# EUR-Lex - 52013PC0233 - EN

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# 52013PC0233

**Proposal for a COUNCIL DECISION addressed to the Republic of Cyprus on specific measures to restore financial stability and sustainable growth /* COM/2013/0233 final - 2013/0121 (NLE) */**

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EXPLANATORY MEMORANDUM

Cyprus has been
under increasing pressure in financial markets, against the background of
rising concerns about the sustainability of its public finances, including its weakened
financial sector and the scale of potential public support measures. Although
some of the imbalances have emerged as a result of negative spill-overs from
the euro-area crisis and developments in Greece, others have been domestic and longer-lasting.
Amidst consecutive downgradings by credit rating agencies of Cypriot sovereign bonds,
the country became unable to refinance itself at rates compatible with
long-term fiscal sustainability. In parallel, the banking sector was
increasingly cut off from international market funding and
major financial institutions recorded substantial capital shortfalls. The
situation in the banking sector worsened dramatically in early-2013, due to a
drop in confidence leading to continuous and substantial deposit outflows. In
March 2013, the Eurogroup reached a political agreement on the key elements of
a macroeconomic adjustment programme for Cyprus with a financial envelope of up
to EUR 10 billion. Following financial turmoil, a bank holiday of 10 days was
imposed, during which the sector was downsized substantially through resolution
and restructuring of banks and separation of the Greek operations of Cypriot
banks.

Against the
background of these severe economic and financial disturbances, the Cypriot
authorities officially requested financial assistance in the form of a loan from
European Financial Stability Facility / European Stability Mechanism on 25 June
2012, as well as from the International Monetary Fund (IMF), with a view to
supporting the return of the economy to sustainable growth, ensuring a
properly-functioning banking system, and safeguarding financial stability in
the European Union and in the euro area. On 27 June
2012, the Eurogroup invited the Commission, in liaison
with the European Central Bank (ECB), the Cypriot authorities and the IMF, to
agree on a macroeconomic adjustment programme, including the financing needs,
and to take appropriate action to safeguard financial stability. On 16 March and 25 March 2013, the Eurogroup reached a political
agreement with the Cypriot authorities on the key elements of a programme, which
included the restructuring and substantial downsizing of the banking sector and
the reinforcement of efforts on fiscal consolidation, structural reforms and privatisation.
An important part of the agreement was that the recapitalisation of banks would
be almost exclusively generated from within the banks (i.e. from shareholders
and creditors). Deposits up to EUR 100,000 were to remain unaffected. Creditors
were not to suffer losses superior to the losses they would have incurred, had
the banks been wound up under normal insolvency proceedings. On 2 April 2013,
an agreement at technical level was reached in respect of a comprehensive
policy package to be implemented in a 3-year macroeconomic adjustment
programme; the key objectives, measures and outcomes were laid down in a draft
Memorandum of Understanding (MoU) between the Commission and the Republic of
Cyprus.

The macroeconomic
adjustment programme shall aim at restoring financial market confidence, re-establishing
sound macroeconomic balances and enabling the economy to return to sustainable
growth. To achieve these goals, the programme builds on three pillars. The first
pillar is a financial sector strategy based on
restructuring and downsizing of its financial institutions and strengthening its
supervision, with efforts to address capital and liquidity shortfalls. The second pillar is an ambitious fiscal consolidation strategy,
building on the consolidation efforts intiated in 2012, in particular through
measures to reduce current primary expenditure, enhance government revenues,
improve the functioning of the public sector and maintain fiscal consolidation
in the medium-term. The aim is to correct the excessive general government
deficit and put the gross public debt-to-GDP ratio on a firm downward path in
the medium term. The authorities are committed to
reducing the deficit to below 3% of GDP as soon as possible. The good
implementation of Structural and other EU Funds, as well as EU policy
initiatives aimed at enhancing jobs and growth, should be preserved. This will
contribute to the long-term growth path for Cyprus. The
third pillar consists of an ambitious structural reform agenda, with a view to
supporting competitiveness and sustainable and balanced growth, in line with
country-specific recommendations addressed to Cyprus in 2012, and allowing for
the unwinding of macroeconomic imbalances. Recalling
the political agreement of 28 February 2013 on a Council Recommendation on
Establishing a Youth Guarantee, opportunities for young people and their
employability prospects should be maintained.

