Proposal for a Council Decision on the existence of an excessive deficit in Cyprus
Date: 2010-06-15
Institutions: European Commission
Subjects: Cyprus, budget deficit, economic recession, public debt, public finance, stability pact

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EUROPEAN COMMISSION 

Brussels, 15.6.2010 
SEC(2010) 740 final 

Proposal for a 

COUNCIL DECISION 

on the existence of an excessive deficit in Cyprus 

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EXPLANATORY MEMORANDUM 

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  in  2008/09.  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  timely,  targeted  and 
temporary and 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 have impacted 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  initiate  the  excessive  deficit 
procedure (EDP) whenever the deficit of a Member State exceeds the 3% of GDP reference 
value.  The  amendments  to  the  Stability  and  Growth  Pact  in  2005  aimed  at  ensuring  that  in 
particular the economic and budgetary background was taken into account fully in all steps in 
the  EDP.  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, and thereby ensuring long-term sustainability of public finances. 

2. 

PREVIOUS STEPS IN THE EXCESSIVE DEFICIT PROCEDURE 

Article 126 of the Treaty on the Functioning of the European Union 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). 

1 

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. 

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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”. 

On  the  basis  of  the  data  notified  by  the  Cypriot  authorities  in  March  20102  and  taking  into 
account  the  Commission  services’  spring  2010  forecast,  the  Commission  adopted  a  report 
under Article 126(3) for Cyprus on 12 May 20103. 

Subsequently, and in accordance with Article 126(4), the Economic and Financial Committee 
formulated an opinion on the Commission report on 27 May 2010. 

3. 

THE EXISTENCE OF AN EXCESSIVE DEFICIT 

According to data notified by the Cypriot authorities in April 2010, the general government 
deficit  in  Cyprus  reached  6.1%  of  GDP  in  2009,  thus  exceeding  the  3%  of  GDP  reference 
value. The Commission report under Article 126(3) considered that the deficit was not close 
to  the  3%  of  GDP  reference  value  and  that  the  excess  over  the  reference  value  can  be 
qualified as exceptional within the meaning of the Treaty and the Stability and Growth Pact. 
In particular, it results from a severe economic downturn in the sense  of the Treaty and the 
Stability and Growth Pact. According to the Commission services’ 2010 spring forecast, real 
GDP  in  Cyprus  is  projected  to  shrink  further,  although  to  a  lesser  extent,  by  almost  ½%  in 
2010  compared  with  1¾%  in  2009.However,  the  planned  excess  over  the  reference  value 
cannot be considered temporary. According to the Commission services’ spring 2010 forecast, 
the budgetary deficit is projected to reach about 7¾% of GDP in 2011 on a no-policy change 
basis. The deficit criterion in the Treaty is not fulfilled. 

According to data notified by the Cypriot authorities in April 2010, the general government 
gross  debt  remains  below  the  60%  of  GDP  reference  value  and  stood  at  56.2%  of  GDP  in 
2009. For 2010, Cyprus notified a planned debt of 62% of GDP, thus exceeding 60% of GDP 
Treaty reference value. The Commission services’ spring 2010 forecast projects debt to rise to 
62.3%  of  GDP  in  2010  and  further  to  67.6%  in  2011  on  the  back  of  a  deteriorated  primary 
balance.  In  view  of  these  trends,  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. The debt criterion in the Treaty is not fulfilled. 

In line with the provisions in the Treaty and the Stability and Growth Pact, the Commission 
also  analysed  in  its  report  “relevant  factors”.  According  to  the  Stability  and  Growth  Pact, 
these can only be taken into account in the steps leading to the decision on the existence of an 
excessive deficit if the deficit satisfies the double condition of closeness and temporariness. In 
the  case  of  Cyprus,  the  double  condition  is  not  met.  Considered  on  their  own  merit,  the 
relevant factors in the current case on balance present a mixed picture. 

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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/excessive_deficit/edp_
notification_tables. 
All EDP-related documents for Cyprus can be found at the following website: 
http://ec.europa.eu/economy_finance/sgp/deficit/countries/index_en.htm. 

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The opinion of the Economic and Financial Committee in accordance with Article 126(4) of 
the Treaty is consistent with the assessment in the Commission report under Article 126(3).  

