EN Official Journal of the European Union C 71/16

COUNCIL OPINION

of 27 February 2007

on the updated convergence programme of Cyprus, 2006-2010

(2007/C 71/05)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies (1), and in particular Article 9(3) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1) On 27 February 2007 the Council examined the updated convergence programme of Cyprus, which covers the period 2006 to 2010.

(2) The macroeconomic scenario underlying the programme envisages that real GDP growth will pick up from 3,7 % in 2006 to 4.1 % on average over the rest of the programme period. Assessed against currently available information, this scenario appears to be based on plausible growth assumptions. The programme's projections for inflation also appear realistic.

(3) For 2006, the general government deficit is estimated at just below 2 % of GDP in the Commission services' autumn 2006 forecast, as targeted in the previous update of the convergence programme. With real GDP growth lower than projected in the previous update (3,7 % instead of 4,2 %), total expenditure is estimated to be higher than planned but this is estimated to be offset by higher total revenues.

(4) After the correction of the excessive deficit in 2005 and the abrogation of the excessive deficit procedure in July 2006, the programme aims at further consolidating public finances. The general government balance is projected to improve from a deficit of 1,9 % of GDP in 2006 to a balanced position in 2010 entirely through expenditure retrenchment as the revenue ratio remains constant over the programme period. While total expenditure is projected to fall by 1 percentage points of GDP over the programme period, of which 1 percentage point of GDP corresponds to declining interest payments, social transfers are planned to increase by 1 percentage point. The primary surplus is planned to rise from 1 % of GDP in 2006-07 to just above 2 % of GDP in 2008 and to remain constant thereafter. The planned consolidation is slightly faster than in the previous update of the convergence programme, against a broadly similar macroeconomic scenario.

(5) The structural balance (i.e. the cyclically-adjusted balance net of one-off and other temporary measures) calculated according to the commonly agreed methodology is planned to improve from a deficit of around 1 % of GDP in 2006 to a surplus of some % of GDP at the end of the programme period. As in the previous update of the convergence programme, the medium-term objective (MTO) for the budgetary position presented in the programme is a structural deficit of 0,5 % of GDP, which the programme aims to achieve by 2008, one year earlier than in the previous update. As the MTO is more demanding than the minimum benchmark (estimated at a deficit of around 1 % of GDP), achieving it should fulfil the aim of providing a safety margin against the occurrence of an excessive deficit. The MTO lies within the range indicated for euro-area and ERM II Member States in the Stability and Growth Pact and the code of conduct and adequately reflects the debt ratio and average potential output growth in the long term.

(6) The risks to the budgetary projections in the programme appear broadly balanced. The target for 2007 seems plausible when compared with the Commission services' autumn 2006 forecast and, for the year 2008, when the primary surplus is planned to improve, there is relatively detailed information in the programme about the measures that support the adjustment. However, there is some risk of spending slippages given the high degree of expenditure restraint envisaged and the limited information on the spending ceilings and their enforcement. On the other hand, the overall track record with respect to the achievement of the budgetary targets is good.

(7) In view of this risk assessment, the budgetary stance in the programme seems sufficient to ensure that the MTO is achieved by 2008, as envisaged in the programme. In addition, it seems to provide a sufficient safety margin against breaching the 3 % of GDP deficit threshold with normal macroeconomic fluctuations throughout the programme period. The pace of adjustment towards the MTO implied by the programme is in line with the Stability and Growth Pact, which specifies that, for euro-area and ERM II Member States, the annual improvement in the structural balance should be 0,5 % of GDP as a benchmark and that the adjustment should be higher in good economic times and could be lower in bad economic times. After the achievement of the MTO, the fiscal policy stance implied by the programme is also in line with the Pact.

(8) Government gross debt is estimated to have reached 64 % in 2006, above the 60 % of GDP Treaty reference value. The programme projects that the debt ratio would fall below the 60 % of GDP reference value in 2008 and would attain just above 46 % of GDP by the end of the programme period. The risks to the projected evolution of the debt ratio appear to be broadly balanced. In view of the risk assessment, the debt ratio is sufficiently diminishing towards the reference value in the early part of the programme period and is planned to approach it by 2007.

(9) The long-term budgetary impact of ageing in Cyprus is among the highest in the EU, influenced notably by a very large increase in pension expenditure as a share of GDP. The initial budgetary position contributes to easing part of the projected considerable long-term budgetary impact of an ageing population, but it is not sufficient to cover it. Moreover, the current level of gross debt is above the Treaty reference value. Continuing the consolidation of the public finances simultaneously with adopting pension reform measures aimed at containing the significant increase in age-related expenditures would contribute, as recognised by the authorities, to reducing risks to the sustainability of public finances. Overall, Cyprus appears to be at high risk with regard to the sustainability of public finances.

(10) The convergence programme contains a qualitative assessment of the overall impact of the October 2006 implementation report of the national reform programme within the medium-term fiscal strategy. In addition, it provides systematic information on the direct budgetary costs or savings of the main reforms envisaged in the national reform programme and its budgetary projections seem to take into account the public finance implications of the actions outlined in the national reform programme. The measures in the area of public finances envisaged in the convergence programme seem consistent with those foreseen in the national reform programme. In particular, both programmes envisage the gradual implementation of pension and healthcare reforms in order to address the impact of ageing populations. Also, there is a need to enhance life-long learning, and to further increase employment and training opportunities for young persons.

