Report from the Commission - Cyprus - Report prepared in accordance with Article 126(3) of the Treaty
Date: 2010-05-12
Institutions: European Commission
Subjects: Bulgaria, Cyprus, Economic and Monetary Union, budget deficit, economic recession, stability pact

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EUROPEAN COMMISSION 

Brussels, 12.5.2010 
SEC(2010) 590 final 

REPORT FROM THE COMMISSION 

Cyprus 

Report prepared in accordance with Article 126(3) of the Treaty 

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REPORT FROM THE COMMISSION 

Cyprus 

Report prepared in accordance with Article 126(3) of the Treaty 

1. 

THE APPLICATION OF THE STABILITY AND GROWTH PACT IN THE CURRENT CRISIS 
SITUATION 

Many  EU  countries  are  presently  facing  general  government  deficits  above  the  3%  of  GDP 
reference value set in the Treaty. The often strong deterioration in the deficit as well as the 
debt  positions  must  be  seen  in  the  context  of  the  unprecedented  global  financial  crisis  and 
economic  downturn.  Several  factors  are  at  play.  First,  the  economic  downturn  brings  about 
declining  tax  revenue  and  rising  social  benefit  expenditure  (e.g.  unemployment  benefits). 
Second,  recognising  that  budgetary  policies  have  an  important  role  to  play  in  the  current 
extraordinary economic situation, the Commission called for a fiscal stimulus in its November 
2008  European  Economic  Recovery  Plan  (EERP),  endorsed  by  the  European  Council  in 
December.  The  Plan  explicated  that  the  stimulus  should  be  differentiated  across  Member 
States  to  reflect  their  different  positions  in  terms  of  public  finance  sustainability  and 
competitiveness and should be reversed when economic conditions improve. Finally, several 
countries have taken measures to stabilise the financial sector, some of which impact on the 
debt position or constitute a risk of higher deficits and debt in the future, although some of the 
costs of the government support could be recouped in the future. 

The Stability and Growth Pact requires the Commission to prepare a report such as the present 
one  whenever  an  actual  or  planned  deficit  of  a  Member  State  exceeds  the  3%  of  GDP 
reference  value.  This  report,  which  represents  the  first  step  in  the  “excessive  deficit 
procedure” (EDP), analyses the reasons for the breach of the reference value with due regard 
to the economic background and all other relevant factors. The amendments to the Stability 
and Growth Pact  in  2005  aimed  specifically at ensuring that in particular the economic and 
budgetary  background  was  fully  taken  into  account  in  all  steps  in  the  EDP.  This  means  for 
instance that, if an “excessive deficit” is deemed to exist, adequate attention needs to be paid 
to the economic background and outlook when making recommendations on the pace of the 
correction.  In  this  way,  the  Stability  and  Growth  Pact  provides  the  framework  supporting 
government  policies  for  a  prompt  return  to  sound  budgetary  positions taking  account  of  the 
economic situation. 

2. 

LEGAL BACKGROUND  

This report, which assesses recent and current budgetary developments in Cyprus and reviews 
the short- and medium-term prospects in the light of overall economic conditions and policy 
action taken by the government, is prepared according to Article 126(3) of the Treaty on the 
Functioning of the European Union (TFEU). 

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Article 126 TFEU lays down an excessive deficit procedure (EDP). This procedure is further 
specified  in  Council  Regulation  (EC)  No  1467/97  “on  speeding  up  and  clarifying  the 
implementation of the excessive deficit procedure”1, which is part of the Stability and Growth 
Pact. According to Article 126(2) of the Treaty, the Commission has to monitor compliance 
with  budgetary  discipline  on  the  basis  of  two  criteria,  namely:  (a)  whether  the  ratio  of  the 
planned or actual government deficit to gross domestic product (GDP) exceeds the reference 
value of 3% (unless either the ratio has declined substantially and continuously and reached a 
level that comes close to the reference value; or, alternatively, the excess over the reference 
value is only exceptional and temporary and the ratio remains close to the reference value); 
and  (b)  whether  the  ratio  of  government  debt  to  GDP  exceeds  the  reference  value  of  60% 
(unless  the  ratio  is  sufficiently  diminishing  and  approaching  the  reference  value  at  a 
satisfactory pace). 