The programme
covers the period 2013-2016.

2013/0121 (NLE)

Proposal for a

COUNCIL DECISION

addressed to the Republic of Cyprus on
specific measures to restore financial stability and sustainable growth

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty on the
Functioning of the European Union, and in particular Article 136(1), in
conjunction with Article 126(6) thereof,

Having regard to the proposal from the
European Commission,

Whereas:

(1)       Article 136(1) of the
Treaty on the Functioning of the European Union (TFEU) foresees the possibility
of adopting measures specific to Member States whose currency is the euro in
order to ensure the proper functioning of economic and monetary union.

(2)       On 13 July 2010, the
Council adopted a Decision under Article 126(6) of the TFEU stating that an
excessive deficit existed in Cyprus[1]
and issued a Recommendation to Cyprus under Article 126(7) of the TFEU with a
view to bringing an end to the situation of an excessive government deficit
stating that 'Cyprus's authorities should put an end to the present excessive
deficit situation as rapidly as possible and at the latest by 2012'.

(3)       In the Recommendation on
the National Reform Programme 2012 of Cyprus and delivering an opinion on the
Stability Programme for Cyprus, 2012-2015[2],
the Council recommended, inter alia, that Cyprus take action to achieve a
durable correction of the excessive deficit in 2012, ensure sufficient progress
with the debt reduction benchmark, strengthen regulatory provisions for the
efficient recapitalisation of the financial institutions and improve
competitiveness.

(4)       Cyprus has been under
increasing pressure in financial markets, against the background of rising
concerns about the sustainability of its public finances, including the
required public support measures to the weakened financial sector. Although
some of the imbalances have emerged as a result of negative spill-overs from
the euro-area crisis, others have been domestic and longer-lasting.[3] Amidst consecutive downgrades
by credit rating agencies of Cypriot sovereign bonds, the country became unable
to refinance itself at rates compatible with long-term fiscal sustainability.
In parallel, the banking sector was increasingly cut off from international
market funding and major institutions recorded substantial capital shortfalls.

(5)       In view of these severe
economic and financial conditions, the Cypriot authorities officially requested
financial assistance under the terms of a loan by the European Financial
Stability Facility / European Stability Mechanism on 25 June 2012, as well as
from the IMF, with a view to supporting the return of the economy to
sustainable growth, ensuring a properly-functioning banking system and
safeguarding financial stability in the European Union and in the euro area. On
27 June 2012, the Eurogroup invited the Commission, in
liaison with the ECB, the Cypriot authorities, and the IMF to agree on a macroeconomic
adjustment programme, including the financing needs, and to take appropriate
action to safeguard financial stability in the current very challenging
environment with a risk of spill-over effects from sovereign market turbulence. On 16 March and 25 March 2013, the Eurogroup reached a political
agreement with the Cypriot authorities on the cornerstones of a programme. The
banking sector were to be restructured and downsized and efforts were to be
stepped-up on fiscal consolidation, structural reforms and privatisation.
Recapitalisation of banks were to be almost exclusively generated from within
the banks (i.e. from shareholders and creditors).

(6)       In the current
circumstances Cyprus should adopt a comprehensive policy package to be
implemented in a 3-year macroeconomic adjustment programme over a period from 2013-Q2
to 2016-Q1.

