Cyprus’s first report card from international creditors included praise and underlined the next challenge: be more Irish than Greek.
Economic output fell less than estimated in the first half of the year and sentiment indicators rebounded from lows in April, a month after the euro area’s first rescue that included seizing deposits and imposing capital controls. The yield on Cypriot bonds maturing in February 2020 dropped 4.2 percentage points to 11.2 percent from the peak level on March 28.
“Program implementation matters,” said Thanos Vamvakidis, a currency strategist at Bank of America Merrill Lynch in London. “We’ve seen this in the case of Ireland where program implementation is supposed to be strongest, compared to Greece where it has been the weakest.”
Ireland, which followed Greece in 2010 and sought emergency funding as borrowing costs soared, is seeking to exit its bailout program this year and finance itself from markets again after 10-year bond yields dropped to below those of Italy and Spain. Greece meanwhile is flirting with a third loan package after six straight years of recession.
Cypriot President Nicos Anastasiades said in an interview in Nicosia last week that his country aims to be “the best” at implementing its agreement with the European Union, European Central Bank and International Monetary Fund.
His goal is to spur growth, tackle rising unemployment and in January dismantle the restrictions on the movement of money that accompanied the banking crisis. The Cypriot economy contracted at an annualized rate of 5.9 percent in the second quarter, following a 5 percent drop in the first quarter.
“We will proceed with the same consistency and decisiveness we have applied to the terms of the loan agreement so far,” said Anastasiades, who was elected in February. “We will be among the best in applying what’s been agreed.”
IMF Managing Director Christine Lagarde warned this month there was no room for slippages, saying continued strong ownership and steadfast policy implementation were “critical” to Cyprus’s success at restoring financial health.
Even after a promising beginning, it’s “too early to tell” whether Cyprus will follow the example of bailout darlings like Ireland, said Vamvakidis at Bank of America Merrill Lynch. Ireland is three quarters of the way through 33.4 billion euros ($45 billion) of spending cuts through 2015.
Cypriot and Greek debt is rated sub-investment grade, or junk, by Moody’s Investors Service, Standard & Poor’s and Fitch Ratings. Ireland is rated junk at Moody’s. The yield on Cyprus’s February 2020 government bonds was more than three times higher than the 3.58 percent of comparable Irish debt.
Cyprus, which replaced the Cypriot pound with the euro in 2008, won approval for its second disbursement of funds this month, part of the 10 billion-euro rescue program decided in March with the troika of creditors.
Under the plan, Bank of Cyprus is absorbing the second- biggest lender, Cyprus Popular Bank Pcl. Bank of Cyprus shareholders elected a 16-member board on Sept. 11 that must finalize by the end of this month a restructuring plan following the acceptance in August of a voluntary redundancy program by about 25 percent of the lender’s workforce.
The euro area’s first capital controls were imposed after a two-week closure of all banks in March as investors and savers moved their money to safer destinations. The restrictions are being gradually withdrawn, Anastasiades said.
“Certainly the sooner they are lifted the better, as they just reinforce a lack of confidence in the banking sector,” said Fiona Mullen, director of research firm Sapienta Economics in Nicosia. “However, I think the authorities will be hard pushed to lift all controls by January because they depend on certain structural targets being met.”
Also causing anxiety among creditors is unemployment. The jobless rate climbed at a faster pace than anticipated under the bailout program and constitutes a serious challenge, the European Commission said in a report published Sept. 18.
Unemployment will rise to 19.5 percent in 2014 from 17 percent this year, compared with an April forecast for an increase to 16.9 percent next year from 15.5 percent in 2013. Gross domestic product is set to shrink a cumulative 13 percent in 2013 and 2014 under the weight of budget measures and as the financial industry shrinks, according to the EU and IMF.
Mullen said that while the economy might beat targets this year, 2014 could see a decline of as much as 7.5 percent as banks begin to tackle bad loans and dismiss workers.
“Cyprus had a very good start and that’s important,” said Vamvakidis, the Bank of America Merrill Lynch strategist. “They need to first fix the banks. If you don’t fix the banks, you can’t have a recovery. It’s as simple as that.”