EN    EN EN 
EN    EN  EUROPEAN COMMISSION 
Brussels, 15.6.2010 
SEC(2010) 741 final 
  
Recommendation for a 
COUNCIL RECOMMENDATION  
with a view to bringing an end to the situ ation of an excessive government deficit in 
Cyprus 
EN 2   EN Recommendation for a 
COUNCIL RECOMMENDATION  
with a view to bringing an end to the situ ation of an excessive government deficit in 
Cyprus 
THE COUNCIL OF THE EUROPEAN UNION, 
Having regard to the Treaty on the Functioning of the European Union, and in particular 
Article 126(7) thereof; 
Having regard to the recommendati on from the European Commission; 
Whereas: (1) According to Article 126 of the Treat y Member States shall avoid excessive 
government deficits. 
(2) The Stability and Growth Pact is base d on the objective of sound government finances 
as a means of strengthening the conditions fo r price stability and for strong sustainable 
growth conducive to employment creation. 
(3) The 2005 reform of the Stability and Growth Pact sought to strengthen its 
effectiveness and economic underpinnings as we ll as to safeguard th e sustainability of 
the public finances in the long run. It aimed at ensuring that in particular the economic 
and budgetary background was taken into account fully in all steps in the EDP. In this 
way, the Stability and Growth Pact pr ovides the framework supporting government 
policies for a prompt return to sound budge tary positions taki ng account of the 
economic situation. 
(4) The Council has decided on [13 July 2010], in accordance with Article 126(6) of the 
Treaty, that an excessive de ficit exists in Cyprus. 
(5) In accordance with Article 126(7) of the Treaty and Article 3 of Council Regulation 
(EC) No 1467/97 on speeding up and clarifying  the implementation of the excessive 
deficit procedure
1 (which is part of the Stability a nd Growth Pact), the Council is also 
required to make recommendations to the Member State concerned with a view to 
bringing the situation of excessive defic it to an end within a given period. The 
recommendation has to establish a deadline of  six months at the most for effective 
action to be taken by the Member State conc erned to correct the excessive deficit as 
well as a deadline for the correction of the excessive deficit, which should be 
completed in the year following its identification unless there are special circumstances. In deciding whether special ci rcumstances exist, “relevant factors” as 
clarified in Article 2(3) of  Regulation (EC) No 1467/97 s hould be taken into account. 
                                                
 
1 OJ L 209, 2.8.1997, p. 6.  
EN 3   EN Furthermore, in a recommendation to corr ect an excessive deficit the Council should 
request the achievement of a minimum annual improvement in the structural balance, 
i.e. the cyclically-adjusted balance excludi ng one-off and other temporary measures, of 
0.5% of GDP as a benchmark. 
(6) Special circumstances, which are relevant for the greater fl exibility in the application 
of the EDP introduced with the 2005 reform of the Stability and Growth Pact, are 
deemed to exist in the case of Cyprus. In  2009, for the first time in 35 years, economic 
activity contracted. The recession reflected a significant fall in domestic demand and 
an adverse external environm ent. In particular, high hous ehold indebtedness together 
with tighter lending conditions, a worsen ing labour market outlook and negative 
confidence effects led to a decline in priv ate consumption. In parallel, investment 
recorded a strong correction, amidst a fall  in foreign demand for housing, low capacity 
utilisation and restructuring of corporate balance sheets . Moreover, exports of goods 
and services, especially tourism, plummeted as a consequence of the financial crisis 
and the global slowdown, in pa rticular the much lower growth prospects of the main 
trading partners (United Kingdom, Euro Area, Russia). The deficit in 2009 is a 
consequence of both the economic downturn and the stimulus measures taken in line with the EERP by the Cypriot authorities.  The existence of special circumstances 
authorises the Council to allo w the correction of the exces sive deficit in a medium-
term framework. 
(7) In the years prior to the crisis and in a context of good economic times, supported by 
an asset boom and buoyant tax receipts, Cyprus was able to build up budgetary surpluses and reduced its gross debt rati o to 48.4% of GDP in  2008 (from 70.2% in 
2004). In 2009, however, the economic crisis weighed heavily on public finances. As a 
result, the budget balance plunged from a surplus of 0.9% of GDP in 2008 to a deficit of 6.1% of GDP in 2009. This was also th e result of a number of discretionary 
measures in response to the economic downtur n (in line with the EERP) and of rather 
large composition effects on account of a much  less tax-rich GDP growth pattern. The 
deficit is projected to widen further to  6.2% of GDP in 2010 acco rding to the March 
2010 EDP notification presented by the Minist ry of Finance. However, the budgetary 
projections of the Commission services’ spring 2010 forecasts indicate that the 
budgetary deficit would reach about 7% of GDP in 2010. Potential extra-budgetary 
measures still under discussion with uncerta in or no information on their modalities 
and timing of implementation, were not incorporated.  