(7)       The policy package should aim
at restoring financial market confidence, re-establishing sound macroeconomic
balances and enabling the economy to return to sustainable growth. It should be
structured on three pillars. The first pillar should be a financial sector
strategy based on restructuring and downsizing financial institutions and
strengthening supervision of the sector, with efforts to address capital and
liquidity shortfalls. The second pillar should be an
ambitious front-loaded fiscal consolidation strategy in particular through
measures to reduce current primary expenditure, enhance government revenues,
improve the functioning of the public sector and maintain fiscal consolidation
in the medium-term, while minimising the impact on disadvantaged people and
preserving the good implementation of Structural and other EU Funds. The third pillar should consist of an ambitious structural reform
agenda, with a view to supporting competitiveness and sustainable and balanced
growth, allowing for the unwinding of macroeconomic imbalances, in particular
by reforming the wage indexation system, in consultation with social partners,
and removing obstacles to the smooth functioning of markets. Recalling the
political agreement of 28 February 2013 on a Council Recommendation on
Establishing a Youth Guarantee, opportunities for young people and their
employability prospects should be maintained.

(8)       Under the Commission’s updated
forecast for nominal GDP growth (-0.5% in 2012, -8.2% in 2013, -2.9% in 2014, 2.6%
in 2015 and 3.7% in 2016), the debt-to-GDP ratio would amount to 87% in 2012, 109%
in 2013, 123% in 2014, 126% in 2015 and 122% in 2016. The debt-to-GDP ratio
would therefore increase rapidly until 2015 and move to a declining path
thereafter, reaching an estimated 105% in 2020. Debt dynamics are affected by
several below-the-line operations. Under the Commission’s updated forecast for
nominal GDP growth, the primary general government balance is projected to
attain a deficit of EUR 395 million (2.4% of GDP) in 2013, a deficit of EUR 678
million (4.3% of GDP) in 2014, a deficit of EUR 344 million (2.1% of GDP) in
2015 and a surplus of EUR 204 million (1.2% of GDP) in 2016.

(9)       Increasing the long-term
resilience of the Cypriot banking sector is critical to restoring financial
stability in Cyprus and - given the strong interlinkages – preserving financial
stability in the euro area as a whole. Substantial downsizing and restructuring
of the Cypriot banking sector is under way. The House of Representatives adopted
legislation establishing a comprehensive framework for the recovery and resolution
of credit institutions. Using this new framework, the Cypriot banking sector
has been downsized immediately and significantly. To preserve the liquidity of
the Cypriot banking sector, temporary administrative measures have been
imposed.

(10)     The implementation of comprehensive
and ambitious reforms in financial, fiscal and structural areas should
safeguard the medium-term sustainability of the Cypriot public debt.

(11)     The Commission, in liaison with
the ECB, and if relevant the IMF, should verify at regular intervals the rigorous
implementation of the macroeconomic adjustment programme through missions and
regular reporting by the Cypriot authorities, on a quarterly basis.

(12)     Throughout the
implementation of the policy package, the Commission should provide additional
policy advice and technical assistance in specific areas.

(13)     The Cypriot authorities
should involve, in accordance with current national rules and practices, the
social partners and civil society organisations in the preparation,
implementation, monitoring and evaluation of the financial assistance programme.

(14)     Any form of financial
assistance received to help implementing the policies under the macroeconomic
adjustment programme must be in line with European Union legal requirements and
policies, in particular with the Union economic governance framework. Any intervention
in support of financial institutions must be carried out in accordance with the
European Union’s rules on competition. The Commission will ensure that any
measures laid down in a Memorandum of Understanding in the context of requested
ESM financial assistance is fully consistent with the present decision.

HAS ADOPTED THIS DECISION:

Article 1

1.           In order to facilitate the
return of the Cypriot economy to a path of sustainable growth and to fiscal and
financial stability, Cyprus shall rigorously implement a macroeconomic
adjustment programme, the main elements of which are laid down in Article 2 of
this decision. The macroeconomic adjustment programme (hereafter the "programme")
shall address the specific risks emanating from Cypus for the financial
stability of the euro area and shall aim at rapidly re-establishing a sound and
sustainable economic and financial situation in Cyprus and restore its capacity
to finance itself fully on the financial markets. The programme shall take due
account of the recommendations addressed to Cyprus under Articles 121, 126, 136
and 148 TFEU as well as its actions to comply with them, while aiming at
broadening, strengthening and deepening the required policy measures.

