Council opinion of 8 March 2005 on the updated convergence programme of Cyprus, 2004-2008
Date: 2005-03-08
Institutions: Council of the European Union
Subjects: Cyprus, stability programme

C 177/4

EN

Official Journal of the European Union

19.7.2005

COUNCIL OPINION

of 8 March 2005

on the updated convergence programme of Cyprus, 2004-2008

(2005/C 177/02)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveil-
lance of budgetary positions and the surveillance and coordination of economic policies (1), and in particu-
lar Article 9(3) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1)

(2)

(3)

On 8 March 2005 the Council examined the updated convergence programme of Cyprus, which
covers the period 2004 to 2008. The programme complies with the data requirements of the
revised ‘code of conduct on the content and format of stability and convergence programmes’.

The programme contains four different scenarios for the macroeconomic and budgetary projections:
a ‘central’ scenario, an ‘upper’ scenario, ‘lower’ scenario and ‘higher interest rate’ scenario. The so-
called ‘central’ scenario is considered as the reference scenario for assessing budgetary projections
because, on the basis of currently available information, it seems to reflect plausible growth assump-
tions. It projects real GDP growth to pick up from 3,6 % in 2004 to 4,3 % on average over the rest
of the programme period. The programme's projections for inflation also appear realistic.

On 5 July 2004, the Council decided that an excessive deficit existed in Cyprus and recommended
that this be corrected by 2005. The update aims at reducing the government deficit to below the
3 % of GDP reference value in 2005, in line with the Council recommendation under Article 104(7).
Compared to the May 2004 convergence programme the update maintains the deficit target for
2005 but sharpens the targets after 2005. It foresees the general government deficit to sharply
decline from 4,8 % of GDP in 2004 to 2,9 % in 2005 and to decline more gradually thereafter, to
0,9 % in 2008. Since interest expenditures are projected to remain constant at around 3,5 % of GDP
the path of the primary balance is similar to that of the overall balance, improving from - 1,3 % in
2004 to 2,5 % at the end of the programme period. To this end, the update envisages a series of
mostly structural measures to restrain expenditure and to increase revenue. Expenditure limits
contribute 2,3 percentage points to the overall deficit reduction of almost 4 percentage points of
GDP over the period 2004-2008. The adjustment path reflects the government commitment to
improve public finances with the intention of early adoption of the euro. This is the main factor
behind the frontloading of the fiscal adjustment which would reduce the general government budget
deficit by 1,9 percentage points of GDP in 2005.

(1) OJ L 209, 2.8.1997, p. 1. The documents referred to in this text can be found at the following website:

http://europa.eu.int/comm/economy_finance/about/activities/sgp/main_en.htm

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Official Journal of the European Union

C 177/5

(4)

(5)

(6)

(7)

(8)

The risks to the budgetary projections in the update appear broadly balanced. In particular, the
main downside macroeconomic risks are the economic outlook in the US and the EU (notably the
UK and Germany, main tourist source countries), tensions in the Middle East, and oil price develop-
ments (1). The update further indicates that several planned measures for 2005 onward are to be
‘studied’ further, which leaves some uncertainty. On the other hand, the estimated deficit outcome
for 2004 has been better than expected. This positive result was achieved despite delays in a
number of consolidation measures originally planned for 2004. These are now to be implemented
in 2005, the budgetary impact of which is prudently considered as a safety margin for 2005 in case
of e.g. delays in other measures, to keep the target of 2,9 % of GDP as an ‘upper limit’ while at the
same time expenditure is to be kept under strict control. Although expenditure overruns were a
main problem in the past,
the consolidation measures now emphasize structural expenditure
control, especially on government consumption. In addition, several of the planned measures for
2005 have now been successfully negotiated with the social partners. The Commission services
autumn 2004 forecast projected a deficit of 3,0 % of GDP for 2005, given a slightly lower GDP
growth forecast for that year. However, the update reiterates that ‘additional measures’ will be taken
if lower growth would risk leading to a higher deficit in 2005. All this would facilitate the adjust-
ment to 2,9 % of GDP for 2005. All in all, the planned deficit reduction for 2005 looks challenging
but increasingly feasible. For the period 2006-2007 the adjustment path is slightly tightened to
reach lower deficits compared to the previous May 2004 programme. However, it is not clear how
this tightening will be achieved, given that the planned measures and GDP growth path have
broadly remained the same. The adjustment path has to be underpinned by measures of a perma-
nent nature.

