CYPRUS AT RISK OF DEEPER RECESSION

In recent months, Cyprus has faced an unprecedented and deepening crisis that has necessitated drastic measures to resolve it. To address the short- and medium-term financial, fiscal and structural challenges, the country has agreed to an ambitious reform programme, backed by substantial financing from international organisations, aimed at restoring financial stability and achieving sustainable public finances to support the recovery of economic activity.

Risks to the outlook are substantial and tilted to the downside. Notably, macroeconomic risks remain unusually high, given the uncertain impact of the banking crisis and fiscal consolidation on economic activity and the adaptation of the business model. On the domestic side, given the size of the banks having been resolved, the losses faced by uninsured resident depositors, temporarily frozen corporate accounts and the need to impose payment restrictions, there are concerns that recession could prove to be deeper than anticipated, with negative feedback loops on public finances, including government debt. Banking sector risks also remain high, including funding liquidity pressures, rising non-performing loans, litigation risks, the future impact of administrative restrictions as well as the potential consequences of their premature lifting and the likelihood of not implementing the programme reforms fully or in a timely manner.

According to the The International Monetary Fund  (IMF) substantial risks still loom for the Cypriot economy even after a multibillion-dollar international bailout aimed at averting a debt default. The IMF latest report predicts a deep recession in Cyprus this year and next, and said there is a danger that the downturn could turn even more severe if authorities do not adhere strictly to conditions imposed as part of the $13 billion bailout deal. The IMF said there are substantial risks that the negative effects of the crisis could be even worse than what is currently anticipated. It said the impact of the banking crisis on economic growth is "highly uncertain'' and an economic slump could result in a "vicious cycle'' of bankruptcies, drops in real estate prices, bank losses and unemployment. If that happens it "could also lead to a deeper recession than anticipated,'' the report said. It also raised the risk that a crisis of confidence could drive away investments by foreign banks and large depositors, further weakening the already-imperiled banking system. The IMF report projects that the Cypriot economy will shrink by 9 percent this year and a further 4 percent in 2014, with unemployment forecast to peak around 17 percent in 2014. However, it says there is a risk this contraction could be even deeper.

Admittedly time is needed to allow the Cyprus economy to address its imbalances, adjust to the deep structural changes in the banking sector and adapt the business model that will set the conditions for sustainable and balanced growth. Restoring financial stability will in turn help to spur economic growth and job creation.