IMF sees smooth Cyprus ERM2 entry

NICOSIA – The IMF believes Cyprus’s admission to ERM2 will be technically «straightforward» and sees no need to adjust the Cyprus pound’s current reference rate against the euro, a fund official said on Friday. Thomas Richardson, head of the International Monetary Fund’s mission to Cyprus, noted it was exclusively for the Cypriot government and the European Union to determine the rate which the pound would peg to the euro in ERM2. However, he added in response to a question: «Looking ahead, one should ask if a move on the exchange (rate) would provide any benefit. Any competitive gain you might get might rapidly get eaten up by higher inflation.» Cyprus, one of 10 European Union newcomers, is seen making its bid for entry into the European Exchange Rate Mechanism, a stabilization anteroom to euro adoption, either later this year or early in 2005. It would require anchoring the Cyprus pound to the euro at a central parity rate with a 15 percent fluctuation band. Cyprus has enforced a rigid cost-cutting drive in a bid to streamline deficits and get the country into the eurozone by 2007, or early in 2008 at the latest. The present central reference rate is one Cyprus pound equaling 1.7086 euros, and the national currency fluctuates in an unofficial band of 15 percent. The IMF mission was in Cyprus as part of an economic assessment held every two years. A preliminary report issued on Friday noted that the island already had in place a successful exchange rate framework similar to ERM2 «so technically the move should be straightforward,» the team said. «Politically, moving into ERM2 will require expenditure restraint and the courage to tackle long-overdue structural reforms,» it added. The IMF has for years been calling on Cypriot authorities to modify COLA, a system which automatically adjusts salaries based on headline inflation. Reforms and debt worry The IMF argues that the mechanism, which authorities show no signs of dismantling, hinders labor mobility and competition. Cyprus is now fully focused on cutting its budget deficit to 5.2 percent of GDP this year from 6.4 percent in 2003. Plans to cut it to 2.9 percent at the end of 2005 hinge on a fiscal consolidation package. Controversial proposals increasing the retirement age in the civil service to 63 from 60 are an integral part of the game plan. Authorities have at the moment ruled out new taxes to plug the deficit gap. «We would view a moderate tax increase as a last resort,» Richardson said. The growing burden of Cyprus’s net external liabilities was also of some concern and an external debt stock of nearly half of the GDP was «moderately worrisome,» he said. Cyprus successfully launched a 500-million-euro bond earlier this year, priced at 23 basis points over the comparable German bund benchmark. «Although lower-cost external borrowing is welcome, it should not feed a temptation to relax fiscal adjustment efforts. It also suggests a need to deepen domestic debt markets,» Richardson said.