EN    EN EN 
 
EN    EN  EUROPEAN COMMISSION 
Brussels, 27.1.2011 
SEC(2011) 114 final 
 
COMMISSION STAFF WORKING PAPER 
Analysis by the Commission s ervices of the action taken 
 
by Cyprus 
 
in response to the Council Recommendation of  13 July 2010 with a view to bringing an 
end to the situation of excessive government deficit 
   
COM(2011) 22 final 
SEC(2011) 113 final SEC(2011) 115 final SEC(2011) 116 final 
 
EN 2   EN COMMISSION STAFF WORKING PAPER 
Analysis by the Commission s ervices of the action taken 
 
by Cyprus 
 
in response to the Council Recommendation of  13 July 2010 with a view to bringing an 
end to the situation of excessive government deficit  
1. INTRODUCTION  
According to the April 2010 EDP notification, the general government deficit in Cyprus 
reached 6.1% of GDP in 2009 from a surplus of 0.9% in 2008. This was a result of a severe 
economic downturn and discretionary measures in  response to the econo mic downturn (in line 
with the EERP) but also of rath er large composition effects on account of a much less tax-rich 
GDP growth pattern. In parallel, the general gov ernment gross debt st ood at 56.2% of GDP, 
below the 60% of GDP reference value but on a rising trend. Against this background, on 13 
July 2010, the Council decide d that an excessive defi cit existed and addressed 
recommendations to Cyprus in accordance with Article  126(7) TFEU with a view to bringing 
an end to the situation of an excessive government deficit by 2012.1 In its recommendations, 
the Council established a deadline of 13 Janua ry 2011 for effective action to be taken. 
The Council recommended to Cyprus to bring the general government deficit below 3% of 
GDP in a credible and sustainable manner by  taking action in a medium-term framework. 
Specifically, to this end, Cyprus should: (a ) take necessary measures to reduce the 2010 
deficit to at most 6% of GDP  and define an expenditure-dri ven consolidation strategy, in 
order to bring the deficit below the reference value by 2012; (b) to  this end ensure an average 
annual fiscal effort of at least 1½ % of GDP  over the period 2011- 2012, which should also 
contribute to bringing the govern ment gross debt ratio back on a declining path that 
approaches the reference value at a satisfactor y pace by restoring an adequate level of the 
primary surplus; and (c) specify and rigorously implement the measures that are necessary to 
achieve the correction of the excessive defi cit by 2012, cyclical conditions permitting, and 
accelerate the reduction of the de ficit if economic or budgetary c onditions turn out better than 
currently expected.  
To limit risks to the adjustment, a strengthen ing of the binding nature  of Cyprus’ medium-
term budgetary framework and better monito ring of budget execution throughout the year 
were requested. In addition, the Cyprus was recommended to improve the long-term 
sustainability of public finances by implementi ng reform measures to control pension and 
health care expenditure in order to curb th e projected increase in age-related expenditure. 
Finally, Cyprus was recommended to seize any opportunity beyond the fiscal effort, including 
from better economic conditions, to accelerate the reduction of the gross debt ratio back 
towards the 60% of GDP reference value.  
This paper reviews the actions taken by C yprus to meet the aforementioned Council 
recommendations, in light of the economic a nd budgetary developments. In particular, it 
                                                 
1 All EDP-related documents for Cyprus can be found at the following website: 
http://ec.europa.eu/econo my_finance/sgp/deficit/countries/cyprus_en.htm   
 