(8) Considering the special circumstances and the EERP framework, an average annual 
fiscal effort is recommended. The fiscal e ffort should take into account all factors 
relevant for achieving the fiscal policy objectives, starting with the level of the general government deficit and gross debt as well as other indicators, such as th e current 
account position, the level of contingent liabi lities of the financial sector, interest 
payments, risk premia and the expected change in age-related expenditure in the medium term. In calculating th e average annual fiscal effo rt, the 2011 deficit in the 
Commission services' spring 2010 forecast is taken as the starting point. The total 
fiscal effort needed to reach the nominal de ficit target of 3% by the deadline is then 
calculated by assuming a gradual closure of the output gap by 2015. 
(9) Against this background, it is appropriate to consider the correc tion of the excessive 
deficit in a medium-term framework with  a deadline for the correction of 2012. In 
particular, in view of the high external and domestic imbalances, a credible and 
EN 4   EN sustainable adjustment path would require C ypriot authorities to strengthen the fiscal 
strategy in 2010 with measures  to control current expenditu re, to reduce the deficit to 
below 6% of GDP in 2010, and take timely action to define an expenditure-driven 
consolidation strategy. To this effect, the C ypriot authorities should ensure an average 
annual fiscal effort of 1¾% of GDP over the period 2010-2012;  specify the measures 
that are necessary to achieve the correcti on of the excessive de ficit by 2012, cyclical 
conditions permitting, and accelerate the redu ction of the deficit if economic or 
budgetary conditions turn out better than curre ntly expected. In its stability programme 
submitted to the Commission and the Council on 1 April 2010, Cyprus committed to reduce its deficit to 4.5% of GDP in 2011 and 3.4% of GDP in 2012. Therefore, the 
additional effort requested to Cyprus in th is recommendation compared to the initial 
plan of the Cypriot authorities is co nsidered to be doable and necessary.  The budgetary 
consolidation should also cont ribute to bringing the governme nt gross debt ratio back 
on a declining path that approaches the reference value at a satisfactory pace by restoring an adequate leve l of the primary surplus. 
(10) In the recent past, Cyprus' budgetary fr amework has been improved with the adoption 
of the Financial Management Accounting System (FIMAS). As from 2006, Cyprus 
also enacted the gradual adoption of a three-year medium term budgetary framework (MTBF) and as from 2007 it introduced a Programme and Performance Budgeting 
(PPB). Nevertheless, the new framework is st ill phasing in and is only foreseen to be 
fully in place in 2012. Therefore, its impact could become effective only in the medium-term. The new framework's timely implementation would be critical for a successful and lasting conso lidation of public finances. The existing practice of 
adopting supplementary budgets during the course  of the year has im plied an increase 
in current expenditure be yond the intended reallocatio n of funds. Once the new 
budgeting framework is fully implemented, it is expected to end this practise and lead 
to a more effective and efficient budgetin g process and contri bute to containing 
expenditure by ministry according to the ceilings set. At the same time, the new budgeting process would set a sound basis for reallocating expenditure in favour of 
growth enhancing activities. 
(11) The long-term budgetary impact of agei ng is significantly above the EU average, 
mainly as a result of a relatively high increa se in pension expenditure as a share of 
GDP over the coming decades partly due to the fact that the pension scheme is still in 
a maturing phase. A pension reform introduced in April 2009 would slightly reduce the increase in pension expenditure and, more  significantly, raise the social security 
contribution rates. The reform should impr ove the long-term balance of the pension 
system and reduce risks to sustainabilit y, however without having an effect on the 
overall assessment. The budgetary position in 2009 compounds the budgetary impact 
of population ageing on the su stainability gap. Improving th e primary balance over the 
medium term and implementing further meas ures aimed at curb ing the substantial 
increase in age-related expenditure, esp ecially pension and healthcare expenditure, 
would contribute to reducing the risks to th e sustainability of public finances, which 
were assessed in the Commission 2009 Sustainability Report
2 as high. 