Article 126(3) stipulates that, if a Member State does not fulfil the requirements under one or 
both of these criteria, the Commission has  to prepare a  report. This report also has to “take 
into account whether the government deficit exceeds government investment expenditure and 
take  into  account  all  other  relevant  factors,  including  the  medium-term  economic  and 
budgetary position of the Member State”. 

Immediately following its accession to the EU in May 2004, an EDP for Cyprus was initiated 
by the Commission2 with the adoption of a report under Article 104(3) of Treaty Establishing 
the European Community (TEC) in view of a deficit of 6.3% of GDP in 2003, i.e. above the 
reference  value  of  3%  of  GDP.  In  July  2004,  following  recommendations  from  the 
Commission, the Council decided, in accordance with Article 104(6) TEC, that an excessive 
deficit existed in Cyprus and addressed a recommendation in accordance with Article 104(7) 
TEC to Cyprus with a view to bringing the excessive deficit situation to an end as rapidly as 
possible  and  by  2005  at  the  latest.  In  July  2006,  following  an  overall  assessment  which 
showed that the deficit was reduced to 2.4% of GDP in 2005, the Council decided to abrogate 
its decision on the existence of an excessive deficit under Article 104(12) TEC. 
According to data notified by the authorities in  March 20103 and subsequently validated  by 
Eurostat4  the  general  government  deficit  in  Cyprus  reached  6.1%  of  GDP  in  2009,  thus 
exceeding  the  3%  of  GDP  reference  value,  while  general  government  gross  debt  stood  at 
56.2% of GDP, below the 60% of GDP reference value but on a rising trend. 

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2 

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4 

to 

related 

OJ L 209, 2.8.1997, p. 6. The report also takes into account the “Specifications on the implementation 
of the Stability and Growth Pact and guidelines on the format and content of stability and convergence 
programmes”,  endorsed  by 
the  ECOFIN  Council  of  10  November  2009,  available  at 
http://ec.europa.eu/economy_finance/sgp/legal_texts/index_en.htm. 
Documents 
http://ec.europa.eu/economy_finance/sgp/deficit/countries/index_en.htm  
According to Council Regulation (EC) No 479/2009, Member States have to report to the Commission, 
twice a year, their planned and actual government deficit and debt levels. The most recent notification 
of Cyprus can be found at: 
http://epp.eurostat.ec.europa.eu/portal/page/portal/government_finance_statistics/procedure/edp_notific
ation_tables 
Eurostat news release No 55/2010 of 22 April 2010. 

the  excessive  deficit  procedure 

for  Cyprus  are  available  at: 

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Table 1: General government deficit and debt a 

2005  2006 

2007 

2008 

2009 

2010 

2011 

-2.4 

-1.2 

3.4 

0.9 

-6.1 

COM 
-7.1 

CY 
-6.0 

COM 
-7.7 

CY 
-4.5 

69.1 

64.6 

58.3 

48.4 

56.2 

62.3 

61.0 

67.6 

63.2 

General  government 
balance 
General  government 
gross debt 

Note: 
a In percent of GDP. 
Source: Eurostat, Commission services’ spring 2010 forecasts and Stability Programme of Cyprus 2009-2013. 

The figure for the 2009 deficit provides prima facie evidence on the existence of an excessive 
deficit  in  Cyprus  in  the  sense  of  the  Treaty  and  the  Stability  and  Growth  Pact.  The 
Commission has therefore decided to initiate the excessive deficit procedure for Cyprus with 
the adoption of this report. Section 3 of the report examines the deficit criterion and section 4 
the debt criterion. Section 5 deals with public investment and other relevant factors.  

This report takes into account the Commission services’ spring 2010 forecast, released on 5 
May. 

3. 

DEFICIT CRITERION  

In 2009, the general government deficit reached 6.1% of GDP. Well in excess of 3% of GDP, 
the deficit is not close to the Treaty reference value.  

The  excess  over  the  3%  of  GDP  reference  value  is  exceptional.  In  particular,  it  does  result 
from  a  severe  economic  downturn  in  the  sense  of  the  Treaty  and  the  Stability  and  Growth 
Pact. According to data published by the statistical service of Cyprus, real GDP contracted in 
the year 2009 by 1.7%. An adverse external environment, as a consequence of the financial 
crisis  and  the  global  downturn  –  in  particular,  the  worsening  growth  outlook  of  the  key 
trading partners (euro area, UK and Russia)- and weak domestic demand weighed strongly on 
growth  in  2009.  In  particular,  exports  of  both  goods  and  services  declined  due  to  lower 
external demand and a weak performance of tourism. Shipping services also declined with the 
collapse  of  world  trade.  Investment  recorded  a  strong  correction,  amidst  a  fall  in  foreign 
demand for housing, low capacity utilisation and the restructuring of corporate balance sheets. 
In parallel, high household indebtedness together with tight lending conditions, a worsening 
labour  market  and  negative  confidence  effects  led  to  a  decline  in  private  consumption. 
Government consumption was the only demand component supporting economic activity.  

