Recommendation for a Council opinion on the updated stability programme of Cyprus, 2009-2013
Date: 2010-05-12
Institutions: European Commission
Subjects: Cyprus, Economic and Monetary Union, budget deficit, coordination of EMU policies, economic convergence, economic policy, stability pact

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EUROPEAN COMMISSION 

Brussels, 12.5.2010 
SEC(2010) 595 final 

Recommendation for a 

COUNCIL OPINION 

on the updated stability programme of Cyprus, 2009-2013 

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EXPLANATORY MEMORANDUM 

1. 

GENERAL BACKGROUND 

The Stability and Growth Pact is based on the objective of sound government finances as a 
means  of  strengthening  the  conditions  for  price  stability  and  for  strong  sustainable  growth 
conducive to employment creation. The 2005 reform of the Pact acknowledged its usefulness 
in  anchoring  fiscal  discipline  but  sought  to  strengthen  its  effectiveness  and  economic 
underpinnings as well as to safeguard the sustainability of the public finances in the long run. 
In  particular,  it  introduced  greater  flexibility  in  the  application  of  the  rules  governing  the 
excessive  deficit  procedure,  notably  with  regard 
the  definition  of  "exceptional 
circumstances" and the setting of deadlines for the correction of an excessive deficit. 

to 

Council  Regulation  (EC)  No  1466/97  on  the  strengthening  of  the  surveillance  of  budgetary 
positions  and  the  surveillance  and  coordination  of  economic  policies1,  which  is  part  of  the 
Stability and Growth Pact, stipulates that each Member State has to submit, to the Council and 
the Commission, a stability or convergence programme and annual updates thereof. Member 
States  that  have  already  adopted  the  single  currency  submit  (updated)  stability  programmes 
and Member States that have not yet adopted it submit (updated) convergence programmes. 

In  accordance  with  the  Regulation,  the  Council  delivered  an  opinion  on  the  first  stability 
programme  of  Cyprus  on  4  March  2008  on  the  basis  of  a  recommendation  from  the 
Commission and after having consulted the Economic and Financial Committee. As regards 
updated  stability  and  convergence  programmes,  the  Regulation  foresees  that  these  are 
assessed  by  the  Commission  and  examined  by  the  Committee  mentioned  above  and, 
following the same procedure as set out above, the updated programmes may be examined by 
the Council.  

2. 

BACKGROUND FOR THE ASSESSMENT OF THE UPDATED PROGRAMME 

The Commission has examined the most recent update of the stability programme of Cyprus, 
submitted on 1 April 2010, and has adopted a recommendation for a Council Opinion on it. 

In  order  to  set  the  scene  against  which  the  budgetary  strategy  in  the  updated  stability 
programme is assessed, the following paragraphs summarise: 

(1) 

(2) 

(3) 

the  Commission  Communication  of  26  November  2008  (“A  European  Economic 
Recovery Plan”); 

the conclusions of the Economic and Financial Affairs Council of 20 October 2009 on 
the “Exit strategy”;  

the most recent assessment of the country’s position under the preventive arm of the 
Stability and Growth Pact (summary of the Council Opinion on the previous update of 
the stability programme). 

1 

OJ L 209, 2.8.1997, p. 1. The documents referred to in this text are available at: 
http://ec.europa.eu/economy_finance/sgp/index_en.htm. 

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2.1. 

The  Commission  Communication  of  26  November  2008  (“A  European 
Economic Recovery Plan”) 

In view of the unprecedented scale of the global crisis that hit financial markets and the world 
economy  in  2008-2009,  the  European  Commission  had  called  for  a  European  Economic 
Recovery Plan (EERP)2. The plan proposed a co-ordinated counter-cyclical macro-economic 
response  to  the  crisis  in  the  form  of  an  ambitious  set  of  actions  to  support  the  economy 
consisting of (i) an immediate budgetary impulse amounting to € 200 bn. (1.5% of EU GDP), 
made up of a budgetary expansion by Member States of € 170 bn. (around 1.2% of EU GDP) 
and EU funding in support of immediate actions of the order of €  30 bn. (around 0.3 % of EU 
GDP); and (ii) a number of priority actions grounded in the Lisbon Strategy and designed to 
adapt  our  economies  to  long-term  challenges,  continuing  to  implement  structural  reforms 
aimed at raising potential growth. The plan called for the fiscal stimulus to be differentiated 
across  Member  States  in  accordance  with  their  positions  in  terms  of  sustainability  of 
government finances and competitive positions. In particular, for Member States outside the 
euro  area  with  significant  external  and  internal  imbalances,  budgetary  policy  should 
essentially aim at correcting such imbalances. The plan was agreed by the European Council 
on 11 December 2008.  

