EUROPEAN COMMISSION Brussels, 2.6.2021 COM(2021) 513 final Recommendation for a COUNCIL RECOMMENDATION delivering a Council opinion on the 2021 Stability Programme of Cyprus {SWD(2021) 501 final}



Recommendation for a COUNCIL RECOMMENDATION delivering a Council opinion on the 2021 Stability Programme of Cyprus THE COUNCIL OF THE EUROPEAN UNION, Having regard to the Treaty on the Functioning of the European Union, 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, Having regard to the Recommendation of the European Commission, Having regard to the resolutions of the European Parliament, After consulting the Economic and Financial Committee, Whereas: (1)On 20 March 2020, the Commission adopted a Communication on the activation of the general escape clause of the Stability and Growth Pact. In its Communication, the Commission set out its view that, given the expected severe economic downturn resulting from the COVID-19 outbreak, the conditions to activate the general escape clause were met. On 23 March 2020, the Ministers of Finance of the Member States agreed with the assessment of the Commission. The general escape clause has granted Member States budgetary flexibility to deal with the crisis. It has facilitated the coordination of budgetary policies in times of severe economic downturn. Its activation allows for a temporary departure from the adjustment path towards the medium-term budgetary objective of each Member State, provided this does not endanger fiscal sustainability in the medium term. On 17 September 2020, in its Annual Sustainable Growth Strategy, the Commission announced that the general escape clause would remain active in 2021. (2)On 20 July 2020, the Council recommended Cyprus to take all necessary measures, in line with the general escape clause, to effectively address the pandemic, sustain the economy and support the ensuing recovery. It also recommended Cyprus to pursue, when economic conditions allow, fiscal policies aimed at achieving prudent medium-term fiscal positions and ensuring debt sustainability, while enhancing investment. (3)The Council Recommendation on the economic policy of the euro area indicates that fiscal policies remain supportive in all euro area Member States throughout 2021 and that policy measures should be tailored to country-specific circumstances and be timely, temporary and targeted. When the epidemiological and economic conditions allow, emergency measures should be phased out, while combatting the social and labour-market impact of the crisis. Fiscal policies should be pursued that are aimed at achieving prudent medium-term fiscal positions and ensuring debt sustainability, while enhancing investment. Member States should pursue reforms that strengthen the coverage, adequacy, and sustainability of health and social protection systems for all. (4)On 18 November 2020, the Commission adopted its Opinions on the 2021 Draft Budgetary Plans of the euro area Member States, which were based on a qualitative assessment of the fiscal measures. The Commission was of the opinion that the Draft Budgetary Plan of Cyprus was overall in line with the fiscal policy recommendations adopted by the Council on 20 July 2020, and that most of the measures included in the plan supported economic activity against the background of considerable uncertainty. (5)Next Generation EU, including the Recovery and Resilience Facility, will ensure a sustainable, inclusive and fair recovery. Regulation (EU) 2021/241 establishing the Recovery and Resilience Facility came into force on 19 February 2021.This Facility will provide financial support for the implementation of reforms and investment, entailing a fiscal impulse financed by the EU. It will contribute to the economic recovery, to the implementation of sustainable and growth-enhancing reforms and investment, notably to promote the green and digital transitions, and it will strengthen the economies’ resilience and potential growth. In turn, it will also help public finances to return to more favourable positions in the near term and will contribute to strengthening sustainable public finances, growth and job creation in the medium and long term. (6)On 3 March 2021, the Commission adopted a Communication providing further policy orientations to facilitate the coordination of fiscal policies and the preparation of Member States’ Stability and Convergence Programmes. The overall fiscal stance, taking into account national budgets and the Recovery and Resilience Facility, should remain supportive in 2021 and 2022. At the same time, given the expectation of economic activity gradually normalising in the second half of 2021, Member States’ fiscal policies should become more differentiated in 2022. Member States’ fiscal policies should take into account the state of the recovery, fiscal sustainability and the need to reduce economic, social and territorial divergences. In view of the need to support a sustainable recovery for the EU, Member States with low sustainability risks should gear their budgets towards maintaining a supportive fiscal policy in 2022, taking into account the impact of the Recovery and Resilience Facility. Member States with high debt levels should pursue prudent fiscal policies, while preserving nationally financed investment and making use of grants under the Recovery and Resilience Facility to fund additional high-quality investment projects and structural reforms. For the period beyond 2022, fiscal policies should continue to take into account the strength of the recovery, the degree of economic uncertainty and fiscal sustainability considerations. A refocusing of fiscal policies towards achieving prudent medium-term fiscal positions, including by phasing out support measures in due course, will contribute to ensuring fiscal sustainability in the medium term. (7)The Communication of 3 March 2021 also announced the Commission’s view that the decision on the deactivation or continued application of the general escape clause should be taken as an overall assessment of the state of the economy, with the level of economic activity in the EU or euro area compared to pre-crisis levels (end-2019) as key quantitative criterion. On the basis of the Commission’s 2021 spring forecast, on 2 June the Commission considered that the conditions to continue to apply the general escape clause in 2022 and to deactivate it as of 2023 were met. Country-specific situations will continue to be taken into account after the deactivation of the general escape clause.

