules,  including  the  2013  Banking 
Communication23. 
the  public 
support  has  been  instrumental  in  allowing  the 
orderly  market  exit  of  the  CCB,  through  the  full 
integration  of  some  activities  into  another  credit 
institution  and  the  wind  down  of  the  CCB’s 
Residual  entity.  The  Commission  also  confirmed 
that  the  measures  do  not  constitute  State  aid  to 
Hellenic Bank, because it was selected in an open, 
transparent  and  non-discriminatory  private  sales 
process,  fully  managed  by  a  private  global 
investment  bank,  ensuring  that  the  activities  were 
sold  at  the  best  offer  available.  As  part  of  the 
burden  sharing  requirements,  in  the  absence  of 
subordinated  bondholders,  the  shareholders  of  the 
CCB – represented by the State and the Resolution 
Fund – will be left in the Residual entity.  

to 

the 

aid 

State 

According 
decision 
underpinned  by  Cyprus’  commitments,  the 
CCB’s  Residual  entity  will  be  entirely  focused 
on working out its remaining assets. Thus, it will 
no  longer  carry  out  any  economic  activities  and 
will  cease  to  compete  in  the  banking  sector  (and 
not receive any financing from the ECB or Central 
Bank  of  Cyprus),  which  will  ensure  that  the 
distortion of competition arising  from the  aid  will 
be limited.  

2.2. Commitments   

As  part  of  the  State  aid  decision,  the  Cypriot 
government has made a series of commitments. 
These  cover,  among  others,  the  integration  of  the 
CCB’s  activities  into  Hellenic  Bank  and  the 
winding  down  of  the  CCB’s  Residual  entity,  as 
well as the efficient  work-out of NPLs in Cyprus. 
Implementation  of  these  commitments  is  not  only 
necessary 
the  distortions  of 
competition are limited to the minimum necessary 
but also to help safeguarding prospective financial 
stability.  

to  ensure 

that 

Cyprus  also  committed  to  introduce  significant 
amendments  in  the  insolvency,  foreclosure  and 
sale  of  loans  legislations  and  to  reform  the 
judicial  system.  These  reforms  should  improve 

(23)  Communication  from  the  Commission  on  the  application, 
from 1 August 2013, of State aid rules to support measures 
in  favour  of  banks  in  the  context  of  the  financial  crisis 
(“2013 Banking Communication”)  OJ C 216, 30.07.2013, 
p. 1. 

Addendum 

the  capacity  of  creditors  to  recover  money  from 
defaulted  borrowers  and  therefore  contribute  to 
reducing NPLs.  

compliance 

of  Cyprus  with 

The 
the 
commitments  stemming  from  the  State  aid 
decision  will  be  closely  monitored  by  an 
independent monitoring trustee. The trustee will 
report back to the Commission on a regular basis. 
In  parallel, 
the  Commission  will  continue 
following closely the actions taken to reduce NPLs 
under  the  EU  standard  surveillance,  including 
the 
Post-Programme 
Macroeconomic Imbalances Procedure. 

Surveillance 

and 

3. Impact on financial sector 

The CCB sale will result in moving a significant 
share  of  NPLs  out  of  the  Cypriot  banking 
system.  In  particular,  the  total  stock  of  NPLs 
within the Cypriot banking system  will drop from 
its  end-2017  volume  of  EUR  21  billion  to  around 
EUR  15  billion,  thus  removing  about  25-30 %  of 
NPLs  from  the  banking  sector.  When  the  sale  is 
completed  the  NPLs  of  Hellenic  Bank  are  also 
expected  to  fall  from  currently  around  52 %  to 
around  30-33 %  of  total  loans.  This  significant 
reduction  in  the  stock  of  NPLs  is  expected  to 
increase  confidence  in  the  banking  system.  The 
transfer  of  performing  loans  to  Hellenic  Bank, 
which has invested to improve its risk management 
framework,  may  also  reduce  the  likelihood  that 
those  loans  fall  into  non-performing  status  over 
time.  

