(2)As a Member State whose currency is the euro and in view of the close interlinkages between the economies in the economic and monetary union, Cyprus should ensure the full and timely implementation of the Recommendation for the euro area which is reflected in recommendations 1 to 5 below.

(1)On 16 November 2016, the Commission adopted the Annual Growth Survey, marking the start of the 2017 European Semester of economic policy coordination. The priorities of the Annual Growth Survey were endorsed by the European Council on 9-10 March 2017. On 16 November 2016, on the basis of Regulation (EU) No 1176/2011, the Commission adopted the Alert Mechanism Report, in which it identified Cyprus as one of the Member States for which an in-depth review would be carried out. On the same day, the Commission also adopted a recommendation for a Council Recommendation on the economic policy of the euro area. That Recommendation was endorsed by the European Council on 9-10 March 2017 and adopted by the Council on 21 March 2017.

Having regard to Regulation (EU) No 1176/2011 of the European Parliament and of the Council of 16 November 2011 on the prevention and correction of macroeconomic imbalances, and in particular Article 6(1) thereof,

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, and in particular Article 5(2) thereof,

(3)The 2017 country report for Cyprus was published on 22 February 2017. It assessed Cyprus’ progress in addressing the country-specific recommendations adopted by the Council on 12 July 2016, the follow-up given to the recommendations adopted in previous years and Cyprus’ progress towards its national Europe 2020 targets. It also included an in-depth review under Article 5 of Regulation (EU) No 1176/2011, the results of which were also published on 22 February 2017. The Commission’s analysis leads it to conclude that Cyprus is experiencing excessive macroeconomic imbalances. In particular, it is essential that it tackles the large stock of imbalances in the form of private, public and external debt overhang, and the high level of non-performing loans.

(4)On 27 April 2017, Cyprus submitted its 2017 Stability Programme and on 28 April 2017 Cyprus submitted its 2017 National Reform Programme. To take account of their interlinkages, the two programmes have been assessed at the same time. Cyprus’ National Reform Programme includes commitments both for the short and the medium term. In particular, it includes measures to reduce private sector indebtedness, improve the business environment, facilitate access to finance, overhaul the healthcare sector, and commits to reforms of the public sector and the justice system. The National Reform Programme also covers the challenges identified in the 2017 country report and the Recommendation for the euro area, including the need to re-launch investment and ensure the sustainability of public finances. If fully implemented within the indicated timelines, these measures would help address Cyprus’ macroeconomic imbalances and country-specific recommendations. Based on the assessment of Cyprus’ policy commitments, the Commission confirms its previous assessment that at this stage no further steps are warranted in the framework of the Macroeconomic Imbalances Procedure. The implementation of the policy reform agenda will be followed closely by means of specific monitoring.

(5)The relevant country-specific recommendations have been taken into account in the Member States’ programmes for the European Structural and Investment Funds (ESI Funds) covering the 2014-2020 period. As foreseen in the legislation governing the ESI Funds, where it is necessary to support the implementation of relevant country-specific recommendations, the Commission may request a Member State to review and amend its relevant ESI Funds programmes. The Commission has provided further guidelines on the application of those rules.

(6)Cyprus is currently in the preventive arm of the Stability and Growth Pact and subject to the debt rule. In its 2017 Stability Programme, the government plans a budgetary surplus in headline terms over 2016-2020 (headline balance around 0.4% of GDP over the programme period). The medium-term budgetary objective, set at a balanced budgetary position in structural terms, is planned to be reached in 2017. The recalculated structural balance is projected to steadily move away from the medium-term objective in the following years, which is not in line with the requirements of the preventive arm of the Stability and Growth Pact. The general government debt-to-GDP ratio is expected to have reached 107.8 % in 2016 and to decline to 99.7% in 2018 and further to 88.8 % by 2020. The macroeconomic scenario underpinning these budgetary projections is plausible. The risks associated to the macroeconomic assumptions presented in the Stability Programme are to the downside, mainly linked to the high stock of non-performing loans and a possible deterioration of the external environment.

(7)On 12 July 2016, following the correction of the excessive deficit, the Council recommended Cyprus to respect the medium-term budgetary objective in 2016 and in 2017. Based on the Commission 2017 spring forecast, Cyprus is compliant with that requirement in 2017 following an overall assessment. For 2018, Cyprus is recommended to remain at the medium-term budgetary objective. Based on the Commission 2017 spring forecast, this is consistent with a maximum nominal growth rate of net primary government expenditure of 0.3%, corresponding to a structural adjustment of 0.2% of GDP. Under unchanged policies, Cyprus would be at risk of some deviation from that requirement in 2018 following an overall assessment. Cyprus is forecast to comply with the debt rule in 2017 and 2018. Overall, the Council is of the opinion that Cyprus needs to stand ready to take further measures to ensure compliance in 2018.

(8)Public debt is on a downward trajectory but its sustainability remains subject to risks. A number of recent fiscal measures as well as delays in the implementation of key structural reforms are expected to lead to a deterioration of the structural balance and risk reducing the scope for growth-enhancing public investments.

(9)Despite having one of the euro area’s highest wage bills (as a percentage of GDP), the Cypriot public sector remains characterised by inefficiencies. Under the macroeconomic adjustment programme, a series of reforms aiming to address this issue were designed and agreed with social partners. These included the introduction of a binding permanent mechanism limiting wage growth for public employees and a comprehensive reform of the public administration. However, the adoption of these legislative reforms is facing obstacles, in particular after a negative vote by the House of Representatives in December 2016. Pending adoption in its binding form, the mechanism limiting growth of public sector wages is being implemented under collective bargaining agreements and is applicable until 2018.