2.2. 

The  conclusions  of  the  Economic  and  Financial  Affairs  Council  of  20  October 
2009 on the “Exit strategy” 

Following first signs of a recovery from the crisis, particularly the halt of the sharp decline in 
economic activity, the stabilisation of financial markets and the improvement in confidence, 
the Council concluded on 20 October 2009 that, while in view of the fragility of the recovery 
it  was  not  yet  time  to  withdraw  the  support  governments  provided  to  the  economy  and  the 
financial sector, preparing a coordinated strategy for exiting from the broad-based policies of 
stimulus  was  needed.  Such  a  strategy  should  strike  a  balance  between  stabilisation  and 
sustainability  concerns,  take  into  account  the  interaction  between  the  different  policy 
instruments, as well as the discussion at global level. Early design and communication of such 
a strategy would contribute to underpinning confidence in medium-term policies and anchor 
expectations.  Beyond  the  withdrawal  of  the  stimulus  measures  of  the  European  Economic 
Recovery  Programme,  substantial  fiscal  consolidation  was  required  in  order  to  halt  and 
eventually  reverse  the  increase  in  debt  and  restore  sound  fiscal  positions.  Increasing  the 
efficiency  and  effectiveness  of  public  finances  and  the  intensification  of  structural  reform 
were  desirable  even  in  the  short  term  as  they  would  contribute  to  fostering  potential  output 
growth and debt reductions. The Council agreed on the following principles of the fiscal exit 
strategy:  (i)  the  strategy  should  be  coordinated  across  countries  in  the  framework  of  a 
consistent  implementation  of  the  Stability  and  Growth  Pact;  (ii)  timely  withdrawal  of  fiscal 
stimulus  was  needed,  taking  country-specific  circumstances  into  account;  (iii)  the  pace  of 
consolidation  should  be  ambitious,  in  most  countries  going  well  beyond  the  benchmark  of 
0.5% of GDP per annum in structural terms; and (iv) the credibility of the strategy should be 
underpinned  by  measures  to  enhance  the  quality of public finances and  ambitious structural 
reform efforts to raise employment and potential growth.  

2 

Communication from the Commission to the European Council of 26 November 2008. 

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2.3. 

The assessment in the Council Opinion on the previous update 

In its opinion of 3 April 2009, the Council summarised its assessment of the previous update 
of  the  stability  programme,  covering  the  period  2008-2012,  as  follows.  The  Council 
considered that "fiscal stance in 2009 will be expansionary due to the adoption of significant 
stimulus measures in 2009 in line with the EERP. In the subsequent years, the fiscal balance 
is projected to continue worsening. The implied fiscal loosening does not appear justified in 
view  of  the  relatively  good  economic  prospects  and  the  existence  of  a  large  external 
imbalance. Moreover, against the background of a sharp deterioration in the global economic 
environment, the budgetary strategy is subject to significant downside risks, with the growth 
assumptions underlying the macroeconomic scenario of the programme being favourable. In 
the  light  of  the  high  external  imbalances,  maintaining  prudent  policies  and  strengthening 
fiscal sustainability should be a major priority. Therefore, controlling current expenditure and 
avoiding  procyclicality  represents  a  major  challenge  for  the  fiscal  policy  in  Cyprus.  In 
addition, fostering the quality of public finances is important also with a view to underpinning 
a smooth adjustment of the economy in the light of the imbalances it is faced with". In view 
of  this  assessment,  the  Council  invited  Cyprus  to  "(i)  implement  the  2009  fiscal  policy  as 
planned in line with the EERP and within the framework of the SGP, while avoiding further 
deterioration  of  public  finances  in  2009  compared  to  the  target;  (ii)  reverse  the  projected 
increase of the fiscal deficit in 2010 and beyond, by limiting the increase in expenditures in 
order  to  ensure  a  sound  fiscal  position  in  the  medium  term;  (iii)  in  view  of  the  projected 
impact of ageing on government expenditure, strengthen the long-term sustainability of public 
finances by pursuing the reform of the pension and health care systems". 

