Council opinion of 27 February 2007 on the updated convergence programme of Cyprus, 2006-2010
Date: 2007-02-27
Institutions: Council of the European Union
Subjects: Cyprus, budget estimate, economic convergence, economic forecasting, public finance, stability programme

C 71/16

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Official Journal of the European Union

28.3.2007

COUNCIL OPINION

of 27 February 2007

on the updated convergence programme of Cyprus, 2006-2010

(2007/C 71/05)

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 particular
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)

(4)

(5)

On 27 February 2007 the Council examined the updated convergence programme of Cyprus, which
covers the period 2006 to 2010.

The macroeconomic scenario underlying the programme envisages that real GDP growth will pick up
from 3,7 % in 2006 to 4.1 % on average over the rest of the programme period. Assessed against
currently available information, this scenario appears to be based on plausible growth assumptions.
The programme's projections for inflation also appear realistic.

For 2006, the general government deficit is estimated at just below 2 % of GDP in the Commission
services' autumn 2006 forecast, as targeted in the previous update of the convergence programme.
With real GDP growth lower than projected in the previous update (3,7 % instead of 4,2 %), total
expenditure is estimated to be higher than planned but this is estimated to be offset by higher total
revenues.

After the correction of the excessive deficit in 2005 and the abrogation of the excessive deficit proce-
dure in July 2006, the programme aims at further consolidating public finances. The general govern-
ment balance is projected to improve from a deficit of 1,9 % of GDP in 2006 to a balanced position
in 2010 entirely through expenditure retrenchment as the revenue ratio remains constant over the
programme period. While total expenditure is projected to fall by 1¾ percentage points of GDP over
the programme period, of which 1 percentage point of GDP corresponds to declining interest
payments, social transfers are planned to increase by 1¼ percentage point. The primary surplus is
planned to rise from 1½ % of GDP in 2006-07 to just above 2 % of GDP in 2008 and to remain
constant thereafter. The planned consolidation is slightly faster than in the previous update of the
convergence programme, against a broadly similar macroeconomic scenario.

The structural balance (i.e.
the cyclically-adjusted balance net of one-off and other temporary
measures) calculated according to the commonly agreed methodology is planned to improve from a
deficit of around 1½ % of GDP in 2006 to a surplus of some ¼ % of GDP at the end of the
programme period. As in the previous update of the convergence programme, the medium-term
objective (MTO) for the budgetary position presented in the programme is a structural deficit of
0,5 % of GDP, which the programme aims to achieve by 2008, one year earlier than in the previous
update. As the MTO is more demanding than the minimum benchmark (estimated at a deficit of
around 1¾ % of GDP), achieving it should fulfil the aim of providing a safety margin against the
occurrence of an excessive deficit. The MTO lies within the range indicated for euro-area and ERM II
Member States in the Stability and Growth Pact and the code of conduct and adequately reflects the
debt ratio and average potential output growth in the long term.

(1) OJ L 209, 2.8.1997, p. 1. Regulation as amended by Regulation (EC) No 1055/2005 (OJ L 174, 7.7.2005, 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

28.3.2007

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Official Journal of the European Union

C 71/17

(6)

(7)

(8)

(9)

The risks to the budgetary projections in the programme appear broadly balanced. The target for
2007 seems plausible when compared with the Commission services' autumn 2006 forecast and, for
the year 2008, when the primary surplus is planned to improve, there is relatively detailed informa-
tion in the programme about the measures that support the adjustment. However, there is some risk
of spending slippages given the high degree of expenditure restraint envisaged and the limited infor-
mation on the spending ceilings and their enforcement. On the other hand, the overall track record
with respect to the achievement of the budgetary targets is good.

In view of this risk assessment, the budgetary stance in the programme seems sufficient to ensure
that the MTO is achieved by 2008, as envisaged in the programme. In addition, it seems to provide a
sufficient safety margin against breaching the 3 % of GDP deficit threshold with normal macroeco-
nomic fluctuations throughout the programme period. The pace of adjustment towards the MTO
implied by the programme is in line with the Stability and Growth Pact, which specifies that, for
euro-area and ERM II Member States, the annual improvement in the structural balance should be
0,5 % of GDP as a benchmark and that the adjustment should be higher in good economic times and
could be lower in bad economic times. After the achievement of the MTO, the fiscal policy stance
implied by the programme is also in line with the Pact.

Government gross debt is estimated to have reached 64¾ % in 2006, above the 60 % of GDP Treaty
reference value. The programme projects that the debt ratio would fall below the 60 % of GDP refer-
ence value in 2008 and would attain just above 46 % of GDP by the end of the programme period.
The risks to the projected evolution of the debt ratio appear to be broadly balanced. In view of the
risk assessment, the debt ratio is sufficiently diminishing towards the reference value in the early part
of the programme period and is planned to approach it by 2007.

The long-term budgetary impact of ageing in Cyprus is among the highest in the EU, influenced
notably by a very large increase in pension expenditure as a share of GDP. The initial budgetary posi-
tion contributes to easing part of the projected considerable long-term budgetary impact of an ageing
population, but it is not sufficient to cover it. Moreover, the current level of gross debt is above the
Treaty reference value. Continuing the consolidation of the public finances simultaneously with
adopting pension reform measures aimed at containing the significant increase in age-related expendi-
tures would contribute, as recognised by the authorities, to reducing risks to the sustainability of
public finances. Overall, Cyprus appears to be at high risk with regard to the sustainability of public
finances.

