Recommendation for a COUNCIL RECOMMENDATION on the National Reform Progamme 2011 for Cyprusand delivering a Council opinionon the updated Stability Programme of Cyprus, 2011-2014
Date: 2011-06-07
Institutions: European Commission
Subjects: Cyprus, banking supervision, budget deficit, economic policy, employment policy, pension scheme, social rights, vocational training

EUROPEAN COMMISSION 

Brussels, 7.6.2011 
SEC(2011) 803 final 

Recommendation for a 

COUNCIL RECOMMENDATION 

on the National Reform Progamme 2011 for Cyprus 

and delivering a Council opinion 

on the updated Stability Programme of Cyprus, 2011-2014 

{SEC(2011) 721 final} 

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Recommendation for a 

COUNCIL RECOMMENDATION 

on the National Reform Progamme 2011 for Cyprus 

and delivering a Council opinion 

on the updated Stability Programme of Cyprus, 2011-2014 

THE COUNCIL OF THE EUROPEAN UNION, 

Having  regard  to  the  Treaty  on  the  Functioning  of  the  European  Union,  and  in  particular 
Articles 121(2) and 148(4) thereof, 

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 
policies1, and in particular Article 5(3) thereof, 

Having regard to the recommendation of the European Commission2, 

Having regard to the conclusions of the European Council, 

Having regard to the opinion of the Employment Committee, 

After consulting the Economic and Financial Committee, 

Whereas: 

(1) 

(2) 

On  26  March  2010,  the  European  Council  agreed  to  the  European  Commission’s 
proposal  to  launch  a  new  strategy  for  jobs  and  growth,  Europe  2020,  based  on 
enhanced coordination of economic policies, which will focus on the key areas where 
to  boost  Europe’s  potential  for  sustainable  growth  and 
action 
competitiveness. 

is  needed 

On 13 July 2010, the Council adopted a recommendation on the broad guidelines for 
the  economic  policies  of  the  Member  States  and  the  Union  (2010  to  2014)  and,  on 
21 October 2010, adopted a decision on guidelines for the employment policies of the 
Member States,3 which together form the ‘integrated guidelines’. Member States were 
invited  to  take  the  integrated  guidelines  into  account  in  their  national  economic  and 
employment policies. 

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OJ L 209, 2.8.1997, p. 1. 
OJ C , p. . 
Maintained for 2011 by Council Decision 2011/308/EU of 19 May 2011. 

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(3) 

(4) 

(5) 

(6) 

(7) 

(8) 

On  12  January  2011,  the  Commission  adopted  the  first  Annual  Growth  Survey, 
marking  the  start  of  a  new  cycle  of  economic  governance  in  the  EU  and  the  first 
European semester of ex-ante and integrated policy coordination, which is anchored in 
the Europe 2020 strategy.  

On  25  March  2011,  the  European  Council  endorsed  the  priorities  for  fiscal 
consolidation  and  structural  reform  (in  line  with  the  Council’s  conclusions  of 
15 February  and  7  March  2011  and  further  to  the  Commission’s  Annual  Growth 
Survey). It underscored the need to give priority to restoring sound budgets and fiscal 
sustainability,  reducing  unemployment  through  labour  market  reforms  and  making 
new efforts to enhance growth. It requested Member States to translate these priorities 
into  concrete measures to be included  in their Stability or Convergence Programmes 
and National Reform Programmes. 

On 25 March 2011, the European Council also invited the Member States participating 
in  the  Euro  Plus  Pact  to  present  their  commitments  in  time  to  be  included  in  their 
Stability or Convergence Programmes and their National Reform Programmes.  

On  6  May  2011,  Cyprus  submitted  its  National  Reform  Programme  and  on  7  May 
2011 its updated Stability Programme covering the period 2010-2014. In order to take 
account of the interlinkages, the two programmes have been assessed at the same time. 

