Projections of the Central Bank of Cyprus (CBC) within the framework of the discussion of the state budget for 2015
Nicosia, 1 December 2014
It is with appreciation, respect and a sense of responsibility that I have come to the Parliamentary Committee on Financial and Budgetary Affairs, after your kind invitation to present my views as Governor of the Central Bank during the debate of the state budget for the year 2015. I am optimistic that 2015 will be the starting point for the return of our economy to growth. This optimism is based on our experience so that the progress towards the end of the crisis has been proceeding at a faster pace and the results are more positive than initially forecasted. The maturity shown by the Cypriot people during these difficult times has certainly helped in the path to recovery.
During 2013, the banking sector in our country faced the most critical period in its history. Cypriot banks faced major liquidity problems and balance sheet imbalances with negative consequences. Since then, the problems have been dealt decisively with a series of corrective measures which have repositioned the banking system on a sound footing.
Systemic banks have strengthened their capital adequacy, while the banking regulatory and supervisory framework has been significantly strengthened. Larger banks have proceeded with the implementation of their restructuring plans, the implementation of corporate governance has improved and changes continue.
The four major banks in Cyprus participated in the pan-European comprehensive assessment conducted jointly by the European Banking Authority (EBA) and the European Central Bank (ECB). The successful results of the exercise now allow the banking sector to focus on its normal functions and play a leading role in the process of Cyprus’s economic recovery.
The healthy and well-capitalised banks will now be able to grant viable loans to households and small businesses that are the backbone of our economy. Furthermore, the CBC will now be able to focus and address the issue of the restructuring of loans, which must be dealt with in a rational, fair and sustainable manner. This is expected to reduce non-performing loans and have positive effects on interest rates and the general economic climate for the benefit of households and businesses.
In relation to economic growth, I would like to note with satisfaction the positive developments since the conclusion of the Memorandum of Understanding. The initial forecasts of our lenders for a significant recession in 2013, amounting to 8,7% did not materialise, with the outturn contained at 5,4%. During the fifth assessment of the economic programme, which took place in July 2014, the Troika adopted a very conservative baseline scenario for 2014. Both the IMF and the European Commission have recently revised this with a more positive outlook.
More specifically, while the forecasts of the fifth assessment in July 2014 indicated a decline of around 4,2% for 2014, the most recent revised forecasts of the IMF and the European Commission expect a contraction of real GDP by 3,2% and 2,8%, respectively. Based on the latest available data, the CBC considers the European Commission's forecast to be more realistic.
The forecasts of the Troika from the fifth assessment are incorporated in the state budget for 2015. Therefore, this budget is necessarily conservative, which would allow, in my opinion, the fastest achievement - and with positive deviations – of the fiscal objectives. This is also required to fully restore confidence, eliminate uncertainty, and achieve the return of economic activity to positive and sustainable levels. Thus, there needs to be continued adherence to the budgetary targets and strict implementation of the measures included in the budget for 2015.
In terms of economic activity in 2015, this is in line with the expected slight recovery in domestic demand. The revised forecasts of both the IMF and the European Commission as well as of the Ministry of Finance, indicate a marginal increase in GDP of around 0,5% in real terms. We are in agreement with these estimates.
In relation to the fiscal balance, the forecasts of our international lenders in the evaluation of the stimulus programme broadly followed the relatively more pessimistic forecasts for economic growth. The budget deficit as a percentage of GDP in the Memorandum of Understanding agreed in April 2013, placed this forecast at 8,3% of GDP for 2013. However, the outturn was 5,4% of GDP, i.e. about three percentage points lower than initially projected. In part, the positive divergence resulted from the relatively smaller than expected recession. Mostly, though, it came from reductions on the expenditure side, resulting from the effective implementation of the state budget.
Our international lenders initially projected the budget deficit for 2014 to be 4,7% of GDP. However, this forecast is already outdated, as evidenced by the more updated forecasts of the IMF and the European Commission, which refer to a deficit of 4,4% and 3%, respectively. These revisions also make the fiscal forecasts for 2015 relatively more favourable, provided of course that the consistent and prudent implementation of the state budget continues. This certainly does not mean that the country’s vulnerable groups will be ignored. On the contrary, the further tidying up of public finances will allow essential support to needy citizens to continue in the medium and long term.
Finally, I would like to refer briefly to the public debt and note that according to the recent announcement of the results of the overall evaluation of the Cypriot banks, it appears that the €1 billion included in the Troika’s financial support programme, which was intended to cover the capital needs of the Cypriot banking system, will not be used for this purpose. Therefore, it is possible at a later stage for the Republic of Cyprus either not to borrow this amount or to use it in order to refinance the existing debt which bears a higher interest rate. There is also an important improvement in the level of public debt expected to result from the savings achieved by the better than expected fiscal results.
The developments in the banking system, the fiscal sector and the economy in general constitute a positive outlook. This is recognised by the international credit rating agencies which have recently upgraded the sovereign ratings. These upgrades reflect the gradual but steady regaining of the credibility of the Cyprus financial sector and economy in general in the markets. However, by itself, this is not enough and does not constitute a final goal nor a reason for complacency. Instead, vigilance is needed since the ultimate goal is the complete restoration of confidence in the economy, ensuring sound macroeconomic conditions and sustainable development in conditions of full employment.
In conclusion, I would like to reiterate the commitment of both the CBC and myself to the full consolidation of the banking system and our economy. Some battles were won but this does not in any way mean that there is room for complacency. The consolidation effort of all sectors of our economy needs to continue unabated so that our country can finally be able to leave behind the recent crisis and enter resolutely on a path of sustainable growth and full employment. The adoption and proper planning and implementation of the budget for 2015 will be an important step in this direction.