EN 3   EN reviews the budgetary implementation in 2010 and the prospects for 2011, on the basis of the 
Commission services’ autumn 2010 forecast, th e 2011 Budget Law, voted by the Parliament 
on 16 December 2010, as well as additional cons olidation measures adopted by Cyprus.  
2. ECONOMIC DEVELOPMENTS  
The global economic and financial crisis hit Cyprus through a slump in external demand. 
After five quarters of contracting economic act ivity which led to a co ntraction of real GDP, 
for the first time in 35 years, by 1.7% in 2009, co mpared to 4.1% for the euro-area average, 
the first three quarters of 2010 witnessed a stronger-than-expected  rebound of economic 
activity. The Commission services' autumn 2010 forecast expects real GDP in 2010 as a 
whole to expand by 0.5%. The economic recovery that started in 2010 is set to continue into 
2011 and to gain momentum in 2012. Real GD P is projected to grow by 1.5% and 2.2% 
respectively, while the compositi on of growth is set to follow a more balanced pattern.  
The macroeconomic outlook for the Cypr iot economy for the period 2010-11 has 
progressively improved since the publica tion of the Commission services' spring 2010 
forecast underpinning the Council recommendations  of 13 July 2010 (Table 1). The national 
authorities have revised their economic projectio ns only slightly upwards during the course of 
the year: in the stability progr amme update of April 2010, economic activity was expected to 
expand by 0.5% and 1.5% in 2010 and 2011, respectively. These were also the underlying real 
GDP growth projections of the 2011 budget. Currently, the national authorities project 
economic activity to expand by ½-1% in 2 010 and 1½-2% in 2011. The main factor 
contributing to the improved economic outloo k, despite the deteriorated performance of 
domestic demand in 2010, is net exports. Alth ough the adjustment of growth to a more 
balanced composition pattern is a positive development, on the other hand, being less tax-rich could pose a challenge on the fi scal consolidation efforts.  
Table 1: Comparison of macroeconomic developments and forecasts 
  2009 2010 2011 
  outturn COM SF10 COM AF10 COM SF10 COM AF10
Real GDP (% change) -1.7 -0.4 0.5 1.3 1.5 
Contributions to real GDP growth:           
 Domestic demand (excl. inventories) -3.7 -3.2 -3.7 1.1 1.0 
 Changes in inventories -4.1 1.8 1.8 0.0 0.0 
 Net exports 5.8 0.9 2.4 0.3 0.5 
Employment (% change) -0.7 -0.7 -0.9 -0.2 0.2 
GDP deflator (% change) 0.0 2.1 2.5 2.4 3.2 
Source  : COM SF10 - Commission services' spring 2010 forecast; CO M AF10 - Commission services' autumn 2010 forecast.  
3. BUDGETARY IMPLEMENTATION IN 2010 
The Commission services' autumn 2010 forecasts, on the basis of available information at the 
time - including the draft budget, estimated that the budget deficit appeared to have stabilised 
in 2010 at a level similar to the previous year, at 5.9% of GDP, as a marginal increase in revenues appeared to have been fully offset by a rise in expenditure s. On the one hand, the 
slowdown of activity and reduced  corporate profitability app ear to have weighed on tax 
receipts. In particular, direct  tax revenues declined further,  dragged down by lower income-
tax receipts. Indirect taxes poste d only marginal growth as a ri se in import duties and excise 
 