The Cypriot economy is recovering moderately after experiencing the first economic 
contraction  in  the  last  thirty-five  years  in  2009,  when  real  GDP  fell  by  1.7 %.  The 
labour  market  suffered  from  the  recession,  with  unemployment  reaching  6.5 %  in 
2010.  Public  finances  also  deteriorated.  From  a  surplus,  the  general  government 
budget  dropped  to  a  deficit  of  6 %  of  GDP  in  2009,  driven  by  automatic  stabilisers, 
discretionary  fiscal  stimulus  measures  to  counter  the  economic  downturn  and  rather 
large  effects  due  to  a  less  tax-rich  growth  pattern.  Economic  activity  improved 
moderately  in  2010  with  growth  at  1 %,  mainly  driven  by  inventory  accumulation, 
after the large destocking that took place in 2009, in tandem with a mild resumption of 
private  consumption.  The  strengthening  economic  outlook  is  expected  to  benefit  the 
labour  market,  employment  is  projected  to  recover  modestly  while  unemployment 
should ease gradually from its peak at the end of 2010.  

Based  on  the  assessment  of  the  updated  Stability  Programme  pursuant  to  Council 
Regulation  (EC)  No  1466/97,  the  Council  is  of  the  opinion  that  the  macroeconomic 
scenario  underpinning  the  budgetary  projections  is  plausible  until  2012,  but  too 
favourable  thereafter,  as  assessed  against  the  Commission  services'  spring  2011 
forecast. The Stability Programme aims to reduce the budgetary deficit to 4 % of GDP 
in 2011 and 2.6 % in 2012, in line with the Council recommendations, and to continue 
consolidation afterwards. The programme projects the debt ratio to peak in 2012 and 
to decline thereafter. The annual average improvement in the structural balance for the 
period 2011-12 is 1.5 % of GDP, in line with the Council recommendations. However, 
the  structural  improvement  is  set  to  be  below  the  requirements  of  the  Stability  and 
Growth  Pact  in  both  2013  and  2014.  The  medium-term  objective  (MTO),  which  is 
reaffirmed  as  a  balanced  budget  in  structural  terms,  will  not  be  reached  within  the 
programme  period.  While  the  overall  adjustment  planned  is  based  on  expenditure 
restraint, most measures in 2011 are on the revenue side. Overall, there are downside 
risks  to  the  consolidation  path  mapped  out  in  the  programme,  associated  with  the 
continued rebalancing towards a less tax-rich growth pattern, the practice of adopting 

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(9) 

supplementary budgets during the course of the year and the timely implementation of 
measures  which  are  still  to  be  agreed  with  the  social  partners  and  others  still  to  be 
specified (e.g. containment of current expenditure). In view of these risks, additional 
measures may need to be adopted if macroeconomic or budgetary developments turn 
out to be worse than expected.  

Despite the decline to around 9 % of GDP in 2010, the current account deficit is still 
large  and  likely  to  constrain  economic  growth  over  the  medium  term.  High  public-
sector outgoings need to be financed by either foreign debt or higher domestic private 
savings.  The  latter  would  imply  lower  output  growth  by  crowding  out  private 
consumption  or  investment.  In  the  medium  term,  the  deficit  would  continue 
improving,  but  at  a  moderate  rate.  On  13  July  2010,  in  the  context  of  the  excessive 
deficit  procedure,  the  Council  recommended  to  the  Cypriot  authorities  to  strengthen 
the  binding  nature  of  their  medium-term  budgetary  framework  too.  Until  now,  no 
progress has been reported. According to the Stability Programme, the medium-term 
budgetary  framework  is  to  be  fully  implemented  from  the  fiscal  year  2014  onwards, 
rather than 2012, as expected until recently. Therefore, its impact would be felt only in 
the medium term. Timely implementation of the new framework would be important 
for successful and lasting consolidation of the public finances. 