2.           The Commission, in liaison
with the ECB, and if relevant the IMF, shall monitor the progress made in the
implementation of the programme. Cyprus shall give the Commission and the ECB
its full cooperation. It shall in particular provide to the Commission and the
ECB all the information that they deem necessary for the monitoring of the programme.

3.           The Commission, in liaison
with the ECB and, where appropriate, with the IMF, shall examine with the Cypriot
authorities any changes and updates to the programme that may be needed in
order to take proper account of, inter alia, any significant gap between
macroeconomic and fiscal forecasts and realised figures (including employment),
negative spill-over effects, as well as macroeconomic and financial shocks. In
order to ensure the smooth implementation of the programme and to help the
correction of imbalances in a sustainable way, the Commission shall provide
continued advice and guidance on fiscal, financial market and structural
reforms. The Commission shall periodically assess the economic impact of the programme
and shall recommend necessary corrections with a view to enhancing growth and
job creation, securing the necessary fiscal consolidation, and minimising
harmful social impacts.

Article 2

1.           The key objectives of the Cypriot
programme are: the restoration of the soundness of the Cypriot banking sector; the
continuation of the on-going process of fiscal consolidation; and the implemention
of structural reforms to support competitiveness and sustainable and balanced
growth.

2.           Cyprus shall pursue fiscal
consolidation consistent with its obligations under the excessive deficit
procedure by means of high-quality permanent measures while minimising the
impact on disadvantaged people.

3.           Cyprus shall adopt the measures
specified in paragraphs 4 to 15.

4.           In order to reduce the
deficit to below 3% of GDP as soon as possible, Cyprus shall stand ready to
take additional consolidation measures. Specifically, in the event of
underperformance of revenues or higher social spending needs due to adverse
macroeconomic effects, the government shall stand ready to take additional measures
to preserve the programme's objectives, including by reducing discretionary
spending, while minimising the impact on disadvantaged people. Over the programme period, cash revenues above the programme
projections, including any windfall gains, shall be saved or used to reduce
debt. If instead over-performance materialises, to the extent that it is deemed
permanent, this can reduce the need for additional measures in the outer years.

5.           Cyprus shall preserve the
good implementation of Structural and other EU Funds.

6.           With a view to restoring
the soundness of the financial sector, Cyprus shall continue to thoroughly
reform and restructure the banking sector and reinforce viable banks by
restoring their capital, addressing their liquidity situation and strengthening
their supervision. The programme shall foresee the following measures and
outcomes:

(a)     ensuring that the liquidity situation
of the banking sector will be closely monitored and appropriate measures to
maintain sufficient liquidity in the system in line with Eurosystem rules will
be taken. The recently-imposed temporary restrictions on the free movement of
capital (inter alia, limits on cash withdrawals,
electronic payments and transfers abroad) will be
closely monitored. The goal is that controls will remain in place no longer than strictly necessary to prevent
serious and immediate risks for financial stability. The
medium-term funding and capital plans of domestic banks
relying on central bank funding
or receiving state aid should realistically reflect the
anticipated deleveraging in the banking sector, and reduce dependency on
borrowing from the central banks, while avoiding asset fire sales and a credit
crunch. The regulations on the minimun liquidity
requirements will be updated to prevent concentration in euro-denominated
assets in the future;

(b)     establishing an independent valuation
of the assets of Bank of Cyprus and Cyprus Popular Bank and quickly
intergrating the operations of Cyprus Popular Bank into Bank of Cyprus. The
valuation shall be completed quickly so as to enable the unfreezing of the
relevant parts of the uninsured deposits at the Bank of Cyprus;