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Recommendation for a 

COUNCIL OPINION 

on the updated stability programme of Cyprus, 2009-2013 

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 
policies3, and in particular Article 5(3) (for SP) thereof, 

Having regard to the recommendation of the Commission, 

After consulting the Economic and Financial Committee, 

HAS DELIVERED THIS OPINION: 

(1) 

(2) 

On  [DD  Month  2010]  the  Council  examined  the  updated  stability  programme  of 
Cyprus, which covers the period 2009 to 2013. 

In  2009  economic  activity  contracted  by  1.7%.  This  is  the  first  time  Cyprus  has 
experienced negative growth in the last thirty-five years. Weak domestic demand and 
an  adverse  external  environment  weighed  strongly  on  growth.  In  particular,  high 
household  indebtedness  together  with  tight  lending  conditions,  a  worsening  labour 
market  outlook  and  negative  confidence  effects  led  to  a  decline  in  private 
consumption.  In  parallel,  investment  recorded  a  strong  correction,  amidst  a  fall  in 
foreign  demand  for  housing,  low  capacity  utilisation  and  the  restructuring  of 
corporate balance sheets. Government consumption was the only demand component 
supporting  economic  activity,  partly  due  to  the  1½%  of  GDP  stimulus  package 
implemented in line with the EERP. In addition to these discretionary measures, the 
contraction of economic activity, the fading out of the asset boom and a less tax-rich 
growth  pattern  has  put  public  finances  under  significant  pressure.  As  a  result, 
government finances turned into a deficit of 6.1% of GDP from a surplus of 0.9% of 
GDP  in  2008.  The  crisis  has  also  highlighted  the  accumulation  of  a  high  external 
imbalance,  which  reflects  not  only  the  low  private  sector  net  savings  but  also  a 
deterioration of the net position of general government and competitiveness losses. A 
weak  domestic  demand  and  a  sluggish  external  recovery  are  expected  to  weigh  on 
recovery  prospects.  GDP  growth  is  forecast  to  shrink  further,  although  to  a  lesser 
extent,  in  2010  and  to  recover  mildly  in  2011.  Therefore,  in  the  medium  term, 
Cyprus is facing the challenge of enhancing growth, against the backdrop of a frail 

3 

OJ L 209, 2.8.1997, p. 1. The documents referred to in this text can be found at the following website: 
http://ec.europa.eu/economy_finance/sgp/index_en.htm. 

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global economic recovery, while addressing the existing macroeconomic imbalances 
through  maintaining  prudent  fiscal  policies.  In  the  long  term,  the  country  is 
confronted with the need to strengthen the sustainability of public finances, in view 
of an ageing population.  

Although much of the observed decline in actual GDP in the context of the crisis is 
cyclical, the level of potential output has also been negatively affected. In addition, 
the  crisis  may  also  affect  potential  growth  in  the  medium  term  through  lower 
investment, constraints in credit availability and increasing structural unemployment. 
Moreover,  the  impact  of  the  economic  crisis  compounds  the  negative  effects  of 
demographic  ageing  on  potential  output  and  the  sustainability  of  public  finances. 
Against  this  background  it  will  be  essential  to  accelerate  the  pace  of  structural 
reforms  with  the  aim  of  supporting  potential  growth.  In  particular,  for  Cyprus  it  is 
important  to  undertake  reforms  in  the  area  of  the  labour  market,  especially  to 
strengthen  lifelong  learning  opportunities,  in  particular,  with  regard  to  the  low-
skilled,  older  workers  and  unemployed  people  as  well  as  to  ensure  the  timely  and 
effective  implementation  of  the  planned  reforms  in  technical  and  vocational 
education. Moreover, there is a need to better align wage growth with productivity, 
employment growth and competitiveness.  