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Table 2: Macroeconomic and budgetary developments a 

government 

Real GDP (% change) 
Potential GDP (% change)  
Output  gap  (%  of  potential 
GDP) 
General 
balance 
Primary balance 
One-off 
and 
temporary measures 
Government  gross 
capital formation 
Cyclically-adjusted balance 
Cyclically-adjusted primary 
balance 
Structural balance b 
Structural primary balance 

fixed 

other 

2005 

2006 

2007 

2008 

2009 

2010 

2011 

3.9 
3.9 
-0.6 

4.1 
3.3 
0.2 

-2.4 

-1.2 

1.1 
0.9 

3.1 

-2.2 
1.3 

-3.1 
0.5 

2.1 
0.0 

3.0 

-1.3 
2.0 

-1.3 
2.0 

5.1 
2.9 
2.4 

3.4 

6.4 
0.0 

2.9 

2.5 
5.5 

2.5 
5.5 

3.6 
2.6 
3.4 

0.9 

3.7 
0.0 

3.0 

-0.4 
2.4 

-0.4 
2.4 

COM 
-0.4 
1.1 
-2.1 

CY3 
0.5 
2.8 
-2.4 

COM 
1.3 
0.7 
-1.6 

CY3 
1.5 
2.8 
-2.5 

-1.7 
2.2 
-0.7 

-6.1 

-7.1 

-6.04 

-7.7 

-4.5 

-3.6 
0.0 

-4.4 
0.0 

-3.7 
0.1 

-4.8 
0.0 

-2.1 
0.1 

4.1 

4.1 

4.1 

4.1 

4.1 

-5.8 
-3.3 

-5.8 
-3.3 

-6.3 
-3.6 

-6.3 
-3.6 

-5.2 
-2.8 

-5.2 
-2.9 

-7.1 
-4.2 

-7.1 
-4.2 

-3.6 
-1.1 

-3.6 
-1.2 

Notes: 
a In percent of GDP unless specified otherwise. 
b Cyclically-adjusted balance excluding one-off and other temporary measures. 
3  Output  gap  (in  %  of  potential  GDP)  and  cyclically-adjusted  balance  according  to  the  programme  as  recalculated  by 
Commission services on the basis of the information in the programme. 
4 For 2010, the updated Stability Programme of Cyprus reported a planned deficit of 6.0% of GDP compared to 6.2% of GDP 
included in the March 2010 EDP notification. 

Source: Eurostat, Commission services’ spring 2010 forecasts and Stability Programme of Cyprus 2009-2013. 

The excess over the 3% of GDP reference value is not temporary in the sense of the Treaty 
and the Stability and Growth Pact. The budgetary forecasts as provided by the Commission 
services  indicate  that  the  budgetary  deficit  would  reach  about  7%  of  GDP  in  2010,  on  the 
basis of a macroeconomic scenario that is significantly less favourable than projected in the 
April 2010 update of the Stability Programme. This projection includes adopted or legislated 
measures.  Potential  extra-budgetary  measures  still  under  discussion  with  uncertain  or  no 
information on their modalities and timing of implementation, are not taken into account. For 
2011, based on the customary no-policy-change scenario assumption5, the deficit is forecast to 
increase further to about 7¾% of GDP. 

In sum, the deficit is not close to the 3% of GDP reference value. While the planned excess 
over the reference value is exceptional, it is not temporary in the sense of the Treaty and the 
Stability and Growth Pact. This analysis suggests that the deficit criterion in the Treaty is not 
fulfilled.  

4. 

DEBT CRITERION 

During the period 2004 and 2008, the general government gross debt ratio declined by over 
20  percentage  points  to  48.4%  in  2008,  well  below  the  60%  Treaty  reference  value.  The 
reduction of debt commenced in 2005 but accelerated in the subsequent years. The declining 
trend  was  mainly  driven  by  favourable  cyclical  conditions  on  the  back  of  high  economic 
growth  and  substantial  primary  surpluses.  Moreover,  a  significant  debt-reducing  stock-flow 

5 

The no-policy change forecast takes into account the (partial) withdrawal of measures of extraordinary 
nature linked to the crisis. 