(10)  The banking sector weathered the global financial crisis and the sovereign debt crisis 
in  the  euro  area  well,  without  any  need  for  government  intervention.  However,  with 
assets  of  more  than  six  times  GDP,  excluding  subsidiaries  and  branches  of  foreign 
banks,  and  ten  times  GDP  when  they  are  included,  the  banking  sector  is  large  in 
relation  to  the  economy.  Moreover,  it  is  relatively  concentrated,  with  the  market 
dominated  by  three  domestic  groups  that  hold  about  55 %  of  total  consolidated 
banking  assets,  excluding  the  cooperative  banks.  The  ongoing  risks  on  international 
financial markets call for continuation of conservative balance-sheet management and 
for  prudent  supervision.  There  are  two  different  supervisors:  the  Central  Bank  of 
Cyprus for commercial banks and the Authority for the Supervision and Development 
of  Cooperative  Societies  (ASDCS)  for  cooperative  credit  institutions.  In  spite  of  the 
IMF recommendation to have a single supervisor for both banks and cooperative credit 
institutions, no progress has been made.  

(11)  The  projected  long-term  budgetary  impact  of  ageing  is  well  above  the  EU  average, 
mainly as a result of a relatively strong increase in pension expenditure as a share of 
GDP  over  the  decades  ahead.  A  pension  reform  was  introduced  in  April  2009.  It  is 
aimed  mainly  at  the  revenue  side  and  would  only  slightly  slow  down  the  rise  in 
pension  expenditure.  Progress  on  healthcare  reform,  with  the  aim  of  curbing  the 
projected rise in expenditure by establishing a national health system and transforming 
public hospitals into autonomous entities, has been very limited. 

(12)  The  twice-a-year  automatic  cost-of-living  allowance  (COLA)  adjustment  is  linked 
directly to the average percentage change in the consumer price index (CPI) over the 
last six months compared with the preceding six months. It enjoys strong support from 
the  social  partners  and  has  remained  non-negotiable  during  the  collective  bargaining 
process. However, its uniform application does not allow wages to reflect productivity 
differences  across  sectors.  The  shortcomings  of  the  COLA  are,  first,  that  wages  are 
connected  to  product  prices  only  and  not  to  productivity  gains.  Second,  those 
benefiting most from this system are those with higher incomes (70 % of whom have 
wages  that  are  index-linked  via  the  COLA),  whereas  most  of  the  lowest-paid 

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(e.g. unskilled  workers)  are  not  covered  (only  6 %  are  index-linked  by  the  COLA). 
Third,  the  COLA  also  has  a  significant  impact  on  public  finances  as,  beyond  wages 
and salaries, it is also an integral feature of pensions, benefits and other allowances. 

(13)  While labour participation in Cyprus is higher than the EU average, the labour market 
displays  strong  gender  imbalances.  Gender  employment  gaps,  the  cost  and 
availability  of  childcare  facilities  (including  geographical  location  and  proximity  to 
places  of  work),  the  scarcity  of  flexible  forms  of  employment  and  the  persistently 
high gender pay gap are acknowledged in the NRP as major bottlenecks hindering 
employment  and  growth.  While  educational  attainment  at  secondary  school  and 
university level  in Cyprus is high, vocational  education  and  training  (VET)  does  not 
appear  to  be  an  attractive  option.  High  youth  unemployment,  combined  with  a  high 
proportion of people with high educational attainment in total unemployment, is a sign 
of a significant skills mismatch in the Cypriot economy. Also, participation in lifelong 
learning  is  low  for  a  country  that  has  generally  good  educational  levels,  particularly 
for  certain  groups  (the  low-skilled,  older  people  and  the  unemployed).  To  address 
these  issues,  the  NRP  envisages  establishing  a  series  of  new  post-secondary  VET 
institutions  from  2012-2013  on.  There  are  also  plans  to  introduce  the  new 
apprenticeship  system  in  the  same  academic  year.  Overall,  the  country’s  strategic 
objective  of  shifting  from  low-  to  high-productivity  jobs  would  benefit  greatly  from 
the  reorientation  of  the  education  and  training  system  to  bring  about  a  better  mix  of 
skills to match the labour market demand.  