The Commission, having taken into account its report under Article 126(3) and the opinion of 
the  Economic  and  Financial  Committee  under  Article  126(4),  is  of  the  opinion  that  an 
excessive  deficit  exists  in  Cyprus.  This  opinion,  adopted  by  the  Commission  on  [15  June 
2010],  is  herewith  addressed  to  the  Council  according  to  Article  126(5).  The  Commission 
proposes  that  the  Council  shall  decide  accordingly,  in  conformity  with  Article  126(6).  In 
addition,  the  Commission  is  submitting  to  the  Council  a  recommendation  for  a  Council 
Recommendation  to  be  addressed  to  Cyprus  with  a  view  to  bringing  the  situation  of  an 
excessive deficit to an end according to Article 126(7). 

4. 

RECOMMENDATIONS TO END THE EXCESSIVE DEFICIT SITUATION 

According 
the  Council 
to  Article  3(4)  of  Council  Regulation  (EC)  No  1467/97, 
recommendation  under  Article  126(7)  has  to  establish  a  deadline  of  six  months  at  most  for 
effective  action  to  be  taken  by  the  Member  State  concerned  as  well  as  a  deadline  for  the 
correction  of  the  excessive  deficit,  which  “should  be  completed  in  the  year  following  its 
identification unless there are special circumstances”. Article 2(6) of the Regulation implies 
that  the  “relevant  factors”  considered  in  the  Commission  report  under  Article  126(3)  of  the 
Treaty have to be taken into account in deciding whether special circumstances exist. Article 
3(4)  of  the  Regulation  specifies  that  the  Council  has  to  recommend  that  the  Member  State 
achieves  a  “minimum  annual  improvement  of  at  least  0.5%  of  GDP  as  a  benchmark,  in  its 
cyclically  adjusted  balance  net  of  one-off  and  temporary  measures,  in  order  to  ensure  the 
correction of the excessive deficit within the deadline set in the recommendation”. 

Special circumstances, which are relevant for the greater flexibility in the application of the 
EDP introduced with the 2005 reform of the Stability and Growth Pact, are deemed to exist in 
the case of Cyprus. In 2009, for the first time in 35 years, economic activity  contracted, by 
1¾%. The recession reflected the significant fall in domestic demand and an adverse external 
environment.  In  particular,  high  household  indebtedness  together  with  tighter  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. Moreover, export of goods and services, especially tourism, plummeted as a 
consequence  of  the  financial  crisis  and  the  global  slowdown,  in  particular  the  much  lower 
growth  prospects  of  the  main  trading  partners  (Euro  Area,  United  Kingdom,  Russia).  The 
deficit  in 2009 is a consequence of  both the economic  downturn and the  stimulus  measures 
taken in line with the EERP by the Cypriot authorities. 

Against this background, it is appropriate to consider the correction of the excessive deficit in 
a  medium-term  framework  with  a  deadline  for  the  correction  of  2012.  Recognising  that  the 
deterioration  of  the  Cypriot  budgetary  position  in  2009  resulted  from  measures  taken  in 
response to the crisis, amounting to about 1½% of GDP annually in 2009 and in 2010, which 
was an appropriate response in line with the European Economic Recovery Plan, and the free 
play  of  automatic  stabilisers,  the  Cypriot  authorities  should  strengthen  the  fiscal  strategy  in 
2010 with measures to control current expenditure. In particular, in view of the domestic and 
external economic imbalances, a credible and sustainable adjustment path would require the 
Cypriot authorities to ensure an average annual structural adjustment of 1¾ percentage points 
of GDP over the period 2010-2012. It would also require the Cypriot authorities to specify the 

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measures  that  are  necessary  to  achieve  the  correction  of  the  excessive  deficit  by  2012,  to 
ensure a swift reduction of the gross debt ratio below the reference value and accelerate the 
reduction  of  the  deficit  if  economic  or  budgetary  conditions  turn  out  better  than  currently 
expected. In this context, the timely implementation of a medium-term budgetary framework 
would  be  critical  for  a  successful  and  lasting  consolidation  of  the  public  finances. 
Furthermore, given that the long-term budgetary impact of ageing in Cyprus is significantly 
above the EU average, mainly as a result of a relatively high increase in pension expenditure, 
measures are needed to improve the long-term sustainability of public finances.  