The  macroeconomic  scenario  underlying  the  programme  envisages  that  real  GDP 
growth  will  rise  from  -1.7%  in  2009  to  0.5%  in  2010,  before  recovering  to  an 
average rate of about 2.6% over the rest of the programme period. Assessed against 
currently  available  information4,  this  scenario  appears  to  be  based  on  favourable 
growth  assumptions  throughout  the  programme  period.  In  particular,  private 
consumption  is  expected  to  follow  a  favourable  trend,  driven  by  a  somewhat 
optimistic employment and wage growth. The Programme projects real construction 
investment growth to remain negative in the short-term and to recover in the second 
half  of  the  programme  period.  However,  forward-looking  indicators  suggest  a 
stronger correction path for the construction sector in the medium-term than the one 
projected by the programme. Moreover, despite the improving economic outlook, the 
fragility of recovery in Cyprus' main trading partners entails non-negligible downside 
risks  to  the  macroeconomic  scenario  in  the  programme.  Due  to  the  contraction  of 
economic  activity  in  2009  there  was  a  significant,  yet  partial,  correction  of  the 
external deficit, which nevertheless remains high, at 8.5% of GDP, and is projected 
in  the  programme  to  rise  again  sharply  to  12.9%  of  GDP  by  2013  as  imports  are 
expected to pick up. The external imbalance is likely to weigh on economic growth 
over the medium-term. High public sector dissavings would need to be financed by 
foreign debt or domestic private savings. Thus, the adjustment of the current account 
imbalance would require either higher cost of debt-financing or higher savings from 
the private sector. The latter would imply lower output growth through lower private 
consumption  or  investment  (crowding-out  effect).  The  programme's  inflation 
projections appear realistic.  

According to the programme, the general government deficit deteriorated strongly in 
2009,  reaching  a  deficit  of  6.1%  of  GDP  from  a  surplus  of  0.9%  of  GDP  in  2008, 
reflecting  mainly  the  impact  of  the  crisis  on  government  finances  but  was  also 

The assessment notably takes into account the Commission services' spring 2010 forecast, but also other 
information that has become available since then.  

(3) 

(4) 

(5) 

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(6) 

(7) 

brought  about  by  stimulus  measures  amounting  to  1½%  of  GDP  which  the 
government  adopted  in  line  with  the  European  Economic  Recovery  Plan  (EERP). 
According to the programme, fiscal policy is planned to be restrictive with a view to 
correcting the excessive deficit by 2013 under the assumed growth scenario. 

According  to  the  update,  the  budgetary  target  for  2010  is  a  deficit  of  6%  of  GDP. 
The 2010 budget law (approved by the Parliament on 24 December 2009) targeted a 
deficit of 4.5% of GDP on the basis of an estimated outturn for the deficit in 2009 of 
about 3% of GDP. Given that the final outturn for 2009 was a deficit of 6% of GDP, 
the  budget  law  would  imply  an  even  higher  deficit.  However,  the  programme 
includes measures which aim to stop further budgetary deterioration and stabilise the 
deficit at the same levels as in 2009. The update projects the revenue-to-GDP ratio to 
rise  by  about  1¼  percentage  points  in  2010  compared  with  the  outturn  of  2009. 
Public expenditure is expected to increase by 1¼ percentage points of GDP. Primary 
expenditure  is  planned  to  rise  further  mainly  driven  by  a  further  rise  in  social 
transfers,  subsidies  and  in  the  public  wage  bill.  According  to  the  update,  interest 
payments are set to continue their declining trend, falling by a ¼ percentage point of 
GDP, despite the rising stock of debt. Public investment is planned to remain at 2009 
levels. Overall, the fiscal policy stance, as measured by the structural balance (i.e. in 
cyclically-adjusted terms net of one-off  and  other  temporary  measures),  implied  by 
the Programme will be tightening in 2010 of an order of ½% of GDP. 