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adjustment took place in 2008, associated to the depletion of the sinking fund deposits held in 
the Central Bank, leading the decline of debt to 48.4% of GDP.  

Table 3: Debt dynamics a 

Government gross debt ratio  
Change  in  debt  ratio  b  (1  = 
2+3+4) 
Contributions: 
• Primary balance (2) 
• “Snowball” effect (3) 
 of which: 

Interest expenditure 
Real GDP growth 
Inflation (GDP deflator) 
• Stock-flow adjustment (4) 

2004 

2005 

2006 

2007 

2008 

2009 

2010 

2011 

70.2 

69.1 

64.6 

58.3 

48.4 

56.2 

COM  CY  COM  CY 
63.2 
62.3 

61.0 

67.3 

1.3 

-1.1 

-4.4 

-6.3 

-9.9 

7.8 

6.1 

4.8 

6.3 

2.2 

0.8 
-1.5 

3.3 
-2.7 
-2.1 
2.0 

-1.1 
-0.6 

3.5 
-2.6 
-1.6 
0.7 

-2.1 
-1.3 

3.3 
-2.7 
-1.9 
-1.0 

-6.4 
-2.7 

3.0 
-3.0 
-2.7 
2.9 

-3.7 
-1.7 

2.8 
-1.9 
-2.6 
-4.4 

7.7 
-0.8 

-1.6 
0.9 
0.0 
0.9 

8.5 
-2.3 

-1.4 
0.2 
-1.2 
-0.1 

3.7 
1.1 

2.3 
-0.3 
-0.9 
0.0 

9.6 
-3.1 

-0.7 
-0.8 
-1.6 
-0.2 

2.1 
0.4 

2.4 
-0.9 
-1.2 
-0.2 

Notes: 
a In percent of GDP. 
b The change in the gross debt ratio can be decomposed as follows: 

1
−

1
−

−

=

+

D
t
Y
t

D
t
Y
t

PD
t
Y
t

SF
t
Y
t
where t is a time subscript; D, PD, Y and SF are the stock of government debt, the primary deficit, nominal GDP and the 
stock-flow  adjustment  respectively,  and  i  and  y  represent  the  average  cost  of  debt  and  nominal  GDP  growth.  The  term  in 
parentheses represents the “snow-ball” effect, measuring the combined effect of interest expenditure and economic growth on 
the debt ratio. 

D
t
Y
t

⎞
+⎟⎟
⎠

−
+

y
y

i
t
1

⎛
⎜⎜
⎝

*

1
−

1
−

t

t

Source: Eurostat and Commission services’ spring 2010 forecasts. 

However, in 2009, the general government gross debt increased again to 56.2% of GDP. This 
increase of 7¾ percentage points of GDP was mainly the result of the significant deterioration 
in the primary balance and debt-increasing "snowball" effects on the back of falling nominal 
GDP. Stock-flow adjustments also had a negative contribution to the debt level equivalent to 
about 1 percentage point of GDP, due to accumulation of government assets at the end of the 
year in order to meet  debt  maturity obligations arising early in January of 2010, as well as, 
differences between cash and accruals. For 2010, Cyprus notified a planned debt of 62% of 
GDP,  thus  exceeding  60%  of  GDP  Treaty  reference  value.  The  April  2010  stability 
programme  plans  a  slightly  lower  figure  (61%)  and  foresees  a  further  increase  to  63.2%  of 
GDP in 2011.  

The Commission services spring 2010 forecasts project debt to rise further to 62.3% of GDP 
in 2010 and 67.6% in 2011on the back of a deteriorated primary balance. 

In view of these trends, the debt ratio cannot be considered as “sufficiently diminishing and 
approaching  the  reference  value  at  a  satisfactory  pace”  in  the  sense  of  the  Treaty  and  the 
Stability and Growth Pact.  

This analysis suggests that the debt criterion in the Treaty is not fulfilled. 

5. 