Enhanced surveillance under the EDP, which seems necessary in view also of the deadline for 
the  correction  of  the  excessive  deficit,  will  require  regular  and  timely  monitoring  of  the 
progress  made  in  the  implementation  of  the  fiscal  consolidation  strategy  to  ensure  the 
correction  of  the  excessive  deficit.  In  this  context,  a  separate  chapter  in  the  forthcoming 
updates of Cyprus’ stability programme could usefully be devoted to this issue. 

Comparison of key macroeconomic and budgetary projections 

Real GDP 
(% change) 
Output gap1 
(% of potential GDP) 
General government balance 
(% of GDP) 
Primary balance 
(% of GDP) 
Cyclically-adjusted balance1 
(% of GDP) 
Structural balance4 
(% of GDP) 

Government gross debt 
(% of GDP) 

COM spring 2010 
SP Apr 2010 
COM spring 20102 
SP Apr 20103 
COM spring 2010 
SP Apr 2010 
COM spring 2010 
SP Apr 2010 
COM spring 2010 
SP Apr 2010 
COM spring 2010 
SP Apr 2010 
COM spring 2010 
SP Apr 20105 

2007 

2008 

2009 

2010 

2011 

5.1 
5.1 
2.4 
1.9 
3.4 
3.4 
6.4 
6.4 
2.5 
2.6 
2.5 
2.6 
58.3 
58.3 

3.6 
3.6 
3.4 
2.9 
0.9 
0.9 
3.7 
3.7 
-0.4 
-0.2 
-0.4 
-0.2 
48.4 
48.4 

-1.7 
-1.7 
-0.7 
-1.3 
-6.1 
-6.1 
-3.6 
-3.6 
-5.8 
-5.6 
-5.8 
-5.6 
56.2 
56.2 

-0.4 
0.5 
-2.1 
-2.4 
-7.1 
-6.0 
-4.4 
-3.7 
-6.3 
-5.2 
-6.3 
-5.2 
62.3 
61.0 

1.3 
1.5 
-1.6 
-2.5 
-7.7 
-4.5 
-4.8 
-2.1 
-7.1 
-3.6 
-7.1 
-3.6 
67.6 
63.2 

2012 
n.a. 
3.0 
n.a. 
-1.6 
n.a. 
-3.4 
n.a. 
-1.0 
n.a. 
-2.9 
n.a. 
-2.9 
n.a. 
63.1 

2013 
n.a. 
3.2 
n.a. 
-0.5 
n.a. 
-2.5 
n.a. 
0.1 
n.a. 
-2.3 
n.a. 
-2.3 
n.a. 
62.3 

Notes: 
1 Output gaps and cyclically-adjusted balances from the programmes as recalculated by Commission services on the basis 
of the information in the programmes. 

2 Based on estimated potential growth of 2.0%, 2.8%, 2.8%, 2.8% and 2.8% respectively in the period 2009-2013. 

3 Based on estimated potential growth of 2.5%, 1.6%, 1.6%, 2.0% and 2.2% respectively in the period 2009-2013. 

4 Cyclically-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. 

5  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. 

Source: 

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

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Proposal for a 

COUNCIL DECISION 

on the existence of an excessive deficit in Cyprus 

THE COUNCIL OF THE EUROPEAN UNION, 

Having  regard  to  the  Treaty  on  the  Functioning  of  the  European  Union,  and  in  particular 
Article 126(6) thereof, 

Having regard to the proposal from the European Commission, 

Having regard to the observations made by Cyprus, 

Whereas: 

(1) 

(2) 

(3) 

(4) 

According  to  Article  126  of  the  Treaty  on  the  Functioning  of  the  European  Union 
Member States shall avoid excessive government deficits. 