Full and effective implementation of the reform 
commitments  undertaken  by 
the  Cypriot 
authorities  is  crucial  to  bring  about  a  positive 
impact  on  the  banking  sector  as  a  whole.  The 
amendments  of  the  insolvency  and  foreclosure 
frameworks  aim  to  increase  NPL  recovery  rates 
and reduce the losses for both the banking system 
and  the  State.  A  well-functioning  insolvency 
framework should reduce the likelihood of banks’ 
balance  sheets  being  filled  with  non-recoverable 
and 
NPLs.  Well-functioning 
foreclosure frameworks should also strengthen the 
viability of Hellenic Bank after the sale as well as 
of  the  entire  banking  sector,  which  is  still  highly 
burdened by NPLs.  

insolvency 

The effective management of the Residual entity 
will also be crucial to efficiently work out NPLs 

47 

 
                                                           
European Commission 

Post-Programme Surveillance Report 

in 
that 

thereby reducing the net costs to the State.  This 
requires that the governance of the Residual entity 
line  with  best 
is  carefully  designed  and 
is 
the  staff 
international  practice,  and 
competent,  adequately  trained  and  incentivised. 
Against  this  background,  it  will  be  important  that 
the scheme that the authorities intend to introduce 
for vulnerable borrowers is also carefully reviewed 
and  designed,  so  as  not  to  undermine  the  efforts 
being made to improve the payment culture. 

impact  although 

All  in  all,  the  CCB  sale  could  have  a  positive 
it  also  entails 
long-term 
downside  risks.  On 
the  one  hand,  further 
consolidation of the banking sector in Cyprus is a 
welcome step, given the size of the economy. The 
sale  process  is  also  expected  to  increase  the 
stability  of 
improve 
depositors’  confidence.  On  the  other  hand,  it 
reinforces  the  interlinkages  between  the  financial 
sector and the sovereign. Moreover, the authorities 
should  also  closely  monitor  potential  adverse 
effects  that  may  arise  due  to  the  increased 
concentration  in  the  banking  sector,  in  particular 
on lending rates and conditions. 

the  banking  sector  and 

Impact  on  macroeconomic  and 

4. 
outlook  

fiscal 

The very high stock of NPLs and developments 
in the financial sector since 2018 were the major 
downside  risks  to  the  Cypriot  macroeconomic 
outlook,  which  will  be  reduced  with  the 
completion  of  the  sale.  Cyprus  macroeconomic 
performance has been particularly robust in the last 
couple of years. Growth was 3.9% in 2017, placing 
Cyprus  among  the  fastest  growing  economies  in 
the Euro Area, and is expected to remain strong in 
2018  and  2019.  Unemployment  fell  rapidly  but 
wage  pressures  remained  contained,  keeping  a  lid 
on inflation. However, very high ratio of NPLs and 
the  recent  developments  related  to  the  CCB 
increased the risks and added a major uncertainty. 
The orderly sale of the CCB combined with market 
exit  and 
the 
foreclosure  and  insolvency  frameworks  would 
the 
reduce 
the  uncertainties  and 
macroeconomic  outlook.  Furthermore, 
these 
changes  aim  to  improve  the  payment  discipline 
and  the  overall  soundness  of  the  banking  sector, 
restore  the  healthy  flow  of  credit  in  the  economy 
and strengthen investors’ confidence. 

the  foreseen  strengthening  of 

risks 

to 

48 

the 

strong 

Following 
fiscal 
remarkably 
performance  in  recent  years,  the  costs  of  the 
CCB sale assumed by the State are expected to 
noticeably  dent  the  fiscal  outlook.  After  falling 
significantly  to  97.5 %  of  GDP  in  2017,  the 
issuance  of  government  debt  to  the  CCB  in  April 
2018  per  se  increased  public  debt  to  a  projected 
105.7 %  of  GDP  in  2018.  The  completion  of  the 
CCB  sale  gives  rise  to  further  fiscal  costs  and 
increases 
the 
developments in the financial sector. In particular, 
public  debt  is  estimated  to  increase  to  around 
110 %  of  GDP  in  2018,  with  the  agreed  in 
principle issuance of additional government debt to 
the  CCB,  which  also  entails  a  corresponding 
increase  in  financing  needs.  Moreover,  contingent 
liabilities,  in  the  form  of  government  guarantees, 
are expected to increase substantially, notably due 
to  the  large  agreed  asset  protection  scheme  in 
favour of Hellenic Bank.  