(10)

The convergence programme contains a qualitative assessment of the overall impact of the October
2006 implementation report of the national reform programme within the medium-term fiscal
strategy. In addition, it provides systematic information on the direct budgetary costs or savings of
the main reforms envisaged in the national reform programme and its budgetary projections seem to
take into account the public finance implications of the actions outlined in the national reform
programme. The measures in the area of public finances envisaged in the convergence programme
seem consistent with those foreseen in the national
In particular, both
programmes envisage the gradual implementation of pension and healthcare reforms in order to
address the impact of ageing populations. Also, there is a need to enhance life-long learning, and to
further increase employment and training opportunities for young persons.

reform programme.

(11)

The budgetary strategy in the programme is broadly consistent with the broad economic policy
guidelines included in the integrated guidelines for the period 2005-2008.

(12) As regards the data requirements specified in the code of conduct for stability and convergence

programmes, the programme provides all required and most of the optional data (1).

The Council considers that, after the correction of the excessive deficit in 2005, the programme is making
good progress towards the MTO over the programme period, owing to expenditure restraint and in a
context of strong growth prospects. The general government gross debt is foreseen to approach the 60 % of
GDP reference value by 2007 and to continue declining in the subsequent years.

(1) In particular, the data on ‘Cyclical Developments’ (Table 5), the contributions to Potential GDP Growth (item 4) are not

provided.

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Official Journal of the European Union

28.3.2007

In view of the above assessment, in particular the level of debt and the projected increase in age-related
spending, Cyprus is invited to:

(i) control public pension expenditure and implement further reforms in the areas of pensions and health

care in order to improve the long-term sustainability of the public finances.

(ii) implement the fiscal consolidation path as foreseen in the programme.

Comparison of key macroeconomic and budgetary projections

Real GDP
(% change)

HICP inflation
(%)

Output gap
(% of potential GDP)

General government
balance
(% of GDP)

Primary balance
(% of GDP)

Cyclically-adjusted
balance
(% of GDP)

Structural balance (2)
(% of GDP)

Government gross debt
(% of GDP)

CP December 2006

COM Nov 2006

CP December 2005

CP December 2006

COM Nov 2006

CP December 2005

2005

2006

2007

2008

2009

2010

3,9

3,8

4,1

2,0

2,0

2,1

3,7

3,8

4,2

2,4

2,4

2,0

3,9

3,8

4,2

2,5

2,0

2,0

4,1

3,9

4,2

2,4

2,4

2,0

4,1

n.a.

4,3

2,0

n.a.

2,0

4,1

n.a.

n.a.

2,0

n.a.

n.a.

CP December 2006 (1)

– 0,9

– 1,0

– 1,1

– 1,1

– 1,1

– 1,1

COM Nov 2006 (5)

– 1,3

– 1,3

– 1,3

– 1,3

CP December 2005 (1)

– 0,8

– 0,3

0,1

0,0

n.a.

0,1

n.a.

n.a.

CP December 2006

– 2,3

– 1,9

– 1,6

– 0,7

– 0,4

– 0,1

COM Nov 2006

– 2,3

– 1,9

– 1,7

– 1,7

n.a.

CP December 2005

– 2,5

– 1,9

– 1,8

– 1,2

– 0,6

CP December 2006

COM Nov 2006

CP December 2005

1,1

1,1

0,7

1,4

1,4

1,2

1,4

1,4

1,2

2,1

1,4

1,4

CP December 2006 (1)

– 2,0

– 1,5

– 1,2

– 0,3

COM Nov 2006

– 1,8

– 1,4

– 1,2

– 1,2

2,1

n.a.

1,7

0,0

n.a.

CP December 2005 (1)

– 2,2

– 1,8

– 1,8

– 1,2

– 0,6

n.a.

n.a.

2,2

n.a.

n.a.

0,3

n.a.

n.a.

CP December 2006 (3)

– 3,3

– 1,9

– 1,0

– 0,3

– 0,1

– 0,1

COM Nov 2006 (4)

– 2,7

– 1,4

– 1,2

– 1,2

n.a.

CP December 2005

– 3,1

– 2,1

– 2,1

– 1,5

– 0,6

CP December 2006

COM Nov 2006

CP December 2005

69,2

69,2

70,5

64,7

64,8

67,0

60,5

62,2

64,0

52,5

59,6

56,9

49,0

n.a.

53,5

n.a.

n.a.

46,1

n.a.

n.a.

Notes:
(1) Commission services calculations on the basis of the information in the programme.
(2) Cyclically-adjusted balance (as in the previous rows) excluding one-off and other temporary measures.
(3) One-off and other temporary measures taken from the programme (1,3 % of GDP in 2005 and 0,4 % in 2006, deficit-reducing,). They

include 0,4 % of GDP in 2005 and 2006 accounting for the EU funds-related transactions.

(4) One-off and other temporary measures taken from the Commission services' autumn 2006 forecast (0,9 % of GDP in 2005; deficit-
reducing) as compared to the programme (see note 3) the Commission services did not treat any EU fund-related transactions as one-
off.

(5) Based on estimated potential growth of 3,9 %, 3,7 %, 3,9 % and 4,0 % respectively in the period 2005-2008.

Source:
Convergence programme (CP); Commission services' autumn 2006 economic forecasts (COM); Commission services' calculations