EN 4   EN taxes, which benefited from the increase of the ex cise duty on petrol as of 1 July due to the 
derogation expiration, was largely offset by a fall  in VAT receipts. Social contributions posted 
positive growth, benefiting from the full- year imp act of the rise of contribution rates adopted 
in the first half of the 2009. On the other hand, current expenditure continued to rise, despite 
the fall in interest payments, on the back of in creases in the public wage  bill, social outlays 
and subsidies. Given that revenues benefited fr om a one-off factor of almost ¾ pp. of GDP, 
associated with the profit on an interest swap  agreement and a transfer of higher-than-usual 
Central Bank profits, the budgetary outcome could have been worse on the basis of 
underlying fiscal trends.  
Moreover, recently published cash data of the consolidated accounts of the central 
government and administered funds for the period January – Nove mber 2010 appear to 
support and even better outturn for 2010, at a bout 5.5% of GDP. In pa rticular, cash data 
demonstrates a reduction of the deficit to  2.44% of GDP for ce ntral government and 
administered funds compared with 2.97% over the same period of 2009, an improvement by 
0.5 percentage points.  
4. PROJECTED BUDGETARY DEVELOPMENTS IN 2011  AND 2012 
On the basis of the 2011 draft budget available at  the time, the Commission services' autumn 
2010 forecast2 projected a deficit of 5.7% of GDP for 2011.  
For 2011, the Budget Law3 targets a deficit of 5.4% of GDP , on the basis of an estimated 
deficit for 2010 of just below 6% of GDP. This budge tary target is lower th an that set in last 
April’s update of the stability programme, of 4.5% of GDP. On the revenue side, the budget 
does not incorporate any additional measures, apart from the phasing-out of the tax-relief, which was part of the stimulus measures and the harmonisation of excise duties on petroleum 
products, in effect since last July. Nevertheless,  these effects are partly offset by a reduction 
in other current revenues. On the expenditure  side, the budget aims  at savings through a 
reduction of operational expenditure, as we ll as restraint in pub lic investment and 
employment. However, these elements are full y offset by a rise in the public wage bill, 
interest payments and in social outlays.  Compared to the dr aft budget, the Commission 
services’ forecast incorporates a more prudent assessment of revenue prospects, given a less 
tax-rich growth composition, and on the expendit ure side, given past tr ends on key items such 
as the wage bill and social transfers. 
After the autumn forecast, Cyprus adopted a fi scal consolidation package in tandem with the 
adoption of the Budget, which consists of measures on both the revenue and expenditures sides. As explained in the lett er sent by Minister of Finance Stavrakis to Commissioner Rehn 
on 7 January 2011, the authorities estimate the cons olidation arising from this package at 1 
percentage point (pp.) of GDP, out of which 0.6 pp. of GDP are on the revenue side and of 
permanent nature. In particular, these includ e the introduction of 5% VAT on foodstuffs and 
pharmaceutical products as of January 2011 (0.3% of GDP), in line with the EU acquis and 
the increase of excise duties on cigarettes a nd tobacco products by 30% (0.3% of GDP). On 
the expenditure side, the authorities plan to make savings through cuts in operating 
                                                
 
2 The Commission services autumn 2010 forecasts were published on 29 November 2010. The data cut-
off date was 15 November 2010. 
3 The 2011 Budget Law was adopted by  the Parliament on 16 December 2010. 
 
EN 5   EN expenditure (0.25% of GDP) a nd through reduction of the si ze of civil service by 1000 
persons annually (0.15% of GDP). 
In addition, the coalition parties have agreed on an additional set of measures, which will be 
submitted to the Parliament for approval in Febr uary 2011. This is estimated by the authorities 
to yield an additional 0.6 p.p. of GDP of cons olidation in 2011, from both revenue supporting 
and expenditure containing measur es. In particular, it includes the harmonisation of water 
consumption tariffs in line with the EU acquis  (0.05% of GDP), levies on the deposits of 
banks for two years, subject to a minimum pr ofitability (0.35% of GDP ) and wage moderation 
in the public sect or (0.2% of GDP).  
 