In view of this risk assessment, the budgetary stance in the programme seems sufficient to reduce
the deficit to below 3 % of GDP by 2005 and seems to provide a sufficient safety margin against
breaching this threshold with normal macroeconomic fluctuations from 2006 onward. It is however
not sufficient to ensure that the Stability and Growth Pact's medium-term objective of a budgetary
position of close to balance is achieved within the programme period.

The debt ratio is estimated to have reached 74,9 % of GDP in 2004, above the 60 % of GDP Treaty
reference value. The programme projects the debt ratio to decline by almost 17 percentage points
over the programme period. The evolution of the debt ratio is partly driven by debt-reducing stock-
flow adjustments linked to the gradual phasing out of sinking funds, the accumulation of which had
earlier on led to debt-increasing stock flow adjustments.

Cyprus presents some risks with regard to long-term sustainability of the public finances, reflected
by the projected budgetary costs of an ageing population. The strategy outlined in the update is
mainly based on the budgetary consolidation in the next few years and additional reforms of
pension and health care system to be implemented in the future. It is imperative to pursue the
reform process in order to reduce the sustainability risks associated with the future evolution of age-
related expenditures,
together with the planned and necessary budgetary consolidation in the
medium term.

The economic policies outlined in the programme are broadly consistent with the country-specific
broad economic policy guidelines in the area of public finances. In particular, the fiscal consolida-
tion programme aims to reduce the general government deficit within a multi-annual framework.
The fiscal consolidation measures both on the expenditure and revenue side are mostly of a struc-
tural nature, and there is still some uncertainty surrounding the implementation of some of the
planned consolidation measures. The deficit objective path, particularly for 2005, is ambitious but
does not look implausible.

(1) It should also be noted that future economic developments in Cyprus remain subject to unusual uncertainty: In case

of reunification, the economic situation of the entire island would fundamentally shift.

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Official Journal of the European Union

19.7.2005

In view of the above assessment and in the light of the recommendations made by the Council under
Article (104(7), the Council is of the opinion that Cyprus should:

(i) implement with vigour the measures envisaged in the updated convergence programme to bring the
deficit below 3 % of GDP by 2005 and ensure through measures of a permanent nature that budgetary
consolidation towards the medium term budgetary position of close to balance or in surplus is
sustained after the excessive deficit has been corrected;

(ii) ensure that the debt ratio will start to decline from 2005 onward; and

(iii) pursue the reform process in the pension and health care system in order to reduce the sustainability
risks associated with the future evolution of age-related expenditures, together with the planned and
necessary budgetary consolidation in the medium term.

Comparison of key macroeconomic and budgetary projections

2004

2005

2006

2007

2008

Real GDP
(% change)

CPI inflation
(%)

General government
balance
(% of GDP)

Primary balance
(% of GDP)

Government gross debt
(% of GDP)

CP Dec2004

COM Nov 2004

CP May 2004

CP Dec2004

COM Nov 2004

CP May2004

CP Dec2004

COM Nov 2004

CPMay2004

CP Dec2004

COM Nov 2004

CP May2004

CP Dec2004

COM Nov 2004

CP May2004

3,6

3,5

3,5

2,1

2,4

2,0

– 4,8

– 5,2

– 5,2

– 1,3

– 1,8

– 1,6

74,9

72,6

75,2

4,0

3,9

4,3

2,6

2,2

2,0

– 2,9

– 3,0

– 2,9

0,7

0,5

0,7

71,9

72,4

74,8

4,4

4,2

4,4

2,2

2,1

2,0

– 1,7

– 2,4

– 2,2

1,8

1,1

1,4

69,2

69,4

71,5

4,5

n.a.

4,5

2,1

n.a.

2,0

– 1,5

n.a.

– 1,6

2,0

n.a.

2,0

65,7

n.a.

68,4

4,5

n.a.

n.a.

2,0

n.a.

n.a.

– 0,9

n.a.

n.a.

2,5

n.a.

n.a.

58,1

n.a.

n.a.

Sources:
Convergence programme (CP); Commission services autumn 2004 economic forecasts (COM); Commission services calculations