(8)On 29 April 2021, Cyprus submitted its 2021 Stability Programme, in line with Article 4 of Regulation (EC) No 1466/97. (9)In 2020, based on data validated by Eurostat, Cyprus’s general government deficit was 5.7% of GDP, while general government debt increased to 118.2% of GDP. The annual change in the primary budget balance amounted to -7.6% of GDP, including discretionary budgetary measures of 3.6% in support of the economy and the operation of automatic stabilisers. Cyprus also provided liquidity support to companies and households (such as guarantees and tax deferrals, which do not have a direct and immediate budgetary impact)estimated at 1.9% of GDP. On 2 June 2020, the Commission issued a report under Article 126(3) TFEU. This report discusses the budgetary situation of Cyprus, as its general government deficit in 2020 exceeded the 3% of GDP Treaty reference value, while its general government debt exceeded the 60% of GDP Treaty reference value and did not diminish at a satisfactory pace. The report concluded that the deficit criterion was not fulfilled and the debt criterion was not complied with. (10)The macroeconomic scenario underpinning the budgetary projections is favourable in 2021 and 2022. According to the Commission 2021 spring forecast, Cypriot real GDP is expected to grow by 3.1% in 2021 and 3.8% in 2022. According to the Stability Programme, the Cypriot economy is expected to grow by 3.6% in 2021 and 3.8% in 2022. The Programme’s comparatively higher growth rate in 2021 is driven by stronger private consumption. (11)In its 2021 Stability Programme, the government plans an increase in the general government deficit from 5.7% of GDP in 2020 to 4.7% of GDP in 2021, while the debt ratio is planned to decrease to 111.9% of GDP in 2021. According to the programme, the change in the primary budget balance in 2021 compared with the pre-crisis level (2019) is set to amount to -6.5% of GDP, reflecting the discretionary budgetary measures of 3.4% of GDP in support of the economy and the operation of automatic stabilisers. These projections are in line with the Commission’s 2021 spring forecast. (12)In response to the COVID-19 pandemic and related economic downturn, Cyprus has adopted budgetary measures to strengthen the capacity of its health system, contain the pandemic and provide relief to those individuals and sectors that have been particularly affected. This forceful policy response has cushioned the contraction in GDP, which, in turn, curtailed the increase in government deficit and public debt. Fiscal measures should maximise support to the recovery without pre-empting future fiscal trajectories. Therefore, measures should avoid creating a permanent burden on public finances. When Member States introduce permanent measures, they should properly fund them to ensure budgetary neutrality in the medium term. The measures taken by Cyprus in 2020 and 2021 have been in line with the Council Recommendation of 20 July 2020. The discretionary budgetary measures adopted by the government in 2020 and 2021 are mostly temporary or matched by offsetting measures. (13)The 2021 Stability Programme assumes investment and reforms financed by grants under the Recovery and Resilience Facility amounting to 0.6% in 2021, 0.4% in 2022, 0.4% in 2023, and 0.4% in 2024. Instead, the Commission forecast assumes that the total budgetary impact of reforms and investments entailed in the Plan amounts to 0.3% of GDP in 2021 and 0.5% of GDP in 2022. (14)The established indicators of fiscal adjustment set out in Regulation (EC) No 1466/97 need to be considered in the context of the current circumstances. First, there is significant uncertainty surrounding output gap estimates. Second, there is a need for fiscal policy to stand ready to rapidly adapt to the evolution of the pandemic, shifting from emergency relief to more targeted measures once health risks diminish. Third, the current context is characterised by a significant policy response to support economic activity. In the presence of sizeable transfers from the EU budget (such as those from the Recovery and Resilience Facility), the established indicators do not capture the full impulse provided by fiscal policies to the economy. Against this background, the structural balance does not appear adequate in the current circumstances. The expenditure benchmark, in turn, needs to be adapted and complemented with additional information in order to fully gauge the fiscal policy orientation. First, similarly to the approach pursed in the assessment of the 2021 Draft Budgetary Plans, temporary emergency measures have been excluded from the expenditure aggregate. These crisis-related temporary emergency measures support health systems and compensate workers and firms for the losses in income due to