EN 6   EN Table 2: Composition of the budgetary adjustment 
2009 2010 2011 2012 
(% of GDP) SP 
Apr 
2010 outturn SP 
Apr 
2010 Budget 
2011 COM 
AF2010 SP 
Apr 
2010 Budget 
2011 COM 
AF2010 COM 
AF20103 
Revenue 40.3 39.8 41.6 40.2 40.2 42.8 40.8 40.4 40.5 
of which:          
- Taxes on production and 
imports 15.0 15.1 15.5 15.1 15.1 16.1 15.5 15.7 15.8 
- Current taxes on income, 
wealth, etc. 11.2 11.2 11.6 10.7 10.7 12.1 11.0 10.8 10.8 
- Social contributions 9.3 8.6 9.6 8.9 8.9 9.7 9.2 8.9 8.8 
- Other (residual) 4.8 4.9 4.9 5.5 5.5 4.9 5.0 5.0 5.0 
Expenditure 46.4 45.8 47.6 46.2 46.2 47.2 46.1 46.2 46.2 
of which:          
- Primary expenditure 43.9 43.2 45.3 43.9 43.9 44.8 43.7 43.8 43.7 
of which:          
Compensation of 
employees 15.6 15.6 15.8 15.9 15.9 15.9 16.0 16.1 16.1 
Intermediate 
consumption 5.6 5.6 5.6 5.3 5.3 5.6 5.0 5.0 5.0 
Social payments 13.8 13.3 14.4 14.2 14.2 14.9 15.0 15.1 15.1 
Subsidies 0.1 0.2 0.4 0.3 0.3 0.4 0.4 0.4 0.4 
Gross fixed capital 
formation 4.1 4.1 4.1 3.9 3.9 4.1 3.8 3.7 3.7 
Other (residual) 4.7 4.4 5.0 4.2 4.2 4.1 3.6 3.5 3.5 
- Interest expenditure 2.5 2.5 2.3 2.3 2.3 2.4 2.4 2.4 2.4 
General government 
balance (GGB) -6.1 -6.0 -6.0 -5.9 -5.9 -4.5 -5.4 -5.7 -5.7 
Primary balance -3.6 -3.4 -3.7 -3.6 -3.6 -2.1 -3.0 -3.3 -3.3 
One-off and other 
temporary measures 0.0 0.7 0.1 0.7 0.7 0.1 0.0 0.0 0.0 
GGB excl. one-offs -6.1 -6.6 -6.1 -6.6 -6.6 -4.6 -5.4 -5.7 -5.7 
Output gap1 -1.3 -1.2 -2.4 n.a. -2.2 -2.5 n.a. -1.8 -0.7 
Cyclically-adjusted balance1 -5.6 -5.5 -5.1 n.a. -5.1 -3.5 n.a. -5.0 -5.4 
Structural balance2 -5.6 -5.7 -5.2 n.a. -5.7 -3.6 n.a. -5.0 -5.4 
Change in structural 
balance -5.4 -5.4 0.4 n.a. 0.0 1.5 n.a. 0.7 -0.4 
Structural primary balance2 -3.1 -3.2 -2.9 n.a. -3.4 -1.2 n.a. -2.6 -3.0 
Change in structural 
primary balance -5.7 -5.7 0.2 n.a. -0.2 1.6 n.a. 0.8 -0.4 
Memorandum Items % 
Real GDP growth -1.7 -1.7 0.5 0.5 0.5 1.5 1.5 1.5 2.2 
GDP deflator 0.0  1.7 3.0 2.5 2.0 2.5 3.2 2.5 
Nominal GDP -1.7 -1.7 2.2 3.5 3.0 3.5 4.0 4.7 4.8 
Notes:  
1 Output gap (in % of potential GDP) and cy clically-adjusted balance according to the programme as recalculated by Commission s ervices 
on the basis of the information in the programme. 
2 Structural (primary) balance = cyclically-adjusted (prima ry) balance excluding one-off and other temporary measures. 
3 On a no policy change basis. 
Source:  
Stability programme (SP) update, April 2010; Commission services’ autumn 2010 forecasts (COM); Commission services’ calculation s 
 
