COMMISSION OPINION on the existence of an excessive deficit in Cyprus - Application of Article 104(5) of the Treaty establishing the European Community

EXPLANATORY MEMORANDUM

On 7 April 2004, the Commission published its Spring 2004 forecasts [1]. According to these forecasts, which took into consideration data reported by Cyprus in March 2004, the general government deficit in Cyprus increased from 4.6% of GDP in 2002 to 6.3% of GDP in 2003, thus exceeding the 3% of GDP Treaty reference value.

[1] The Commission Spring 2004 forecast is available at the following website: http://europa.eu.int/comm/economy_finance/publications/european_economy/2004/ee204en.pdf.

Based on this prima facie evidence, the Commission initiated the excessive deficit procedure for Cyprus on 12 May 2004, with the adoption of the report foreseen in Article 104(3) of the Treaty [2]. On 24 May 2004, the Commission received the convergence programme of Cyprus, which confirmed a deficit figure of 6.3% of GDP for 2003.

[2] The full text of this report is available at the following website: http://europa.eu.int/comm/economy_finance/about/activities/sgp/procedures_en.htm.

The application of the excessive deficit procedure (EDP) is governed by Article 104 of the Treaty and by Council Regulation (EC) No 1467/97 "on speeding up and clarifying the implementation of the excessive deficit procedure", which is part of the Stability and Growth Pact [3]. Countries that joined the EU on 1 May 2004 are Member States with a derogation and are to avoid excessive deficits, but sanctions according to Article 104 (9) and (11) cannot be imposed on them.

[3] OJ L 209, 2.8.1997.

The Commission report according to Article 104(3) of the Treaty concluded that the excess of the Cyprus deficit in 2003 over the 3% of GDP Treaty reference value did not result from an unusual event outside the control of the Cypriot authorities, nor was it the result of a severe economic downturn in the sense of the Stability and Growth Pact, as real GDP growth reached 2.0% in 2003. Concerning developments in 2004, the report concluded that the general government deficit is likely to decrease but remain above 3% of GDP. In particular, the Commission Spring 2004 forecast is for a general government deficit of 4.6% of GDP in 2004, which is below the 5.2% of GDP projected by the Cypriot authorities in the convergence programme.

Based on the Commission Spring 2004 forecasts, the Commission report also concluded that the debt-to-GDP ratio, which had reached 72.2% of GDP in 2003, will further deviate from the 60% reference value of the Treaty in 2004. In particular, the Commission Spring 2004 forecast projects the debt ratio to reach 74.6% of GDP in 2004, which is below the 75.2% of GDP projected by the Cypriot authorities in the convergence programme.

Article 104(4) of the Treaty states that "the Committee provided for in Article 114 (i.e. the Economic and Financial Committee) has to formulate an opinion on the report of the Commission". The Committee issued its opinion on 25 May 2004, subscribing to the assessment made by the Commission in its report. In particular, the Committee concluded that the budgetary situation in Cyprus indicated the existence of an excessive deficit under both criteria foreseen by Article 104(2) for the identification of such deficits. Consideration of other relevant factors, in particular the medium-term budgetary position and the public investment ratio, did not change the assessment based on the criteria themselves. The Committee also considered as likely that the general government deficit would continue to exceed the Treaty reference value in 2004, and that general government gross debt would further rise above the Treaty reference value of 60% of GDP in 2004.

The Commission, having examined the relevant factors taken into account in its report and having regard to the opinion of the Committee, is of the opinion that an excessive deficit exists in Cyprus. This opinion, adopted by the Commission on 24 June 2004, is herewith addressed to the Council, according to Article 104(5) of the Treaty. The Commission recommends that the Council shall decide accordingly, in conformity with Article 104(6). In addition, the Commission is submitting to the Council a recommendation for a Council recommendation to be addressed to Cyprus with a view to bringing the situation of an excessive deficit to an end, according to Article 104(7) of the Treaty.