                                                 
2 In the Council conclusions from 10 November 2009 on sustainability of public finances "the Council 
calls on Member States to focus attention to sustainability-oriented strategies in their upcoming stability 
and convergence programmes" and further "invites th e Commission, together with the Economic Policy 
Committee and the Economic and Financial Committee, to further develop methodologies for assessing 
EN 5   EN (12) According to data notified by the C ypriot authorities in  April 2010, general 
government gross debt was 56.2% of GDP in 2009. This increase was mainly the result of the significant deterioration in  the primary balance and debt-increasing 
"snowball" effects on the back of falling nominal GDP. Stock-flow adjustments also 
had a negative contribution to the debt level equivalent to about 1 percentage point of 
GDP, due to accumulation of government assets at the end of the year in order to meet debt maturity obligations arising early in January of 2010, as well as, differences 
between cash and accruals. Fo r 2010, Cyprus notified a planned debt of 62% of GDP, 
thus exceeding the 60% of GDP Treaty reference value (the April 2010 stability programme plans a slightly lower figure (61%) and foresees a further increase to 
63.2% of GDP in 2011). In view of the downward risks to the macroeconomic 
scenario and the budgetary targets, the e volution of the debt  ratio may be less 
favourable than planned. The Commission services spring 2010 forecast projects debt 
to rise further to 62.3% of GDP in  2010 and 67.6% in 2011, on the back of a 
deteriorated primary balance. 
(13) Enhanced surveillance under the EDP will require regular and timely monitoring of 
the progress made in the implementation of the fiscal consolidation strategy. In this 
context, a separate chapte r in the forthcoming updates of the Cypriot stability 
programme could usefully be  devoted to this issue. 
(14) In general, in the view  of the Council, budgetary conso lidation measures should secure 
a lasting improvement in the general governme nt balance, while be ing geared towards 
enhancing the quality of the public finances and reinforcing the growth potential of the 
economy. 
HAS ADOPTED THIS RECOMMENDATION: (1) Recognising that Cyprus’ budgetary pos ition in 2009 resulted from measures 
amounting to about 1½% of GDP in 2009, wh ich is an adequate  response to the 
downturn and were in line with the European Economic Recovery Plan, as well as 
from the free play of automatic stabilisers, Cyprus’ authorities should put an end to the present excessive deficit situation as rapidly as possible and at the latest by 2012. 
(2) The Cypriot authorities should bring th e general government deficit below 3% of 
GDP in a credible and sustainable ma nner by taking action in a medium-term 
framework. Specifically, to this end, the Cypriot author ities should:  
(a) take necessary measures to reduce th e 2010 deficit to below 6% of GDP and 
define an expenditure-driven consolid ation strategy, in or der to bring the 
deficit below the reference value by 2012; 
(b) to this end ensure an average annual fiscal effort of at least 1¾% of GDP over 
the period 2010-2012, which should also co ntribute to bringing the government 
gross debt ratio back on a declining path that approach es the reference value at 
a satisfactory pace by restoring an adequa te level of the primary surplus;  
                                                                                                                                                        
 
the long-term sustainability of public finances in time for the next Sustainability report", which is 
foreseen in 2012. 
EN 6   EN (c) specify and rigorously implement the meas ures that are necessary to achieve 
the correction of the excessive deficit by 2012, cyclical conditions permitting, and accelerate the reduction of the defi cit if economic or budgetary conditions 
turn out better than currently expected.  
(3) To limit risks to the adjustment, Cyprus should strengthen the bi nding nature of its 
medium-term budgetary framework as well as improve the monitoring of the budget 
execution throughout the year.  
(4) Improve the long-term sustainability of  public finances by implementing reform 
measures to control pensi on and health care expenditure  in order to curb the 
projected increase in ag e-related expenditure. 
(5) In addition, the Cyprio t authorities should seize oppor tunities beyond the fiscal 
effort, including from better economic conditions, to accelerate the reduction of the gross debt ratio back towa rds the reference value.  
(6) The Council establishes the deadline of [13 January 2011] for the Cypriot 
government to take effective action to specify  the measures that will be necessary to 
progress towards the correction of the excessive deficit. The assessment of effective 
action will take into acc ount economic developments compared to the economic 
outlook in the Commission serv ices' spring 2010 forecast.  
The Cypriot authorities should report on prog ress made in the implementation of these 
recommendations in a separate chapter in  the forthcoming updates of the stability 
programmes until the abrogation of the excessive deficit procedure.  
In addition, the Council highlights the impor tance of achieving the medium-term objective 
(MTO) for appropriate b udgetary management of economic dow nturns. It therefore invites the 
Cypriot authorities to ensure that budgetary consolidation towards th e medium-term objective 
for the budgetary position – a balanced budget in structural terms – is sustained after the 
excessive deficit will have been corrected. The adherence to the budgetary targets and the 
firm containment of expenditure over the medium-term could be improved by the full 
implementation, as envisaged, of an effective multi-annual budgetary framework.  
This recommendation is addressed to the Republic of Cyprus. Done at Brussels,  
 For the Council 
 The President