It also assessed that returning the economy to its potential growth depends critically on a credible fiscal consolidation, continued market confidence in the financial sector, and structural reforms to improve competitiveness and the business climate.
According to the IMF assessment, concluded on August 27, the near-term outlook is still fragile as global financial risks remain elevated and growth prospects in trading partners muted, while a positive inflation differential with the euro area has reopened.
Directors also agreed that the immediate policy challenge is to reverse the large structural fiscal deficit following the sizeable stimulus in 2009, with a view to preserving debt sustainability and creating fiscal space to guard against financial sector risks.
They welcomed the government’s commitment to reduce the deficit to below 3 per cent of GDP by 2012, consistent with its EU obligations.
Containing the wage bill and better targeting social transfers were seen as important elements, while more fundamental reforms of the pension system would also be needed to lessen the burden on public finances, through lower replacement rates and higher retirement age, the report said.
In light of the still large current account deficit, Directors stressed that structural reforms aimed at boosting competitiveness would be crucial for supporting the recovery and enhancing growth potential.
According to the assessment key priorities include restraining public sector wages and employment to free resources for the private sector, and phasing out the wage indexation system to allow wages to reflect productivity gains. Also, active labour market policies, aimed particularly at addressing skill mismatches, should help reduce unemployment.
Directors observed that the banking sector remains sound and retains a capacity to absorb further shocks, as suggested by stress test results, including those conducted in the context of the EU-wide exercise.
However, they noted that risks have risen significantly both in Cyprus and in the region and in light of the relatively large size and external exposure of Cyprus’ financial sector, these risks call for continued vigilance, close cooperation with foreign supervisors, and an enhanced framework for crisis management and contingency planning, including for cross-border banks.
Cyprus was placed under the Excessive Deficit Procedure of the EU on July 2010, prompting the government to adopt a programme of fiscal consolidation aimed at reducing the fiscal deficit to 4.5 percent of GDP in 2011 and below 3 percent in 2012.
Published on September 5, 2010, Cyprus Mail