In absolute numbers they fell by €3.5bn in two years but as a percentage of economic output, the drop was more spectacular, an analysis of Central Bank of Cyprus (CBC) and Cystat data shows.

When in December 2014, the CBC introduced the current methodology of classifying loans as non-performing, it also produced the first figure based on it. It was €27.3bn against a gross domestic product (GDP) of below €17.6bn, a rate of 155.6%.

The following year, in which Cyprus exited a prolonged recession, the amount of non-performing loans dropped slightly to €26.7bn with economic output increasing marginally in nominal terms to above €17.6bn. This resulted into a ratio of bad loans to GDP of 151.2%.

Last year, the size of the economy increased at a faster rate and reached €17.9bn, helping an even faster reduction of non-performing loans compared to 2015, at €2.8bn. This helped reduce the ratio of non-performing loans against GDP to 133.2%.

“The situation that we have now in the economy is not perfect but it is improving and one can indeed argue that we are entering a virtuous circle,” said Andreas Assiotis, group economist at Hellenic Bank, in a telephone interview on Friday.

A group of leading indicators, including employment, consumption and other data, are suggesting that Cystat will announce on Tuesday that annual economic growth in the first quarter increased further compared to the 3% of the fourth quarter of 2016, Assiotis said. “What is also important is that growth is not the result of increased government spending,” he continued. “It is the outcome of an increase in investment and consumption”.

Cyprus’s economy expanded 2.8% last year and is forecast to grow 2.9% in 2015. Last year the unemployment rate fell to 13%, from 14.9% in 2015, and an all-time peak of 16.1% in 2014.

Still, the drop in non-performing loans is not evenly distributed in the economy, with households considerably lagging behind enterprises. In 2014, household bad debts accounted for 72.8% of economic output and last year it dropped to 67.5%.

On the other hand, corporate non-performing loans fell in 2014 to 2016 by 16.5 percentage points of GDP, which is three times as much as that of the households, to 65.2%.

“Banks should become more aggressive, even if it means reducing the spreads they charge to encourage restructurings and stop strategic defaults,” said economist Alexander Michaelides, who teaches at the London-based Imperial College. “They are still charging hefty spreads and have lots of costs they can reduce to encourage households to trust them again”.

Assiotis said banks have been improving their restructuring skills since the banking and fiscal crisis of 2013, reflected in an increase in restructurings.

“In addition, (banks) have better tools at their disposal, such as the new foreclosure and insolvency legislation,” he added. “This does not mean they would automatically apply it, but it’s a useful leverage”.

The ratio of restructured loans against total non-performing loans increased from 47.1% in December 2014 to 53.1% a year later and 56.4% in December 2016.

The two economists expressed concerns about the sustainability of economic growth favouring the reduction of bad loans and vice versa.

“Investment remains low as the starting point was low,” Assiotis said. “And the problem is that it is not productive investment that will help growth but mainly in housing. Still, economic growth does strengthen the borrowers’ debt repayment ability.”

Last year, total investment rose to €3bn, from €2.3bn in 2015, mainly on increased investment in ships and construction, which rose by €648.8m and €95m to €898.9m and €1.3bn respectively, Cystat figures show. Investment in machinery dropped by €90.4m, to €767m.

“The issue though is whether this (the reduction in NPLs as a percent of GDP) is happening fast enough,” said Michaelides, adding that geopolitical uncertainty or unexpected economic shocks could potentially put an end to the virtuous cycle.

“It is now that you are growing that you want to see this go down and the household ones have barely moved, even though unemployment fell,” he said.

Source: Cyprus Mail