The  main  goal  of  the  programme's  medium-term  budgetary  strategy  is  to  bring  the 
general  government  balance  below  the  3%  of  GDP  reference  value  by  2013.  The 
programme  projects the nominal budget deficit  to decline to 4.5%  of GDP  in  2011 
(from 6.1% in the previous year) and 3.4% in 2012 before it eventually reaches 2.5% 
in  2013.  The  primary  balance  is  expected  to  follow  a  similar  pattern  and  reach  a 
balanced position by the end of the period, from a deficit of 3.7% of GDP in 2010. 
The  structural  deficit,  calculated  according  to  the  commonly  agreed  methodology, 
would  continue  to  improve  after  2010,  to  reach  around  3½%  of  GDP  in  2011,  just 
below 3% in 2012 and 2¼% in 2013. The annual fiscal effort would average at 3/4% 
of  GDP  per  year  over  the  period  2010-2013.  The  adjustment  appears  front-loaded, 
although measures taken in 2010 will have their full effect only in 2011. Moreover, 
measures taken within the context of the EERP will only be phased out by the end of 
2010. Consolidation is planned to be achieved mainly from the revenue side of the 
budget,  which  is  projected  to  increase  by  2.6  pp.  of  GDP  between  2010  and  2013, 
while  expenditure  retrenchment  would  contribute  an  additional  percentage  point  of 
GDP.  Revenue  supporting  measures  include  the  fight  against  tax  evasion,  a  town 
planning  amnesty,  harmonisation  of  the  minimum  excise  duties  on  petroleum 
products  and  application  of  the  reduced  VAT  on  foodstuff  and  pharmaceutical 
products  as  well  as  dividend  income  from  semi-governmental  organisations.  As 
regards expenditure measures, the bulk of the programme's adjustment comes from 
controlling  operational  expenditure  and  reducing  current  transfers.  The  programme 
lists  the  targeting  of  social  transfers  and  the  containment  of  size  and  the  rate  of 
growth  of  public  wage  bill  as  expenditure  categories  for  consolidation  when 
consensus  would  be  reached  among  social  partners.  The  update  confirms  the 
commitment to the country-specific medium-term budgetary objective (MTO), which 
is a balanced budgetary position in structural terms (i.e. in cyclically-adjusted terms 
net  of  one-off  and  other  temporary  measures).  The  MTO  adequately  reflects  the 

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(8) 

(9) 

(10) 

objectives  of  the  Pact.  The  structural  balances  corresponding  to  the  programme’s 
deficit targets imply that the MTO will not be reached within the programme period. 

The  budgetary  outcomes  could  be  worse  than  targeted  in  the  programme.  In 
particular, the macroeconomic scenario projected in the update appears to be based 
on favourable growth assumptions throughout the programme period. On the revenue 
side, risks for public finances, particularly in 2010-2011, are higher than in previous 
years  and  are  associated  with  a  possible  sharper  contraction  and  rebalancing  of 
economic  growth  towards  a  less-tax  rich  composition  of  growth.  In  view  of  the 
expected  moderate  economic  recovery  and  the  pressure  to  stimulate  domestic 
demand through increased public expenditure, the risks of potential overruns are non 
negligible.  These  risks  are  mainly  associated  to  the  practise  of  submitting 
expenditure-increasing  supplementary  budgets  during  the  course  of  the  year  which, 
beyond  the  intended  reallocation  of  funds,  has  implied  an  increase  in  current 
expenditure.  Moreover,  social  transfers  might  turn  higher  than  expected  in  view  of 
the recent past track record and the absence of a targeting mechanism at place as well 
as of the somewhat optimistic employment (thus unemployment) growth projections.  

The government gross debt-to-GDP ratio is estimated at 56.2% of GDP in 2009, up 
from 48.4% in the year before. Apart from the increase in the deficit and the decline 
in GDP growth, a stock-flow adjustment accounting for 1 percentage point of GDP 
contributed  to  the  rise  in  the  debt  ratio.  The  latter  reflects  an  accumulation  of 
government  assets,  due  to  over-financing  at  the  end  of  2009  in  order  to  meet 
obligations arising early  in  January  of  2010.  The  debt  ratio is projected to increase 
over the programme period, mainly driven by continued although declining primary 
deficits. The debt ratio will breach the reference value of 60% of GDP in 2010 and is 
projected to remain above the reference value throughout the programme period. It is 
projected  to  increase  to  around  63%  of  GDP  in  2011  and  2012,  thereafter  slightly 
declining.  In  view  of  the  downward  risks  to  the  macroeconomic  scenario  and  the 
budgetary  targets,  the  evolution  of  the  debt  ratio  may  be  less  favourable  than 
projected in the programme.  

The  long-term  budgetary  impact  of  ageing  is  significantly  above  the  EU  average, 
mainly as a result of a relatively high increase in pension expenditure as a share of 
GDP over the coming decades partly due to the fact that the pension scheme is still in 
a  maturing  phase.  The  programme  discusses  a  pension  reform  introduced  in  April 
2009  that  is  projected  to  slightly  reduce  the  increase  in  pension  expenditure  and, 
more significantly, increase the social security contribution rates. The reform would 
improve  the  long-term  balance  of  the  pension  system  and  reduce  risks  to 
sustainability,  however  without  having  an  effect  on  the  overall  assessment.  The 
budgetary position in 2009 as estimated in the programme compounds the budgetary 
impact of population ageing on the sustainability gap. Improving the primary balance 
over  the  medium  term  and  implementing  further  measures  aimed  at  curbing  the 
substantial  increase  in  age-related  expenditure,  especially  pension  and  healthcare 
expenditure,  would  contribute  to  reducing  the  risks  to  the  sustainability  of  public 
finances,  which  were  assessed  in  the  Commission  2009  Sustainability  Report5  as 

