IMF Wraps Up 2025 Article IV Talks with Cyprus

• Growth is expected to decelerate to 2.5 percent in 2025 and stabilize at 3 percent in the medium term as Cyprus shifts towards more investment-driven growth.
• The fiscal surplus reached an impressive 4.3 percent of GDP in 2024, while public debt declined to 65 percent of GDP. Fiscal policy should continue to prioritize debt reduction to further build buffers against potential shocks.
• The banking sector boasts substantial capital and liquidity buffers, with financial risks appearing well-contained. The recent tightening of the macroprudential policy stance, will further enhance these financial buffers.

Washington, DC: The Executive Board of the International Monetary Fund (IMF) completed the Article IV Consultation for Cyprus and endorsed the staff appraisal without a meeting. [1] The authorities have consented to the publication of the Staff Report prepared for this consultation. [2]

In 2024, Cyprus's growth accelerated to 3.4 percent—one of the highest rates in the euro area (EA)—driven by a strong tourism season, continued Information and Communication Technology (ICT) sector expansion, and robust public and private consumption. While inflation has remained volatile, it has generally decreased, with headline inflation falling to 2.1 percent by March 2025. Fiscal performance continues to be very strong, with the fiscal surplus increasing to 4.3 percent of GDP in 2024, supported by robust tax revenues. As a result, public debt has declined to 65 percent of GDP by the end of 2024, while cash buffers remain large. Financial conditions remain tight, accompanied by subdued credit growth. Nevertheless, the banking sector possesses sizable capital and liquidity buffers, and overall banking sector risks appear contained.

Growth is expected to moderate to 2.5 percent in 2025 before reaching 3 percent in the medium term, driven by higher investment and structural reforms. Inflation is anticipated to hit the 2 percent target later this year, supported by moderating growth and lower oil prices. Near-term risks are tilted to the downside, including from elevated uncertainty from global trade tensions. In contrast, longer-term risks are more balanced, with risks on insufficient progress on structural reforms acting against the upside potential of Cyprus's evolving business model.

Executive Board Assessment

In concluding the 2025 Article IV consultation with Cyprus, Executive Directors endorsed staff's appraisal, as follows:

Cyprus has demonstrated remarkable economic resilience, with growth among the highest in the EA. This strong performance is underpinned by robust service exports and domestic consumption. The labor market remains tight, characterized by a declining unemployment rate and elevated job vacancy levels. While uncertainties persist, there are indications of potential overheating in the economy. This, along with tariff-related trade disruption, will lead growth to moderate this year. While volatile, inflation is projected to stabilize around 2 percent by the end of the year. The current account deficit is estimated to have moderated in 2024, but the external position is assessed to be weaker than the level implied by fundamentals.

The immediate outlook presents downside risks, while longer-term risks appear more balanced. An escalation of trade conflicts—particularly if this broadened to include services trade and FDI—poses an important downside risk. An escalation of regional tensions, and possible new energy price shocks, could affect FDI, tourism, and inflation. Domestically, there are concerns about further overheating, which may arise from a more accommodative fiscal policy. In the medium-to-long term, investment-driven growth will rely on continuous progress in structural reforms. On the upside, Cyprus's agile and dynamic economy offers substantial potential for growth.

Cyprus's strong fiscal position has reduced vulnerabilities. In 2024, the primary fiscal surplus reached 5.6 percent, fueled by significant revenue growth that more than compensated for increased public wages and social transfers. As a result, public debt decreased to 65 percent of GDP by the end of 2024, with substantial cash reserves supporting liquidity. This further increased resilience, built policy space for future shocks, and improved investor sentiment.

Fiscal policy should continue to prioritize debt reduction. Given overheating risks, it is crucial to avoid new discretionary measures that would ease fiscal policy and add to inflationary pressures. Instead, efforts should focus on reducing debt well below 60 percent of GDP, thereby ensuring a robust buffer against potential shocks. The authorities' commitment to maintaining fiscal surpluses through 2028, as specified in the MTFSP under the new EU economic governance framework, supports this goal.

As spending pressures increase, careful management of fiscal space is essential. The financial commitments required for achieving climate and digital transitions will persist beyond the end of EU RRP funding. Additionally, an aging population will necessitate higher expenditures on pensions and healthcare, alongside other long-term expenditures. As a result, the scope for fiscal loosening in the medium term is constrained.

Public spending should emphasize investment while retaining flexibility in response to economic shocks. Capital expenditures should take precedence to enhance potential growth and facilitate the climate transition. At the same time, expanding current spending—such as increasing public wages, broadening subsidies, or introducing untargeted social programs—should be avoided. Specifically, the authorities should resist further increases to the COLA indexation or new ad-hoc salary increases to contain the existing substantial public-private wage gap and prevent additional pressure on real wage growth.

The banking sector boasts substantial capital and liquidity buffers, with financial risks appearing well-contained. Profitability metrics have reached record highs for the second consecutive year, and capitalization levels are now among the highest in Europe. Despite elevated interest rates, asset quality continues to improve, supported by strong economic growth. Nonetheless, ongoing vigilance is essential, particularly concerning the real estate sector.

Recent tightening of the macroprudential policy stance will enhance financial buffers further. The announced increase in the CCyB will bolster resilience by securing already high capital buffers without adversely affecting credit availability or economic growth. In the future, careful calibration of macroprudential policies should continue to strike a balance between financial stability and effective credit intermediation.

Although legacy NPLs continue to decrease, they remain at elevated levels. Most NPLs have been successfully transitioned away from the banking sector and do not pose a significant issue for financial stability. The ongoing resolution of legacy NPLs is expected to accelerate, given the full operationalization of the foreclosure framework and a strong uptake of the mortgage-to-rent scheme. Resolving legacy NPLs is expected to help mobilize domestic capital.

Structural reforms aimed at enhancing judicial efficiency and boosting labor productivity are vital for fostering long-term growth. With employment levels already high, capital deepening will increasingly drive growth. Consequently, policies must create a stable and streamlined business environment conducive to investment. Additional efforts are required in the judicial sector to strengthen the institutional framework for insolvency and creditor rights and to improve court efficiency. Labor policies should focus on addressing skill gaps and mismatches and engaging remaining segments of the labor force, particularly among youth and the long-term unemployed.

Key energy projects and reforms must be expedited to reduce energy costs, enhance energy security, and fulfill climate commitments. Completing the LNG terminal and improving electricity interconnectedness would represent significant progress toward these objectives. Additionally, increasing competition in the electricity market would help lower costs and emissions through market forces. The planned introduction of green taxation would further facilitate the energy transition.

Maintaining a strong AML framework is vital for mitigating reputational risks and business uncertainty. Ongoing efforts to broaden the definition of obliged entities for AML supervision are commendable. Furthermore, the proposed establishment of the National Sanctions Implementation Unit at the Ministry of Finance will enhance clarity for reporting entities regarding compliance with sanctions.

[1] Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. The Executive Board takes decisions under its lapse-of-time procedure when the Board agrees that a proposal can be considered without convening formal discussions.

[2] Under the IMF's Articles of Agreement, publication of documents that pertain to member countries is voluntary and requires the member consent. The staff report will be shortly published on the www.imf.org/cyprus page.