sovereign 

exposure 

the 

to 

fiscal 

being 

While  there  are  also  mitigating  factors,  the 
significant 
incurred 
risks 
underscore  the  need  for  a  continuation  of  very 
prudent  fiscal  policy.  The  fiscal  position  is 
projected  to  remain  strong,  with  the  headline 
surplus  expected  at  around  2 %  of  GDP  in  2018 
and 2019, excluding the potential fiscal impact of 
the  measures  related  to  the  CCB.  In  addition, 
public debt is projected to resume a declining path 
in 2019. Moreover, while the sale of the CCB was 
ongoing,  Cyprus’  sovereign  credit  rating  was 
upgraded  by  Fitch  and  DBRS  by  one  notch,  both 
keeping  outlook  at  positive.  It  is  worth  noting  in 
this  context  that  the  potential  impact  on  public 
finances of the bank support measures is subject to 
a formal decision on the statistical treatment by the 
competent authorities, EUROSTAT and CYSTAT. 
It  should  furthermore  be  kept  in  mind  that  the 
current  government  headline  surplus,  refinancing 
costs  and  financing  needs  projections  are  also 
subject to uncertainty and rely on the continuation 
of current strong macroeconomic conditions, fiscal 
discipline, and favourable financing conditions for 
the banking sector and the sovereign. As illustrated 
by the recent market volatility, there is no room for 
complacency.  Thus, 
continuous  prudent 
a 
budgetary  policy  remains  essential  to  safeguard 
fiscal  sustainability  in  line  with  the  requirements 
under  the  preventive  arm  of  the  Stability  and 
Growth Pact. 

 
 
EUROPEAN ECONOMY INSTITUTIONAL SERIES 

European  Economy  Institutional  series  can  be  accessed  and  downloaded  free  of  charge  from  the  following 
address:  
https://ec.europa.eu/info/publications/economic-and-financial-affairs-
publications_en?field_eurovoc_taxonomy_target_id_selective=All&field_core_nal_countries_tid_selective=All
&field_core_date_published_value[value][year]=All&field_core_tags_tid_i18n=22621. 

Titles published before July 2015 can be accessed and downloaded free of charge from: 
• 

http://ec.europa.eu/economy_finance/publications/european_economy/index_en.htm  
(the main reports, e.g. Economic Forecasts) 
http://ec.europa.eu/economy_finance/publications/occasional_paper/index_en.htm  
(the Occasional Papers) 
http://ec.europa.eu/economy_finance/publications/qr_euro_area/index_en.htm 
(the Quarterly Reports on the Euro Area) 

• 

• 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
GETTING IN TOUCH WITH THE EU 

In person 
All  over  the  European  Union  there  are  hundreds  of  Europe  Direct  Information  Centres.  You  can  find  the 
address of the centre nearest you at: http://europa.eu/contact.  

On the phone or by e-mail 
Europe  Direct  is  a  service  that  answers  your  questions  about  the  European  Union.  You  can  contact  this 
service:  
• 
• 
• 

by freephone: 00 800 6 7 8 9 10 11 (certain operators may charge for these calls), 
at the following standard number: +32 22999696 or 
by electronic mail via: http://europa.eu/contact.  

FINDING INFORMATION ABOUT THE EU 

Online 
Information  about  the  European  Union  in  all  the  official  languages  of  the  EU  is  available  on  the  Europa 
website at: http://europa.eu. 

EU Publications 
You  can  download  or  order 
from  EU  Bookshop  at: 
http://publications.europa.eu/bookshop.  Multiple copies of free publications may be obtained by contacting 
Europe Direct or your local information centre (see http://europa.eu/contact).  

free  and  priced  EU  publications 

EU law and related documents 
For  access  to  legal  information  from  the  EU,  including  all  EU  law  since  1951  in  all  the  official  language 
versions, go to EUR-Lex at: http://eur-lex.europa.eu.  

Open data from the EU 
The  EU  Open  Data  Portal  (http://data.europa.eu/euodp/en/data)  provides  access  to  datasets  from  the  EU. 
Data can be downloaded and reused for free, both for commercial and non-commercial purposes.