IMF: Cyprus growth flat in 2011, to shrink in 2012

By MENELAOS HADJICOSTIS | October 12, 2011 | 8:25 AM EDT

NICOSIA, Cyprus (AP) — International Monetary Fund officials urged the Cyprus government to move fast with deep spending cuts and tax increases to curb a burgeoning deficit, after projecting that the island's economy will contract next year.

IMF officials Wes McGrew and J. Erik Jan de Vrijer said Wednesday that the Cypriot economy will stagnate this year but shrink by one percent next, while the fiscal deficit will grow to 7 percent of national income in 2011 before moderating to 4 percent in 2012.

Those projections contrast Cypriot government figures which last month forecast 1 to 1.5 percent growth next year and a deficit of around 6 to 6.5 percent in 2011 and 2.3 percent in 2012.

"A doom scenario is a lot worse than what you see here, and one of the things that we're saying is the time to take action is now in order to avoid getting into a doom scenario," Jan de Vrijer told a news conference at the end of a weeklong review of the island's economy.

Buffeted by the ongoing eurozone crisis, Cyprus is finding it more expensive to borrow from international markets because of a string of credit rating agency downgrades due to the exposure of the country's large banking sector to Greece.

That has stoked fears that the small island with a population of around 1 million and a euro17 billion ($23 billion) economy may be forced to seek a bailout from its partners in the eurozone, as Greece, Ireland and Portugal already have.

"We think that the situation at the moment is very serious. The fact that the government cannot access the capital markets is very, very serious and the risks to the banking sector compound that very much," Jan de Vrijer said.

To finance its debt and stimulate growth, the Cypriot government is looking to finalize a 4½ year, euro2.5 billion ($3.4 billion) loan agreement with Russia at a 4.5 percent annual interest rate. That's much lower than markets are currently offering.

McGrew said it's crucial that any such loan deal doesn't weaken the resolve of the government to roll back spending and push through fiscal reforms.

Cyprus' 2012 draft budget includes a euro840 million ($1.14 billion) package of spending cuts and tax increases, aimed at reducing the deficit.

Measures include slashing 1,100 public sector positions, rolling back social handouts by euro200 million ($272 million) and raising the sales tax from 15 to 17 percent for at least three years — a move that is meeting resistance from opposition parties.

Jan de Vrijer said there is no wriggle room to discount the measures which need to be implemented fully.

"The first priority is for Cyprus to do all it can to avoid that these problems get out of hand," he said.

"I think there is time and there is opportunity for the government to take really decisive and large action to avert the possibility of these problems getting worse and worse."