RELEVANT FACTORS 

Article 126(3) of the Treaty provides that the Commission report “shall also take into account 
whether  the  government  deficit  exceeds  government  investment  expenditure  and  take  into 
account other relevant factors including the medium-term economic and budgetary position of 
the Member State”. These factors are further clarified in Article 2(3) of Council Regulation 

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(EC)  No  1467/97,  which  also  specifies  that  “any  other  factors  which,  in  the  opinion  of  the 
Member State concerned, are relevant in order to comprehensively assess in qualitative terms 
the  excess  over  the  reference  value  and  which  the  Member  State  has  put  forward  to  the 
Commission and to the Council” need to be given due consideration.  

In  view  of  the  above  provisions,  the  following  four  subsections  consider  in  turn  (1)  the 
medium-term  economic  position;  (2)  the  medium-term  budgetary  position  (including  public 
investment);  (3)  other  factors  put  forward  by  the  Member  State;  [and]  (4)  other  factors 
considered relevant by the Commission. 

5.1. 

Medium-term economic position 

Cyclical  conditions  and  potential  growth.  According  to  provisional  estimates  released  by 
the Cypriot Statistical Service, the Gross Domestic Product (GDP) of Cyprus appears to have 
contracted by 1.7% in real terms in 2009. This is the first time economic activity in Cyprus 
recorded a negative growth rate in the last 35 years. The Commission services' spring  2010 
forecast projects a further shrinking, although to a lesser extent, of the economy in 2010 with 
activity projected to decline by almost ½%. Subdued private consumption and investment in 
tandem  with  sluggish  demand  from  Cyprus'  main trading partners weigh on growth. This is 
followed by a moderate recovery of real GDP by 1¼% in 2011 on the back of an improving 
outlook  of  domestic  demand  concurrently  with  a  rebound  in  world  trade  and  the  positive 
effects  of  the  fiscal  stimulus  measures.  Cyclical  conditions  showed  a  rapid  widening  of  the 
positive  output  gap  since  2006  and  a  sharp  reversal  in  2009,  with  the  output  gap  turning 
strongly  negative  in  2009  and  2010.  In  2009,  the  Cypriot  economy  was  clearly  below  its 
potential, with an estimated output gap of -0.7 percentage points. The Commission services' 
spring  2010  forecast  project  a  further  widening  of  the  output  gap  to  –2.1%,  reflecting  a 
decrease  in  labour  contribution  and  lower  capital  accumulation  as  a  result  of  a  drop  in 
investment. 

Recent  structural  reforms.  At  microeconomic  policy  level,  the  revised  National  Reform 
Programme 2008-2010 (NRP) aims at unlocking the business potential through enhancement 
of  competition  and  entrepreneurship  as  well  as  investing  in  knowledge  and  innovation  in 
order  to  boost  Cyprus’  attractiveness  as  business  location  for  both  investors  and  the  labour 
force. Given the low levels of private investment on R&D, due to the small size and services-
orientation  of  the  economy,  the  government  introduced  a  series  of  measures  to  encourage 
stronger  industry  participation.  Given  the  de  facto  limitations  though,  the  government  has 
reinforced the role of the Research Promotion Foundation and invests more on the promotion 
of  innovation.  Cyprus  being  heavily  dependant  on  imported  oil  for  its  energy  supply  and 
having a small and isolated island system has set energy efficiency as a top priority alongside 
addressing  climate  change.  For  this  purpose,  an  energy  centre  that  would  enable  the 
importation of natural gas to the island is under construction  and expected to commence its 
operation  by  2013.  Regarding  measures  to  further  improve  labour  market  performance,  the 
educational  reform  is  progressing  with  initiatives  in  primary,  secondary,  and  tertiary 
education as well as the preparation of the new apprenticeship scheme. However, the gender 
pay  gap  remains  high.  So  do  also  gender  gaps  in  employment  and  unemployment. 
Furthermore, the action plan for the integration of migrants in the Cypriot society is still in the 
preparatory phase.  

5.2. 