5 

In the Council conclusions from 10 November 2009 on sustainability of public finances "the Council 
calls on Member States to focus attention to sustainability-oriented strategies in their upcoming stability 
and convergence programmes" and further "invites the Commission, together with the Economic Policy 

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(11) 

(12) 

high.  Medium-term  debt  projections  that  assume  GDP  growth  rates  to  gradually 
recover  to  the  values  projected  before  the  crisis,  tax  ratios  to  return  to  pre-crisis 
levels,  and  include  the  projected  increase  in  age-related  expenditure  show  that  the 
budgetary  strategy  envisaged  in  the  programme,  taken  at  face  value  and  with  no 
further policy change, would almost be enough to stabilise the debt-to-GDP ratio by 
2020. 

In recent years, Cyprus has over-achieved its budgetary targets, albeit in a context of 
buoyant economic activity and tax-rich composition of growth. In the recent past, the 
budgetary  framework  has  been  improved  by  the  adoption  of  the  Financial 
Management Accounting System (FIMAS), the gradual introduction of a three-year 
medium-term  budgetary  framework  (MTBF)  and  of  Programme  and  Performance 
Budgeting (PPB).  However,  the practice of  adopting supplementary  budgets during 
the  course  of  the  year  has  implied  an  increase  in  current  expenditure  beyond  the 
intended  reallocation  of  funds.  According  to  the  Programme,  the  new  budgeting 
framework is expected to cease this practice when fully implemented and lead to a 
more  effective  and  efficient  budgeting  process,  contributing 
to  containing 
expenditure.  At  the  same  time,  the  new  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. However, the new framework 
is still at an early stage of implementation and is only foreseen to be fully in place in 
2012.  Therefore,  its  impact  could  become  effective  only  in  the  medium-term.  The 
new framework's timely implementation would be critical for a successful and lasting 
consolidation of the public finances. 

increased  use  of  computers 

As  regards  the  quality  of  public  finances,  the  programme  acknowledges  its 
importance  as  a  means  to  support  potential  growth  and  to  ensure  the  long-term 
sustainability  of  public  finances.  In  particular,  the  programme  notes  the  impact  the 
MTBF  and  PPB  budgeting  will  have  upon  full  implementation  on  the  better 
allocation of resources to high-priority, growth enhancing areas in tandem with better 
control  of  non-productive  expenditure.  On  the  expenditure  side,  the  programme 
includes  a  review  of  recent  projects  aimed  at  enhancing  infrastructure,  through 
Private Public Partnerships (PPP), as well as measures to improve education, through 
the 
in  primary  and  secondary  education  and 
improvements  in  research  and  academic  institutions.  The  update  also  includes  the 
allocation  of  funds  to  restructure  public  hospitals  into  autonomous  units  and  the 
adoption of a National Health Scheme, with the aim of improving effectiveness via 
regulated  competition  and  cost  containment.  This  seems  essential  as  a  means  to 
control the anticipated expenditure increases associated to an ageing population. On 
the revenue side, the programme emphasizes the positive impact the introduction of 
the  MTBF  would  have  on  improving  the  accuracy  and  sensitivity  of  revenue 
forecasts over the medium-term. The authorities note that given the volatility of tax 
elasticities in recent years due to the asset boom, revenue projections were adapted to 
take into account the impact of asset prices and the composition of GDP growth. The 
programme  also  notes  the  constant  monitoring  of  the  tax-benefit  system  by  the 

Committee and the Economic and Financial Committee, to further develop methodologies for assessing 
the  long-term  sustainability  of  public  finances  in  time  for  the  next  Sustainability  report",  which  is 
foreseen in 2012. 

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(13) 

authorities in order to endure that work pays while ensuring the support to vulnerable 
social groups.  