lockdowns and supply chain disruptions; their reversal by the public authorities is contingent on the return of the public health and economic situation to normality. Second, to assess the overall fiscal stance at the current juncture, the sizeable transfers from the EU budget (such as those from the Recovery and Resilience Facility) should be included in the relevant expenditure aggregate. Therefore, the fiscal stance is then measured by the change in primary expenditure (net of discretionary revenue measures and excluding crisis-related temporary emergency measures) including expenditure financed by grants under the Recovery and Resilience Facility and other EU funds. Going beyond the overall fiscal stance, the analysis also aims at assessing whether national fiscal policy is prudent and its composition is conducive to a sustainable recovery consistent with the green and digital transitions. For that reason, particular attention is paid to the evolution of nationally financed primary current expenditure and investment. (15)In its 2021 Stability Programme, Cyprus’s general government deficit is planned to decrease to 0.9% of GDP in 2022, mainly due to a discontinuation of the temporary support measures adopted in 2020 and 2021. The general government debt ratio is planned to decrease to 103.9% of GDP in 2022. These projections are below the Commission’s 2021 spring forecast. The Commission forecasts a deficit of 2% of GDP, mainly due to higher expected expenditure and lower revenue, and a general government debt ratio of 106.6% of GDP in 2022. Based on the Commission’s forecast, the overall fiscal stance as defined above – also including the impact on aggregate demand in 2022 from investment financed by both the national and the EU budgets, notably the Recovery and Resilience Facility – is estimated at -0.3% of GDP. The positive contribution of expenditure financed by Recovery and Resilience Facility grants and other EU funds is projected to increase 0.4 percentage points of GDP. Nationally financed investment is projected to provide a contractionary contribution of 0.1 percentage point of GDP. Nationally financed primary current expenditure (net of discretionary revenue measures) is projected to provide a contractionary contribution of 0.1 percentage points of GDP. (16)The quality of Member States’ budgetary measures appears particularly important. Fiscal structural reforms aimed at improving the composition of national budgets can support potential growth, create much-needed fiscal space and help ensuring fiscal sustainability over the longer term, including in view of climate change and health challenges. On the revenue side, the COVID-19 crisis has reinforced the importance of reforms for more efficient and fairer public revenue systems. On the expenditure side, it has made even more crucial to increase the level and quality of sustainable and growth-enhancing investments, consistent with serving the objectives of enhancing growth potential, economic and social resilience and the green and digital twin transition. The Recovery and Resilience Plans will allow to improve the composition of national budgets. (17)According to the programme’s medium-term budgetary plans, the general government surplus is planned to increase from 0.1% in 2023, to 1.6% of GDP in 2024. Based on the programme, the overall fiscal stance – also including the impact on aggregate demand from investment financed by both the national and the EU budgets, notably the Recovery and Resilience Facility – is estimated at 2.8% of GDP in 2023 and 2024 on average. The positive contribution of expenditure financed by Recovery and Resilience Facility grants and other EU funds is projected to increase by 0.1 percentage point of GDP. Nationally financed investment is projected to provide a contractionary contribution of 0.1 percentage point of GDP. Nationally financed primary current expenditure (net of discretionary revenue measures) is projected to provide a contractionary contribution of 2.8 percentage points of GDP. The current estimate of the 10-year average nominal potential growth is 3½%. However, this estimate does not include the impact of thereforms that are part of the Recovery and Resilience Plan and can boost Cyprus’ potential growth. (18)The general government debt ratio is planned to decrease from 99.5% of GDP in 2023 to 92.9% of GDP in 2024. Cyprus is considered to face medium fiscal sustainability risks over the medium term, as per the latest debt sustainability analysis. (19)In view of the currently still exceptionally high degree of uncertainty, the fiscal policy guidance should remain predominantly qualitative. More precise quantified guidance for the later years should be provided in 2022, if the degree of uncertainty has sufficiently declined by then.