Medium-term budgetary position 

Structural deficit and fiscal consolidation in good times. During the period 2005-2009, the 
Cypriot economy made significant progress in consolidating public finances in conditions of 
good economic times, supported by an asset boom and buoyant tax receipts partly owing to 

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tax-rich  composition  of  growth.  From  a  deficit  of  2.4%  of  GDP  in  2005  the  government 
balance turned into a surplus of almost 1% of GDP in 2008, after reaching a surplus of 3.4% 
in  2007.  In  parallel,  the  debt  ratio  declined  from  69.1%  of  GDP  down  to  48.4%.  This  was 
contemporaneous  to  a  continued  improvement  in  the  structural  balance  (i.e.,  the  cyclically-
adjusted balance net of one-off and other temporary measures)6 from a deficit of around 3% 
of  GDP  in  the  year  2005  to  a  surplus  of  2½%  of  GDP  in  2007,  well  above  the  MTO  (of  a 
balanced budget in structural terms). However, already in 2008 (which was still characterised 
by  economic  good  times),  the  structural  balance  decreased  to  a  deficit  of  ½%  of  GDP, 
implying  a  procyclical  fiscal  policy.  In  2009  the  structural  balance  further  deteriorated 
markedly  to  a  deficit  of  almost  6%  of  GDP.  This  was  the  result  of  not  only  a  number  of 
discretionary measures in response to the economic downturn (in line with the EERP) but also 
of  rather  large  composition  effects  on  account  of  a  much  less  tax-rich  GDP  growth  pattern. 
According to the Commission services' spring 2010 forecast, the fiscal stance is expected to 
deteriorate further in 2010 and 2011 with the structural deficit projected to rise to 6¼ % of 
GDP in 2010 and, based on the assumption of unchanged policies, to increase even further to 
about 7% of GDP in 2011. 

Public investment. Government investment has been relatively constant in terms of GDP at 
about  3½%  between  2005  and  2008.  In  2009,  the  government  investment-to-GDP  ratio 
increased by 1¼ percentage points, reaching almost 5% of GDP, reflecting the discretionary 
fiscal  stimulus  package  in  response  to  the  EERP.  According  to  the  Commission  services’ 
spring 2010 forecast, in 2010 and 2011, the public investment ratio is expected to remain at 
similar levels because of the continuation of infrastructure projects. In both years, the general 
government deficit ratio in both headline and structural terms would exceed the government 
investment-to- GDP ratio.  

Quality of public finances. Between 2003, when the deficit reached the peak of the decade at 
6.5%  of  GDP,  and  2008,  Cyprus  implemented  a  fiscal  adjustment  of  about  7½  pp  of  GDP. 
Consolidation has been mainly revenue-driven, 5% of GDP, on the back of sizeable deficit-
reducing  one-offs,  especially  between  2003  and  2005.  However,  the  tax  amnesty  launched 
during  those  years,  together  with  improvements  in  tax  administration,  might  have  led  to  a 
broadening  of  the  tax  bases  and,  thus,  to  a  permanent  increase  of  tax  revenues.  On  the 
expenditure  side,  general  government  expenditure  has  fallen  from  45%  of  GDP  in  2003  to 
42½% in 2008. In particular, current primary expenditure declined by 1¼ percentage points. 
Nevertheless,  in  2009  expenditure  increased  by  about  3¾  percentage  points  of  GDP,  partly 
due to measures in response to the economic and financial crisis and additional expenditure 
due  to  automatic  stabilisers.  As  a  result,  public  investment  increase  by  about  1  percentage 
point  of  GDP  while  social  payments  also  increased  by  1¾  percentage  points  due  to  social 
cohesion measures in line with objectives of the National Reform Programme. In the recent 
past,  Cyprus'  budgetary  framework  has  been  improved  with  the  adoption  of  the  Financial 
Management  Accounting  System  (FIMAS).  As  from  2006,  Cyprus  also  enacted  the  gradual 
adoption  of  a  3-year  medium  term  budgetary  framework  (MTBF)  and  as  from  2007  it 
introduced  a  Programme  and  Performance  Budgeting  (PPB).  Nevertheless,  the  new 
framework is still phasing in and it is only foreseen to be fully in place in 2012. The hitherto 
practice  of  adopting  supplementary  budgets  during  the  course  of  the  year,  has  implied  an 
increase  in  current  expenditure  beyond  the  intended  reallocation  of  funds.  Once  the  new 
budgeting framework is fully implemented, it is expected to cease this practise and lead to a 
more  effective  and  efficient  budgeting  process,  contributing  to  contain  expenditure  by 

6 

Estimated by the Commission services on the basis of the commonly agreed methodology on estimating 
output gaps. 

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ministry according to the ceilings set. 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. 