Overall, taking into account the risks to the budgetary targets mentioned above, the 
strategy to maintain supportive fiscal policies also in 2010 can be considered in line 
with the EERP. However, following the negative effects of the economic crisis, the 
general  government  deficit  is  to  remain  at  6%  of  GDP  in  2010,  gradually  abating 
below the 3% reference value thereafter. While the programme's strategy foresees an 
average  annual  fiscal  effort  of  ¾  percentage  points  of  GDP  over  the  period  2010-
2013,  this  is  subject  to  downside  risks.  Therefore,  in  view  of  the  risks,  the  fiscal 
effort may not be sufficient to bring the deficit below the 3% of GDP reference value 
by 2013 as planned. Moreover, the composition of the consolidation strategy of the 
programme  appears  to  be  based  largely  on  revenue-increasing  measures  with 
expenditure  retrenchment  being  minimal.  In  fact,  the  programme  projects  the 
expenditure-to-GDP ratio to stabilise at a higher level in 2013 than the 2009 outturn. 
Measures  that  could  reverse  this  situation  are  still  under  discussion  with  the  social 
partners  and,  thus,  subject  to  risks  regarding  the  modalities  and  the  timing  of  their 
implementation.  As  a  result,  the  evolution  of  the  debt  ratio,  which  is  planned  to 
exceed 60% of GDP from 2010 onward, may also be less favourable than projected 
in the update. 

(14) 

As  regards  the  data  requirements  specified  in  the  code  of  conduct  for  stability  and 
convergence programmes, the programme provides all required and optional data. 

The overall conclusion is that Cyprus' public finances deteriorated significantly as a result of 
the economic downturn and an expansionary fiscal stance due to the adoption of significant 
stimulus measures in line with the EERP. As a result, the budgetary balance turned to a deficit 
of 6.1% of GDP in 2009 from a surplus of 0.9% of GDP in 2008. The programme outlines a 
consolidation path starting in 2010 which aims to bring the general government balance below 
the 3% of GDP reference value by 2013. However, the adjustment is planned to be achieved 
mainly  from  the  revenue  side  of  the  budget  while  the  expenditure-to-GDP  ratio  remains  at 
historically  high  levels.  Moreover,  against  the  background  of  a  frail  global  economic 
recovery,  the  budgetary  strategy  is  subject  to  significant  downside  risks,  as  the  growth 
assumptions underlying the macroeconomic scenario of the programme are favourable. In the 
light  of  the  high  domestic  and  external  imbalances,  maintaining  prudent  policies  and 
strengthening  fiscal  sustainability  should  be  a  priority.  Therefore,  controlling  current 
expenditure  through  the  implementation  of  an  effective  multi-annual  budgetary  framework 
would  be  an  essential  instrument  to  support  the  achievement  of  the  consolidation  plans  and 
budgetary targets. In addition, fostering the quality of public finances is important also with a 
view to underpinning a smooth adjustment of the economy in the light of the imbalances it is 
faced  with,  notably  by  lifting  potential  GDP,  enhancing  competitiveness  and  further 
narrowing the external imbalance. 

In view of the above assessment, Cyprus is invited to: 

(i) 

limit  the  2010  deficit  to  at  most  6%  of  GDP,  if  necessary  by  reinforcing  the 
consolidation  measures,  notably  in  case  macroeconomic  developments  proves  less 
favourable  than  the  programme  scenario,  and  take  timely  action  to  define  a  more 
expenditure-driven consolidation strategy; seize opportunities beyond the announced 
fiscal effort to accelerate fiscal consolidation and the reduction of the gross debt ratio 
back below the reference value; 

EN 

10 

   EN 

 
(ii) 

(iii) 

implement, as envisaged, an effective multi-annual budgetary framework in order to 
ensure the adherence to the budgetary targets and to firmly contain expenditure over 
the medium-term;  

improve  the  long-term  sustainability  of  public  finances  by  implementing  reform 
measures  to  control  pension  and  health  care  expenditure  in  order  to  curb  the 
projected increase in age-related expenditure. 