(c)     adopting the necessary regulatory
requirements regarding an increase in the minimum core tier 1 capital adequacy ratio
to 9% by end of 2013;

(d)     taking steps to minimise the cost to
the taxpayers of bank restructuring. Undercapitalised commercial and
cooperative credit institutions shall raise, to the largest extent possible,
capital from private sources, including but not limited to bank shareholders
and creditors, before state-aid measures are granted. Any restructuring or
resolution plans shall be formally approved under state-aid rules, before such state
aid is provided;

(e)     ensuring that a credit register is
created, that the current regulatory framework on loan processes is reviewed
and amended, if necessay, and that legislation strengthening the governance of
commercial banks is adopted;

(f)      strengthening banks' governance,
including by prohibiting lending to independent board members or their
connected parties;

(g)     maximising recovery for non-performing
loans, while minimising incentives for strategic default by borrowers. This
will include easing constraints on the seizure of collateral and proper
monitoring and managing of non-perfroming loans. The Central Bank of Cyprus
will issue guidance to classify as non-performing all loans past due by more
than 90 days;

(h)     aligning the regulation and
supervision of cooperative credit institutions to those of commercial banks;

(i)      ascertaining the viability of
cooperative credit institutions and developing, in consultation with the Commission
and informing the ECB and the IMF, a strategy for the future structure,
functioning and viability of the cooperative credit institution sector. The
implementation of the strategy should be completed by mid-2015;

(j)      augmenting the monitoring of the
indebtedness of the corporate and household sectors and establishing a
framework for targeted private sector restructuring; and

(k)     further enhancing the anti-money
laundering framework and ensuring full entity
transparency, in line with best practice.

7.           Over 2013, the authorities
shall rigorously implement the 2013 Budget Law with additional permanent
measures of at least EUR 351 million (2.1% of GDP). Cyprus shall amend the 2013
Budget Law to include the additional consolidation measures. Cyprus shall adopt
the following measures:

(a)     On the expenditure side, the budget
shall include the reduction of expenditure on housing schemes by at least EUR
36 million and a further scaled reduction of public sector wages, the
streamlining of certain social benefits;

(b)     On the revenue side, the additional
measures shall include increases in property taxes, the statutory corporate
income tax rate, the tax rate on interest income, the bank levy, and in the
fees for public services;

(c)     Cyprus shall reform the tax system for
motor vehicles, based on environmentally-friendly principles and with a view to
raising additional revenues;

(d)     Cyprus shall introduce measures to
control healthcare expenditure and improve cost efficiency in the healthcare
sector by enhancing public hospitals' efficiency, competitiveness and
cost-effectiveness. In addition, Cyprus shall introduce a co-payment system for
a limited number of medical services and pharmaceuticals; and

(e)     Cyprus shall ensure full
implementation of consolidation measures adopted since December 2012.

8.           The following measures shall
apply as of 1 January 2014:

(a)     On the expenditure side, the budget
shall include: a reduction in total outlays for social transfers through better
targeting to yield at least EUR 28.5 million; a further reduction in the public
and broader public sector wages; the introduction of a fee on public
transportation card for students and pensioners; and structural reform measures
in the educational sector to reduce wage expenditure; and

(b)     On the revenue side, the budget for
2014 shall include: an extension of the temporary contribution on gross
earnings of public and private sector employees up to 31 December 2016;
increases in the VAT; increases in excise duties; and an increase in the contributions
to General Social Insurance Scheme.