EN 7   EN However, despite the adopted measures, the pub lic wage bill is still on a rising trend. This 
may suggest that the numerical reduction of public sector’s employees is not enough to 
restrain expenditure on this field. Also, no measures have be en adopted to target social 
transfers, which have been on high growth rates in  recent years. Together, the public wage bill 
and social outlays account for about ⅔ of total expenditure. The adopted consolidation 
strategy does not address comprehensiv ely these expenditure categories.  
The Commission services’ autumn 2010 forecast does not incorporate the recently adopted 
package of consolidation measures, as this was not  available as at the data cut-off date. This 
forecast implies an improvement in the structural balance (the cyclically-adjusted balance net of one-off and other temporary measures) by ¾ pp. of GDP in 2011, after a neutral impact in 
2010. The adoption of the aforementioned fiscal c onsolidation package, taken at face value, 
would improve both the headline and the structur al balance by a 1 percentage point of GDP. 
The adoption of the additional set of pendi ng measures, accounting for 0.6 pp. of GDP is 
expected to have a similar impact. Overall, the improvement of the headline and the structural 
balance in 2011 would be around 2¼ pp. of GDP. Benefiting from the base-effect of the 
lower-than-expected deficit outturn in 2010 (by 0.4 percentage points of GDP),  the headline 
balance would thus be expected to amount to 3¾% of GDP in 2011.  
However, the Commission services see risks to  the achievement of the 2011 deficit target. 
These are mainly stemming from the standard practise of 
adopting supplementary budgets 
during the course of the year.  Hitherto, this  implied an increase in current expenditure, beyond 
the intended reallocation of funds. Moreover, slippages in social transfers due to pressure to adopt 
measures to alleviate the impact of indirect tax rises , especially given that  Cyprus enters an 
electoral cycle, pose a consider able risk. Furthermore, the impact of the wage indexation 
(COLA) on the public wage bill,  in case of a higher-than-expected increase in inflation also due 
to aforementioned VAT rise, constitutes a non-negligible risk.  Moreover, there are risks for the 
budgetary impact of announced yet not adopted cons olidation measures due to pressures from 
affected parties. 
For 2012, the authorities plan to reduce the defi cit further, below the 3% of GDP reference 
value, through the con tinuation of the adopted consol idation measures. Based on the 
customary no-policy-change assumption and wit hout incorporating the announced package of 
consolidation measures, the Commission services ' autumn 2010 forecast projected the deficit 
to stabilise as a percentage of GDP to the sa me levels as in 2011, at 5.7%. Nevertheless, in 
view of the base effect in 2011, from a lowe r-than-expected deficit in 2010 (0.4% of GDP), 
and of the continuation in 2012 of the adopted  consolidation measur es, the 2012 budgetary 
deficit would also be expected to declin e by 1 pp. of GDP and by an additional 0.6 p.p., 
subject to Parliament’s approval of the additional consolidation measures. 
5. DEBT DEVELOPMENTS  
In the autumn 2010 forecast, th e Commission services estimat e Cyprus’ gross government 
debt-to-GDP ratio to increase to  65.2% by 2011. The main driver of this deterioration is the 
primary deficit, which is only partly offset by the positive impact fr om the acceleration of 
growth.  
In the 2011 budget, the Cypriot authorities projec t the government debt to deteriorate mildly 
and reach about 62% of GDP in 2010, from 58%  in 2009. The positive impact of the projected 
growth in nominal GDP is more than offset by interest payments. Moreover, the existence of a 
 
EN 8   EN primary deficit weighs on the debt. For 2011, the authorities project a further increase in the 
debt ratio to 63.8%, due to the cont inuation of a primary deficit.  
The adoption of the fiscal conso lidation package is e xpected to stabilise the debt-to-GDP-ratio 
in 2011 at levels similar to 2010, through the containment of the primary deficit. The continuation of consolidation measures in 2012,  coupled with the acceleration of growth, 
should contribute in reversing debt to a declining trend.  
Table 3: Debt Developments 
(% of GDP) 2009 2010 2011 
 Outturn SP Apr 
2010 SP Apr 
2010 Budget 
2011 COM 
AF10SP Apr 
2010 Budget 
2011 COM 
AF10 
Gross debt ratio1 58.0 56.2 61.0 61.9 62.2 63.2 63.8 65.2 
Change in the ratio 9.7 7.8 4.8 3.9 4.2 2.2 1.9 3.0 
Contributions2:         
1. Primary balance 3.4 3.6 3.7 3.6 3.6 2.1 3.0 3.3 
2. “Snow-ball” effect 3.5 3.3 1.1 0.3 0.5 0.4 0.0 -0.4 
Of which:         
Interest expenditure 2.5 2.5 2.3 2.3 2.3 2.4 2.4 2.4 
Nominal GDP growth effect 1.0 0.8 -1.2 -2.0 -1.7 -2.1 -2.4 -2.8 
3. Stock-flow adjustment 2.8 0.9 0.0 0.0 0.0 -0.2 -1.1 0.1 
Of which:         
Cash/accruals diff. 0.2 0.2 0.0 n.a. n.a. 0.0 n.a. n.a. 
Acc. financial assets 2.6 0.7 0.0 n.a. n.a. -0.1 n.a. n.a. 
Privatisation n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 
Val. effect & residual 0.0 0.0 0.0 n.a. n.a. 0.0 n.a. n.a. 
Notes :   
1End of period.         
2The snow-ball effect captures the impact of interest expenditure  on accumulated debt, as well as the impact of real GDP growth and 
inflation on the debt ratio (through the denominator). The stock-fl ow adjustment includes differences in cash and accrual accou nting, 
accumulation of financial assets and valuation and other residual effects.  
Source :   
Stability programme (SP); Commission services’ spring 2010 forecasts (COM); Commission services’ calculations 
6. FISCAL GOVERNANCE , QUALITY OF THE PUBLIC FINANCES AND LONG -TERM 
SUSTAINABILITY  
The authorities have not outlined any specific measures to accelerate the implementation and 
to strengthen the binding natu re of Cyprus’ three-year me dium-term budgetary framework 
(MTBF). The full implementation of the new b udgeting framework is expected to cease the 
practise of adopting supplementary budgets during the course of the year, which has hitherto  
implied an increase in current expenditure, beyond the intended reallocation of funds. A medium-
term budgetary framework, as noted by the authorities, is expected to lead to a more effective 
and efficient budgeting process, contributing to contain expend iture by ministry according to 
the ceilings set. At the same time, the ne w budgeting process would set a sound basis for 
reallocating expenditure in favour of growth enhancing activities consistent with the priorities 
set by the National Reform Programme. Furtherm ore, no independent institution is involved 
in the formulation of the macroeconomic a ssumptions underlying the budgetary projections.  
As regards reform measures to control pension and health care expenditure, the authorities are 
in the process of setting up negotia tions with the public sector’s so cial partners with a view to 
 