EN 

11 

   EN 

 
Comparison of key macroeconomic and budgetary projections 

Real GDP 
(% change) 

HICP inflation 
(%) 

Output gap1 
(% of potential GDP) 

Net lending/borrowing vis-à-
vis the rest of the world 
(% of GDP) 

General government revenue 
(% of GDP) 

General government 
expenditure 
(% of GDP) 

General government balance 
(% of GDP) 

Primary balance 
(% of GDP) 

Cyclically-adjusted balance1 
(% of GDP) 

Structural balance3 
(% of GDP) 

Government gross debt 
(% of GDP) 

Notes: 

SP Apr 2010 
COM May 2010 
SP Feb 2009 
SP Apr 2010 
COM May 2010 
SP Feb 2009 
SP Apr 2010 
COM May 2010 
SP Feb 2009 
SP Apr 2010 
COM May 2010 
SP Feb 2009 
SP Apr 2010 
COM May 2010 
SP Feb 2009 
SP Apr 2010 
COM May 2010 
SP Feb 2009 
SP Apr 2010 
COM May 2010 
SP Feb 2009 
SP Apr 2010 
COM May 2010 
SP Feb 2009 
SP Apr 2010 
COM May 2010 
SP Feb 2009 
SP Apr 2010 
COM May 2010 
SP Feb 2009 
SP Apr 2010 
COM May 2010 
SP Feb 2009 

2008 
3.6 
3.6 
3.8 
4.4 
4.4 
4.4 
2.9 
3.4 
0.8 
-17.7 
-17.6 
-12.4 
43.5 
43.5 
45.3 
42.6 
42.6 
44.3 
0.9 
0.9 
1.0 
3.7 
3.7 
3.9 
-0.2 
-0.4 
0.7 
-0.2 
-0.4 
0.7 
48.4 
48.4 
49.3 

2009 
-1.7 
-1.7 
2.1 
0.2 
0.2 
2.0 
-1.3 
-0.7 
-0.1 
-8.5 
-8.2 
-12.1 
40.3 
40.3 
43.8 
46.4 
46.4 
44.6 
-6.1 
-6.1 
-0.8 
-3.6 
-3.6 
1.5 
-5.6 
-5.8 
-0.8 
-5.6 
-5.8 
-0.8 
56.2 
56.2 
46.8 

2010 
0.5 
-0.4 
2.4 
2.7 
2.7 
2.5 
-2.4 
-2.1 
-0.6 
-11.5 
-6.8 
-11.5 
41.6 
41.2 
44.0 
47.6 
48.3 
45.5 
-6.0 
-7.1 
-1.4 
-3.7 
-4.4 
0.8 
-5.1 
-6.3 
-1.2 
-5.2 
-6.3 
-1.2 
61.0 
62.3 
45.4 

2011 
1.5 
1.3 
3.0 
2.0 
2.5 
2.5 
-2.5 
-1.6 
-0.5 
-12.2 
-6.7 
-10.9 
42.8 
41.3 
44.4 
47.2 
49.0 
46.3 
-4.5 
-7.7 
-1.9 
-2.1 
-4.8 
0.2 
-3.5 
-7.1 
-1.7 
-3.6 
-7.1 
-1.7 
63.2 
67.6 
44.2 

2012 
3.0 
n.a. 
3.2 
2.0 
n.a. 
2.5 
-1.6 
n.a. 
-0.2 
-12.6 
n.a. 
-10.2 
43.6 
n.a. 
44.8 
47.0 
n.a. 
47.1 
-3.4 
n.a. 
-2.2 
-1.0 
n.a. 
-0.2 
-2.8 
n.a. 
-2.1 
-2.9 
n.a. 
-2.1 
63.1 
n.a. 
44.2 

2013 
3.2 
n.a. 
n.a. 
2.0 
n.a. 
n.a. 
-0.5 
n.a. 
n.a. 
-12.9 
n.a. 
n.a. 
44.2 
n.a. 
n.a. 
46.7 
n.a. 
n.a. 
-2.5 
n.a. 
n.a. 
0.1 
n.a. 
n.a. 
-2.3 
n.a. 
n.a. 
-2.3 
n.a. 
n.a. 
62.3 
n.a. 
n.a. 

1Output gaps and cyclically-adjusted balances from the programmes as recalculated by Commission services on the basis 
of the information in the programmes. 
2Based on estimated potential growth of 2.0%, 2.8%, 2.8%, 2.8% and 2.8% respectively in the period 2009-2013. 

3Cyclically-adjusted balance excluding one-off and other temporary measures. One-off and other temporary measures are 
0.1% in years 2010, 2011 and 2012(all deficit reducing) according to the most recent programme. There are no one-off and 
other temporary measures in the Commission services' spring 2010 forecast. 

Source: 

Stability programme (SP); Commission services’ spring 2010 forecasts (COM); Commission services’ calculations. 

EN 

12 

   EN