Cyprus: IMF staff concluding statement of the 2025 Article IV Mission

Nicosia, 28 March 2025

Cyprus has demonstrated impressive resilience to successive shocks. Growth has remained among the highest in the euro area, mainly supported by foreign investment, strong tourism, and a boom in the ICT sector. Inflation is declining but remains above 2 percent and signs of moderate overheating have emerged. Fiscal performance continues to be strong, with debt on a firm downward trajectory.

Key policy priorities

• Fiscal policy should focus on reducing debt comfortably below 60 percent of GDP to enhance resilience and boost confidence.
• Any fiscal loosening—including unbudgeted public sector pay increases—should be avoided, especially given that inflation risks remain elevated.
• The financial sector appears resilient but requires continued vigilance, including close monitoring of the real estate sector.
• Improving the efficiency of the judicial sector is essential to support investment-driven growth.
• Labor policies should focus on addressing skill mismatches, encouraging higher female employment, and further reducing youth unemployment.
• Key energy projects and reforms should be expedited to enhance energy security and meet climate commitments.

Robust Growth, Persistent Inflation, and Strong Fiscal Performance

Growth has been robust, albeit with some signs of moderate overheating. Last year, growth of 3.4 percent was among the highest in the euro area, supported by strong export of services and consumption. The labor market remains tight, with the unemployment rate declining further and high but moderating job vacancy rates. Although uncertainty is high, taken together there are modest signs of economic overheating. However, growth is expected to moderate to around 2½ percent this year and gradually stabilize at 3 percent in the medium term.

Inflation remains somewhat elevated. Consistent with the euro area trend, rising services prices have kept inflation above 2 percent. Part of this is due to the ongoing pass-through from the 2022 energy price shock. But a tight labor market and rising wages have also contributed to price pressures. At the same time, inflation is anticipated to stabilize at 2 percent by the end of the year.

The strong fiscal position is rapidly lowering public debt. The primary fiscal surplus recorded 5.8 percent in 2024, as strong revenue growth overshadowed higher public wages and social transfers. High growth and strong fiscal performance led to a further decline in public debt to 65 percent of GDP at the end of 2024, from 74 percent a year before, amid ample cash buffers.

Near-term risks are tilted to the downside, while longer-term risks are more balanced. External risks include potential trade conflicts impacting Cyprus’s main trading partners, the intensification of regional tensions, or new energy price shocks. Domestic risks include further overheating, potentially triggered by looser fiscal policy. Further out, investment-driven growth will depend on steady progress on structural reforms, including those outlined in the Recovery and Resilience Plan (RRP). Conversely, Cyprus’s nimble and dynamic economy presents significant upside potential.

Further Building Fiscal Buffers and Promoting Long-Term Growth

Fiscal policy should prioritize debt reduction. Given overheating risks, new discretionary measures that loosen fiscal policy should be avoided. Instead, fiscal policy should target bringing debt sufficiently below 60 percent of GDP to allow a robust buffer against potential shocks. The authorities’ commitment to fiscal surpluses up to 2028 in the Medium-Term Fiscal Structural Plan delivered under the new EU economic governance framework is consistent with this objective.

Rising fiscal pressures call for fiscal space to be carefully guarded. Spending needs to realize the climate and digital transitions will continue to ramp up beyond the expiration of RRP funding. Meanwhile, population ageing will require increased expenditures on pensions and health on top of other potential long-term needs. Hence, the scope for loosening in the medium term is limited.

Public spending should support investment, while maintaining flexibility in the face of shocks. Priority should be given to capital spending to raise potential growth and support the climate transition. Meanwhile, expansion of rigid current spending such as increasing the public wage bill, expanding subsidies, or launching untargeted social programs should be avoided to maintain agility in the face of potential new shocks to the economy. Specifically, the authorities should refrain from further increases to the cost-of-living-adjustment (COLA) indexation or new ad-hoc pay rises to contain the already large public-private wage gap and avoid further pressure on real wage growth.

Emerging fiscal risks should be carefully managed. Additional resources may be required to fund the completion of large energy infrastructure projects, meet higher-than-projected uptake of the mortgage-to-rent scheme, and acquire carbon emission rights. The evolution of these fiscal risks should be closely monitored and incorporated into Cyprus’s medium term fiscal plans to avoid a sudden materialization that could compromise compliance with fiscal rules or progress on debt reduction.

Maintaining Financial Sector Resilience

The banking sector has large capital and liquidity buffers, and financial sector risks appear to be contained. Profitability metrics are at record highs for the second year in a row, while capitalization levels grew to among the highest in Europe. Despite high interest rates, asset quality improved further as non-performing loans (NPLs) declined, supported by strong economic growth. Nevertheless, continued vigilance is required, including the close monitoring of the real estate sector.

Recent tightening of the macro-prudential policy stance will further strengthen buffers. The announced increase to the Counter-Cyclical Capital Buffer (CCyB) will build greater resilience by securing already high capital buffers with little impact on credit and economic growth. Looking ahead, careful calibration of macro-prudential policies should continue balancing financial stability and healthy credit intermediation.

Legacy NPLs continue to fall but remain elevated. Most NPLs have now successfully migrated from the banking sector and do not pose a significant risk to financial stability. The continued resolution of legacy NPLs should accelerate with the foreclosure framework now in full operation and a high uptake of the mortgage-to-rent scheme.

Unlocking Long-Term Growth Potential

Structural reforms aimed at improving the efficiency of the judiciary and increasing labor productivity are essential to support long-term growth. With employment already at a high level, capital will become an increasingly important driver of growth. Therefore, policies should ensure a stable and streamlined business environment conducive to investment. Further efforts are needed in the judicial sector to strengthen the institutional framework supporting insolvency and creditor rights and improve the efficiency of courts. Labor-oriented policies should focus on addressing skill mismatches and activating remaining segments of the labor force, particularly among youth and the long-term unemployed.

Key energy projects and reforms must be expedited to lower energy prices, improve energy security, and meet climate commitments. Completing the Vassiliko LNG terminal and the Great Sea Interconnector would be significant steps toward achieving these goals. Similarly, the opening of the electricity market to greater competition would help reduce costs and emissions through market mechanisms. The planned adoption of green taxation would further support the energy transition.

Maintaining a strong anti-money laundering (AML) framework is crucial for safeguarding against reputational risks and business uncertainty. Ongoing efforts to extend the definition of obliged entities for AML supervision are welcomed. The proposed establishment of the National Sanctions Implementation Unit at the Ministry of Finance will provide greater clarity to reporting entities regarding sanctions compliance.

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A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF’s Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.

Source – IMF