(10)Some reforms have been undertaken to tackle corruption. Recent developments include reforms to professionalise public procurement at local level, and a political party funding law enacted in December 2015. A constitutional amendment enabling asset disclosure for public officials has been adopted in 2016. However, the Coordinating Body against Corruption is not adequately staffed, and weaknesses in the disciplinary regime for public servants remain unaddressed.

(11)Cyprus also continues to face critical challenges for the functioning of the judicial system. Inefficient court procedures and limited capacity lead to significant delays in processing court cases. This in turn undermines the business environment and notably the functioning of the new foreclosure and insolvency frameworks. The latter have been introduced to help reduce unviable private debt, providing incentives to banks and debtors to agree on restructuring solutions. Yet, the effectiveness of these tools is impaired by a number of factors, including the aforementioned inefficiencies in the court system, weak administrative capacity and a low level of awareness of the procedures among debtors. Backlogs and delays with issuing and transferring title deeds also remain significant. These contribute to undermining debt reduction efforts and weigh on the recovery of the housing market.

(12)The level of non-performing loans is declining but remains very high, hampering the proper functioning of the banking sector and impacting credit supply to the real economy. Banks underperform the loan restructuring targets agreed with the Central Bank of Cyprus, pointing to the need to broaden the targeting system and make it more efficient and binding, notably by setting ambitious targets for the reduction of non-performing loans, consistent with banks’ non-performing loans reduction strategies. Re-default rates remain high, exposing potential deficiencies in loan restructuring solutions. Risk provisioning levels increased but remain below the euro area average, underscoring the need to ensure that collateral valuations are reliable and underpin appropriate risk provisioning. The lack of a secondary market for loans and a loan securitisation framework limit the scope for accelerating deleveraging and moving non-performing loans off banks’ balance sheets, which calls for additional regulatory and legislative actions to complete the necessary tools to facilitate banks' balance sheet management. In addition, the governance and administrative capacity of insurance and pension funds supervision remain weak, posing risks to financial stability.

(13)Cyprus’ economic recovery continues. Yet, potential growth remains weak, constrained by limited implementation of structural reforms, bottlenecks to investment and shortcomings in the business environment. Growth-enhancing initiatives presented in the action plan for growth are being implemented, albeit rather slowly. A legislative proposal to attract and facilitate strategic investments is still in the draft stage. The government is working on improving access to finance for medium-sized and small businesses. In order to solve this pressing issue, some new targeted initiatives have been launched, as reported in the National Reform Programme. However, most of these new initiatives on access to finance still remain at a preliminary stage. Privatisation efforts, aimed at attracting productivity-enhancing foreign investments, are facing political opposition and, in many cases, have come to a standstill. The reform of the energy sector can also be an important driver for competitiveness, yet there have been delays in its implementation. These notably concern the unbundling of the Electricity Authority of Cyprus and the establishment of the new electricity market, which still hinges upon ensuring the effective independence of the transmission system operator.

(14)Unemployment is decreasing but remains high, especially among young people and the long-term unemployed. Plans to increase the numbers of counsellors in public employment services and improve their specialisation have not yet been implemented. Moreover, their recruitment is likely to occur on temporary contracts, therefore not addressing the challenge in structural terms. As a consequence, there is still insufficient capacity to meet the needs of jobseekers, especially those having more difficulties to integrate in the labour market, and to put in place outreach measures for their activation. The impact of active labour market programmes and income support schemes continues to be constrained by limited quality assessment and follow-up measures.

(15)Cyprus maintains a level of spending in education that is above the EU average. But, educational outcomes are low and have even declined compared to previous years. According to the 2015 results of the Programme for International Student Assessment, Cyprus ranks among the lowest in the EU on the level of basic skills in mathematics, science and reading. While recently introduced remedial measures such as a better system for appointing teachers and a modernisation of school curricula are first steps in the right direction, further action to complete planned reforms, including of teachers’ evaluation, could significantly contribute to improving the situation.

(16)Skills mismatches in the labour market are still largely unaddressed, affecting prospects for long-term sustainable growth. Participation levels are low in upper-secondary vocational education and training and the labour market relevance of higher education is weak, resulting in a high share of tertiary graduates working in occupations that do not necessarily require a tertiary degree.

(17)The Cypriot healthcare sector remains characterised by a lack of universal coverage and various levels of inefficiency. This limits access to adequate and effective care. Legislation aiming to create a national health system and provide public hospitals with greater autonomy is key to improving the capacity and cost-effectiveness of the healthcare sector but is still pending parliamentary adoption.

(18)In the context of the European Semester the Commission has carried out a comprehensive analysis of Cyprus’ economic policy and published it in the 2017 country report. It has also assessed the Stability Programme and the National Reform Programme and the follow-up given to the recommendations addressed to Cyprus in previous years. It has taken into account not only their relevance for sustainable fiscal and socioeconomic policy in Cyprus, but also their compliance with EU rules and guidance, given the need to strengthen the EU’s overall economic governance by providing EU-level input into future national decisions.

(19)In the light of this assessment, the Council has examined the Stability Programme and its opinion is reflected in particular in recommendation 1 below.

(20)In the light of the Commission’s in-depth review and this assessment, the Council has examined the National Reform Programme and the Stability Programme. Its recommendations made under Article 6 of Regulation (EU) No 1176/2011 are reflected in recommendations 1 to 4 below,

HEREBY RECOMMENDS that Cyprus take action in 2017 and 2018 to:

1.Pursue its fiscal policy in line with the requirements of the preventive arm of the Stability and Growth Pact, which implies to remain at its medium-term budgetary objective in 2018. By end-2017, adopt key legislative reforms aiming to improve efficiency in the public sector, notably on the functioning of public administration, governance of State-owned entities and local governments.