COMMISSION OPINION on the existence of an excessive deficit in Cyprus - Application of Article 104(5) of the Treaty establishing the European Community

GENERAL CONSIDERATIONS

According to Article 104 of the Treaty, Member States are to avoid excessive government deficits. This applies also to the Member States with a derogation, the case of all countries that joined the EU on 1 May 2004. Decisions on the existence of an excessive deficit are governed by the excessive deficit procedure (EDP) specified by Article 104 of the Treaty and Council Regulation (EC) No 1467/97, which is part of the Stability and Growth Pact [4].

[4] OJ L 209, 2.8.1997.

Article 104(2) of the Treaty requires the Commission to monitor the development of the budgetary situation and of the stock of government debt in the Member States with a view to identifying gross errors. In particular, the Commission has to examine compliance with budgetary discipline on the basis of two criteria, one for the ratio of the planned or actual government deficit to gross domestic product (GDP) and one for the ratio of government debt to GDP. The statistical data on these variables are provided by the Commission on the basis of reporting by the Member States.

Article 104(3) of the Treaty requires the Commission to prepare a report if the requirements under one or both of the criteria of Article 104(2) are not fulfilled or if, notwithstanding the fulfilment of the requirements under the criteria, the Commission is of the opinion that there is a risk of an excessive deficit in a Member State. The Commission report also takes into account whether the government deficit exceeds government investment expenditure and all other relevant factors, including the medium-term economic and budgetary position of the Member State, as required by Article 104(3) of the Treaty. On the basis of its Spring 2004 forecasts, which took into consideration data reported by Cyprus in March 2004, the Commission has adopted such a report for Cyprus on 12 May 2004.

Subsequently, and in accordance with Article 104(4), the Economic and Financial Committee has formulated an opinion on the report of the Commission on 24 May 2004.

Article 104(5) of the Treaty requires the Commission to address an opinion to the Council if it considers that an excessive deficit in a Member State exists or may occur. In order to reach a conclusion on whether an excessive deficit exists or may occur, the Commission considers that account should be taken of: (i) the conclusions of its own report and (ii) the opinion of the Economic and Financial Committee on it. On the basis of these elements, the Commission has established a number of considerations for Cyprus.

CONSIDERATIONS CONCERNING CYPRUS

1. The general government deficit in Cyprus was 6.3% of GDP in 2003, well above the 3% of GDP reference value of the Treaty. It increased relative to the 2002 deficit (4.6 % of GDP).

2. The excess of the deficit over the 3% of GDP reference value in 2003 did not result from an unusual event outside the control of the Cypriot authorities, nor from a severe economic downturn, in the sense of the Stability and Growth Pact. In 2003, real GDP growth reached 2.0%.

3. The outturn for the general government deficit in 2003 was 4.4 percentage points of GDP above the value planned in August 2002 when the budget for 2003 was adopted. This increase was linked to the adverse external environment; modest growth of the EU -the major tourist source for Cyprus-, repercussions of September 11, 2001 and other terrorist attacks, the Iraqi war and SARS, all of which contributed to diminishing external (tourism) demand feeding directly and indirectly into lower growth and a deterioration of public finances, further exacerbated by increased government spending and revenue shortfalls.

4. Gross government investment in 2003 was 3.8% of GDP, compared to a general government deficit of 6.3% of GDP.

5. The general government deficit is likely to continue to exceed the Treaty reference value in 2004. In particular, the Commission Spring 2004 forecasts project the general government deficit in Cyprus to reach 4.6% of GDP in 2004, which is below the 5.2% of GDP projected by the Cypriot authorities in the May 2004 convergence programme.

6. The gross government debt to GDP ratio in Cyprus, which reached 72.2% of GDP in 2003, is likely to further deviate from the 60% of GDP Treaty reference value in 2004. In particular, the Commission Spring 2004 forecasts project gross government debt to reach 74.6% of GDP in 2004, which is below the 75.2% of GDP projected by the Cypriot authorities in the convergence programme.

CONCLUSION

The monitoring of the budgetary situation in Cyprus and, in particular, the examination of the compliance with the criteria laid down in Article 104(2) have led the Commission to prepare a report in accordance with Article 104(3) of the Treaty. The Commission, having examined the relevant factors taken into account in this report and having regard to the opinion of the Economic and Financial Committee, is of the opinion that an excessive deficit exists in Cyprus.