(11) The budgetary strategy in the programme is broadly consistent with the broad economic policy guidelines included in the integrated guidelines for the period 2005-2008.

(12) As regards the data requirements specified in the code of conduct for stability and convergence programmes, the programme provides all required and most of the optional data (2).

The Council considers that, after the correction of the excessive deficit in 2005, the programme is making good progress towards the MTO over the programme period, owing to expenditure restraint and in a context of strong growth prospects. The general government gross debt is foreseen to approach the 60 % of GDP reference value by 2007 and to continue declining in the subsequent years.

In view of the above assessment, in particular the level of debt and the projected increase in age-related spending, Cyprus is invited to:

(i) control public pension expenditure and implement further reforms in the areas of pensions and health care in order to improve the long-term sustainability of the public finances.

(ii) implement the fiscal consolidation path as foreseen in the programme.

Comparison of key macroeconomic and budgetary projections

2005 2006 2007 2008 2009 2010 Real GDP (% change) CP December 2006 3,9 3,7 3,9 4,1 4,1 4,1 COM Nov 2006 3,8 3,8 3,8 3,9 n.a. n.a. CP December 2005 4,1 4,2 4,2 4,2 4,3 n.a. HICP inflation (%) CP December 2006 2,0 2,4 2,5 2,4 2,0 2,0 COM Nov 2006 2,0 2,4 2,0 2,4 n.a. n.a. CP December 2005 2,1 2,0 2,0 2,0 2,0 n.a. Output gap (% of potential GDP) CP December 2006 (3) – 0,9 – 1,0 – 1,1 – 1,1 – 1,1 – 1,1 COM Nov 2006 (7) – 1,3 – 1,3 – 1,3 – 1,3 n.a. n.a. CP December 2005 (3) – 0,8 – 0,3 0,1 0,0 0,1 n.a. General government balance (% of GDP) CP December 2006 – 2,3 – 1,9 – 1,6 – 0,7 – 0,4 – 0,1 COM Nov 2006 – 2,3 – 1,9 – 1,7 – 1,7 n.a. n.a. CP December 2005 – 2,5 – 1,9 – 1,8 – 1,2 – 0,6 n.a. Primary balance (% of GDP) CP December 2006 1,1 1,4 1,4 2,1 2,1 2,2 COM Nov 2006 1,1 1,4 1,4 1,4 n.a. n.a. CP December 2005 0,7 1,2 1,2 1,4 1,7 n.a. Cyclically-adjusted balance (% of GDP) CP December 2006 (3) – 2,0 – 1,5 – 1,2 – 0,3 0,0 0,3 COM Nov 2006 – 1,8 – 1,4 – 1,2 – 1,2 n.a. n.a. CP December 2005 (3) – 2,2 – 1,8 – 1,8 – 1,2 – 0,6 n.a. Structural balance (4) (% of GDP) CP December 2006 (5) – 3,3 – 1,9 – 1,0 – 0,3 – 0,1 – 0,1 COM Nov 2006 (6) – 2,7 – 1,4 – 1,2 – 1,2 n.a. n.a. CP December 2005 – 3,1 – 2,1 – 2,1 – 1,5 – 0,6 n.a. Government gross debt (% of GDP) CP December 2006 69,2 64,7 60,5 52,5 49,0 46,1 COM Nov 2006 69,2 64,8 62,2 59,6 n.a. n.a. CP December 2005 70,5 67,0 64,0 56,9 53,5 n.a. Source: Convergence programme (CP); Commission services' autumn 2006 economic forecasts (COM); Commission services' calculations

(1) OJ L 209, 2.8.1997, p. 1. Regulation as amended by Regulation (EC) No 1055/2005 (OJ L 174, 7.7.2005, p. 1). The documents referred to in this text can be found at the following website:

http://europa.eu.int/comm/economy_finance/about/activities/sgp/main_en.htm

(2) In particular, the data on ‘Cyclical Developments ’(Table 5), the contributions to Potential GDP Growth (item 4) are not provided.

(3) Commission services calculations on the basis of the information in the programme.

(4) Cyclically-adjusted balance (as in the previous rows) excluding one-off and other temporary measures.

(5) One-off and other temporary measures taken from the programme (1,3 % of GDP in 2005 and 0,4 % in 2006, deficit-reducing,). They include 0,4 % of GDP in 2005 and 2006 accounting for the EU funds-related transactions.

(6) One-off and other temporary measures taken from the Commission services' autumn 2006 forecast (0,9 % of GDP in 2005; deficit-reducing) as compared to the programme (see note 3) the Commission services did not treat any EU fund-related transactions as one-off.

(7) Based on estimated potential growth of 3,9 %, 3,7 %, 3,9 % and 4,0 % respectively in the period 2005-2008.

Source:

Convergence programme (CP); Commission services' autumn 2006 economic forecasts (COM); Commission services' calculations