EN 9   EN reform the public sector’s pensions. For this purpose, an independent actuarial firm has been 
appointed to assess the impact  of the government pensions’ scheme on public finances. The 
preliminary findings of this study, which will form the basis of dialogue with the social 
partners, are expected within the next two months. In this framework the authorities also 
envision to also discuss reforms of other sect or-related issues, such as the public sector’s 
wage structure and the wage indexation. 
Table 4: Comparison of key macro economic and budgetary projections 
    2008 2009 2010 2011 
COM  3.6 -1.7 0.5 1.5 
CY 3.6 -1.7 0.6 1.5 Real GDP 
(% change) 
SP 3.6 -1.7 0.5 1.5 
COM2 3.1 -1.2 -2.2 -1.8 
CY n.a. n.a. n.a. n.a. Output gap 
(% of potential GDP) 
SP1 2.9 -1.3 -2.4 -2.5 
COM 0.9 -6.0 -5.9 -5.7 
CY 0.9 -6.0 -5.9 -5.4 General government balance 
(% of GDP) 
SP 0.9 -6.1 -6.0 -4.5 
COM 3.7 -3.4 -3.6 -3.3 
CY 3.7 -3.4 -3.6 -3.0 Primary balance 
(% of GDP) 
SP 3.7 -3.6 -3.7 -2.1 
COM -0.3 -5.5 -5.1 -5.0 
CY n.a. n.a. n.a. n.a. Cyclically-adjusted balance 
(% of GDP) 
SP1 -0.2 -5.6 -5.1 -3.5 
COM -0.3 -5.7 -5.7 -5.0 
CY n.a. n.a. n.a. n.a. Structural balance3 
(% of GDP) 
SP -0.2 -5.6 -5.2 -3.6 
COM 48.3 58.0 62.2 65.2 
CY 48.3 58.0 61.9 63.8 Government gross debt 
(% of GDP) 
SP 48.4 56.2 61.0 63.2 
Notes :           
1 Output gaps and cyclically-adjusted balances  according to the programmes as recalculated 
by Commission services on the basis of the information in the programmes. 
2 Based on estimated potential growth of 2.5%, 1.5%, 1.1% and 1.1% respectively in the 
period 2009-2012 
3 Cyclically-adjusted balance excluding one-off and other temporary measures. One-off and 
other temporary measures are 0. 3% of GDP in 2009 and 0.7% in 2010; all deficit-reducing.  
            
Source :           
April 2010 update of Stability programme (S P); Commission services’ autumn 2010 forecasts 
(COM); Commission services’ calculations