9.           In order to ensure the
long-term sustainability of public finances, Cyprus shall implement fiscal-structural
reforms, comprising, inter alia, the following measures and outcomes:

(a)     reforms of the
general and public sector pension system in order to
put the pension system on a sustainable path, while addressing the adequacy of
pensions. If necessary, reforms will be further
reinforced;

(b)     control the growth of health
expenditure in order to strengthen the sustainability of the funding structure
and the efficiency of public healthcare provision;

(c)     an improvement in the efficiency of
public spending and the budgetary process by means of an effective medium-term
budgetary framework as part of an improved public finance management, fully
compliant with the Directive on requirements for budgetary frameworks and the
Treaty on Stability, Coordination and Governance (TSCG);

(d)     adoption of an
adequate legal and institutional framework for Public Private Partnerships
designed according to best practices;

(e)     elaboration of a programme to achieve
a solid corporate governance system for state-owned and semi-public enterprises
and initiation of a privatisation plan to help improve
economic efficiency and restore debt sustainability;

(f)      elaboration and implementation of a
comprehensive reform plan to improve the effectiveness and efficiency of tax
collection and administration, including measures to safeguard the full and
timely applicability of laws and standards governing international tax
cooperation and the exchange of tax information;

(g)     reform of the immovable property tax;

(h)     reform of the public administration to
improve its functioning and cost-effectiveness, notably by reviewing the size,
employment conditions and functional organisation of public service in order to
ensure an efficient use of government resources and a quality service provision
to the population; and

(i)      reforms of the overall structure and the
levels of welfare benefits, with the aim of producing an efficient use of
resources and ensuring an appropriate balance between welfare assistance and
incentives to take up work.

10.         Cyprus shall implement a
reform of the system of wage indexation, after consultation with the social
partners, and consistent with the objectives of improving the economy's
competitiveness and reflecting developments in labour productivity. The planned
reform of public assistance should ensure that social assistance serves as a
safety net to ensure a minimum income for those unable to support a basic
standard of living, while safeguarding incentives to take up work. Any change
in the minimum wage shall be in line with the economic and labour market
developments, and after consultation with the social partners.

11.         Cyprus shall adopt the
remaining necessary amendments to sector specific legislation in order to fully
implement the Services Directive. Unjustified obstacles in services markets, in
particular in relation to regulated professions shall be eliminated. The
competition framework shall be improved by enhancing the functioning of the
competent competition authority and by reinforcing the independence and powers
of the national regulatory authorities.

12          Cyprus shall reduce to less
than 2000 the title deed issuance backlog by end of 2014 and shall implement guaranteed
timeframes for the issuance of building certificates and title deeds.

13.         Cyprus shall amend the
forced sale of mortgaged property and allow for private auctions within the
shortest feasible timespans by the end of 2013. The pace of court case handling
shall be improved and court backlogs shall be eliminated by the end of the
programme.

14.         Cyprus shall take initiatives
to strengthen the competitiveness of the tourism sector. These initiatives
shall include a review of the Tourism Strategy for 2011-2015, based on a study
on how to improve the tourism sector business model, and a thorough analysis of
the best means of achieving sufficient air connectivity for Cyprus.

15.         In the energy sector,
Cyprus shall transpose and fully implement the Third Energy Package. In
addition, a comprehensive development plan for the rearrangement of the Cypriot
energy sector shall be formulated. The plan shall encompass:

(a)     a roll-out plan for the infrastructure
required for the exploitation of gas;

(b)     an outline of the regulatory regime
and market organisation for the energy sector and gas exports; and

(c)     a plan to establish the institutional
framework for the management of hydrocarbon resources, including a resource
fund, which should receive and manage the public revenues from offshore gas
exploitation and which is set up based on internationally-recognized best
practices.

Article 3

This Decision is addressed to the Republic
of Cyprus.

Article 4

This Decision shall be published in the Official
Journal of the European Union.

Done at Brussels,

For
the Council

The
President

[1]               OJ L 186, 20.7.2012, p. 30.

[2]               OJ C 219, 24.7.2012, p. 13.

[3]               as specified in the 2012 In-depth Review for Cyprus
and the 2012 country-specific recommendations addressed to Cyprus under the
European Semester.