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 excessive deficit procedure (EDP) under Article 126 of the Treaty, as clarified by 
Council  Regulation  (EC)  No  1467/97  on  speeding  up  and  clarifying 
the 
implementation of the excessive deficit procedure4 (which is part of the Stability and 
Growth  Pact),  provides  for  a  decision  on  the  existence  of  an  excessive  deficit.  The 
Protocol  on  the  excessive  deficit  procedure  annexed  to  the  Treaty  sets  out  further 
provisions  relating  to  the  implementation  of  the  EDP.  Council  Regulation  (EC)  No 
479/20095 lays down detailed rules and definitions for the application of the provision 
of the said Protocol.  

The  2005  reform  of  the  Stability  and  Growth  Pact  sought  to  strengthen  its 
effectiveness and economic underpinnings as well as to safeguard the sustainability of 
the public finances in the long run. It aimed at ensuring that in particular the economic 
and budgetary background was taken into account fully in all steps in the EDP. 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. 

(5) 

Article  126(5)  of  the  Treaty  requires  the  Commission  to  address  an  opinion  to  the 
Council if the Commission considers that an excessive deficit in a Member State exists 
or may occur. Having taken into account its report in accordance with Article 126(3) 

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OJ L 209, 2.8.1997, p. 6.  
OJ L 145, 10.6.2009, p. 1. 

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(6) 

(7) 

(8) 

(9) 

and  having  regard  to  the  opinion  of  the  Economic  and  Financial  Committee  in 
accordance  with  Article  126(4),  the  Commission  concluded  that  an  excessive  deficit 
exists in Cyprus. The Commission therefore addressed such an opinion to the Council 
in respect of Cyprus on 15 June 20106. 

Article 126(6) of the Treaty states that the Council should consider any observations 
which the Member State concerned may wish to make before deciding, after an overall 
assessment,  whether  an  excessive  deficit  exists.  In  the  case  of  Cyprus,  this  overall 
assessment leads to the following conclusions. 

According  to  data  notified  by  the  Cypriot  authorities  in  April  2010,  the  general 
government deficit in Cyprus reached 6.1% of GDP in 2009, thus exceeding the 3% of 
GDP reference value. The deficit was not close to the 3% of GDP reference value, but 
the excess over the reference value can be qualified as exceptional within the meaning 
of the Treaty and the Stability and Growth Pact. In particular, it results from a severe 
economic  downturn  in  the  sense  of  the  Treaty  and  the  Stability  and  Growth  Pact. 
According  to  the  Commission  services’  2010  spring  forecast,  real  GDP  in  Cyprus  is 
projected  to  shrink  further,  although  to  a  lesser  extent,  by  almost  ½%  in  2010 
compared with 1¾% in 2009. However, the  planned excess over the reference value 
cannot be considered temporary. According to the Commission services’ spring 2010 
forecast, the budgetary deficit would reach about 7¾% of GDP in 2011 on a no-policy 
change basis. The deficit criterion in the Treaty is not fulfilled. 

According  to  data  notified  by  the  Cypriot  authorities  in  April  2010,  the  general 
government gross debt remains below the 60% of GDP reference value and stood at 
56.2% of GDP in 2009. For 2010, Cyprus notified a planned debt of 62% of GDP, thus 
exceeding  60%  of  GDP  Treaty  reference  value.  The  Commission  services’  spring 
2010 forecast projects debt to rise further to 62.3% of GDP in 2010 and 67.6% in 2011 
on the back of a deteriorated primary balance. In view of these trends, 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. The debt criterion in the Treaty is not fulfilled. 

According to Article 2(4) of Council Regulation (EC) No 1467/97, “relevant factors” 
can  only  be  taken  into  account  in  the  steps  leading  to  the  Council  decision  on  the 
existence  of  an  excessive  deficit  in  accordance  with  Article  126(6)  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.  In  the  case  of  Cyprus,  this  double 
condition is not met. Therefore, relevant factors are not taken into account in the steps 
leading to this decision. 

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All EDP-related documents for Cyprus can be found at the following website: 
http://ec.europa.eu/economy_finance/sgp/deficit/countries/index_en.htm. 

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HAS ADOPTED THIS DECISION: 

From an overall assessment it follows that an excessive deficit exists in Cyprus. 

Article 1 

Article 2 

This decision is addressed to the Republic of Cyprus. 

Done at Brussels,  

For the Council 
The President 

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