Long-term sustainability  of  public finances.  The long-term budgetary impact of ageing is 
well  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  introduces  a  recently  adopted  pension 
reform that is projected to reduce the increase in pension expenditure. In view of the projected 
impact of ageing on  government  expenditure, the Council invited Cyprus  to "strengthen the 
long-term  sustainability  of  public  finances  by  pursuing  the  reform  of  the  pension  and 
healthcare  systems".  The  assessment  of  long-term  sustainability  has  not  changed  since  the 
adoption of the Council opinion. 

5.3. 

Other factors put forward by the Member State 

In  a  letter  of  27  April  2010,  the  authorities  of  Cyprus  listed  some  relevant  factors  in 
accordance with Article 2(3) of Council Regulation (EC) No 1467/97. The analysis presented 
above already covers most of the items put forward by the authorities.  

5.4. 

Other factors considered relevant by the Commission 

Recent public finance developments in Cyprus were also influenced by the following factors 
in  the  area  of  budgetary  institutions  and  procedures.  As  a  response  to  the  economic  crisis, 
Cyprus  has  adopted  some  fiscal  stimulus  and  structural  measures  in  line  with  the  European 
Economic  Recovery  Plan  (EERP).  The  overall  impact  of  the  total  of  recovery  measures  is 
estimated  to  have  been  about  2¼%  of  GDP  in  2009  and  almost  2%  in  2010,  excluding  the 
impact of the pension reform. Of these, about three fourths are temporary measures, which at 
their expiry will automatically reduce government expenditure. 

As regards financial markets, the Cypriot government has not adopted any specific package to 
stabilise the financial sector. However, the Government issued treasury bills in early January 
2009, with maturity December 2009, for refinancing its short-term (cash flow) needs and for 
increasing  the  liquidity  conditions  in  the  banking  system.  The  total  value  is  of  the  order  of 
almost  8%  of  GDP,  of  which  about  one  half  has  been  deposited  in  banks  and  credit 
institutions. 

In  its  opinion  of  27  April  2009  on  the  previous  update  of  the  Stability  Programme,  the 
Council  considered  that  the  expansionary  fiscal  measures  were  in  line  with  the  EERP. 
However,  against  the  background  of  a  sharp  deterioration  in  the  global  economic 
environment,  the  budgetary  strategy  was  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. In particular, controlling current 
expenditure represented a major challenge for the fiscal policy in Cyprus while fostering the 
quality  of  public  finances  was  also  important  with  a  view  to  underpinning  a  smooth 
adjustment of the economy in the light of the imbalances it is faced with.  

Therefore, the Council invited Cyprus to (i) implement the measures in line with the EERP as 
planned,  while  avoiding  further  deterioration  of  public  finances  in  2009  compared  to  the 
target;  (ii)  reverse  the  projected  fiscal  loosening  in  2010  and  beyond,  by  restraining 
expenditures in order to ensure a sound fiscal position in the medium term; (iii) in view of the 
ongoing fiscal deterioration and of the projected impact of ageing on government expenditure, 

EN 

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   EN 

 
improve the long-term sustainability of public finances by pursuing the reform of the pension 
and health care systems. 

6. 

CONCLUSIONS 

According  to  the  April  2010  EDP  notification  the  general  government  deficit  in  Cyprus 
reached 6.1% of GDP in 2009, above and not close to the 3% of GDP reference value. The 
planned excess over the reference value can be qualified as exceptional within the meaning of 
the  Treaty  and  the  Stability  and  Growth  Pact.  However,  it  cannot  be  considered  temporary. 
This suggests that the deficit criterion in the Treaty is not fulfilled. 

General  government  gross  debt  remains  below  the  60%  of  GDP  reference  value  in  2009. 
However it is on a rising trend and it is planned to exceed the reference value in 2010. The 
debt  ratio  cannot  be  considered  as  diminishing  sufficiently  and  approaching  the  reference 
value  at  a  satisfactory  pace  within  the  meaning  of  the  Treaty  and  the  Stability  and  Growth 
Pact. This suggests that the debt criterion in the Treaty is not fulfilled. 

In line with the Treaty, this report has also examined “relevant factors”, which, according to 
the  Stability  and  Growth  Pact,  can  only  be  taken  into  account  in  the  steps  leading  to  the 
decision  on  the  existence  of  an  excessive  deficit  if  the  double  condition  -  that  the  deficit 
remains close to the reference value and that its excess over the reference value is temporary - 
is fully met. Considered on their own merit, the relevant factors in the current case on balance 
present a mixed picture.  

EN 

10 

   EN