(14)  Cyprus adopted a general law for transposition of the Services Directive in July 2010. 
However,  there  are  concerns  about  the  completeness  and  thoroughness  of  the 
transposition, as many obstacles to establishment and free provision of services persist 
in sector-specific legislation, where no amendments have been made. These obstacles 
range  from  generally  applicable  ones,  such  as  authorisations  required  by  local 
authorities  for  any  business  activity  or  the  limited  duration  of  authorisations, 
irrespective  of  the  field  and  the  risks  involved,  to  very  specific  ones,  such  as  fixed 
tariffs  applicable  to  tourism  services,  economic  needs  tests  and  involvement  of 
competitors  in  the  authorisations  for  car  rentals,  discriminatory  treatment  of 
construction  companies  from  other  Member  States  and  bans  on  architects  and 
engineers exercising their profession as legal persons. 

(15)  Overall, environmental constraints and issues connected with resource and energy use 
could  create  severe  bottlenecks  to  growth.  These  are  related  to  its  specific 
geographical location and to the consequences of climate change in the form of severe 
droughts. The cost-effectiveness of support schemes for renewable energy would need 
to be assessed. The functioning of the energy sector can be significantly improved in 
the short term already, by means of market liberalisation, introduction of competition 
and facilitation of infrastructure investments.  

(16)  Cyprus has made a number of commitments under the Euro Plus Pact.4 On the fiscal 
side,  the  Pact  commits  the  country  to  strengthen  fiscal  sustainability  by  preparing  a 
framework  law  for  dealing  with  financial  crises  and  setting  up  a  fully  independent 
Financial Stability Fund. Furthermore, a dialogue on restructuring the public pension 
system  is  taking  place  and  should  be  concluded  by  the  end  of  2011.  Employment 

4 

More details on the commitments made under the Euro Plus Pact can be found in (SEC(2011) 721. 

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measures are focusing on combating illegal and undeclared work, addressing the skills 
mismatch  and  increasing  the  competitiveness  of  enterprises.  The  competitiveness 
measures  cover  containing  public-sector  wages  (redesigning  the  wage  indexation 
mechanism),  strengthening  the  competitiveness  of  SMEs,  finalising  the  National 
Digital  Strategy  by  2011  and  promoting  energy  efficiency  and  renewable  energy 
sources.  These  commitments  reflect  the  four  areas  of  the  Pact.  They  provide  for 
continuity of the broader reform agenda outlined in the Stability and National Reform 
Programmes  and  confirm  the  plans  already  announced  to  deliver  reforms  to  address 
the  country’s  structural  weaknesses,  without  at  this  stage  specifying  a  timeframe  to 
address  issues  such  as  the  public-sector  wages  and  pension  system.  These 
commitments have been assessed and taken into account in the recommendations. 

(17)  The  Commission  has  assessed  the  Stability  Programme  and  National  Reform 
Programme,  including  Euro  Plus  Pact  commitments5.  It  has  taken  into  account  not 
only  their  relevance  for  sustainable  fiscal  and  socio-economic  policy  in  Cyprus  but 
also  their  respect  of  EU  rules  and  guidance,  given  the  need  to  reinforce  the  overall 
economic governance of the European Union by providing EU-level input into future 
national decisions. In this light, the Commission considers that more efforts are needed 
on achieving the 2011 budget deficit target and that additional consolidation measures 
should  be  specified  for  2012  and  beyond.  In  order  to  improve  the  long-term 
sustainability of public finances, further action on the pension and healthcare system is 
needed. Further steps should also be taken to strengthen the prudential framework of 
banking supervision, to adjust the wage-indexation system and to improve vocational 
education, training and skills, the business environment and energy efficiency.  

(18) 

In the light of this assessment, also taking into account the Council Recommendation 
of 13 July 2010 under Article 126(7) of the Treaty on the Functioning of the European 
Union,  the  Council  has  examined  the  2011  update  of  the  Stability  Programme  of 
Cyprus  and  its  opinion6  is  reflected  in  particular  in  its  recommendations  (1)  and  (3) 
below. Taking into account the European Council conclusions of 25 March 2011, the 
Council has examined the National Reform Programme of Cyprus, 

HEREBY RECOMMENDS that Cyprus should take action within the period 2011-2012 to:  

(1) 

Adopt the necessary measures of a permanent nature to achieve the correction of the 
excessive deficit by 2012. Take measures to keep tight control over expenditure and 
make use of any better-than-expected budgetary developments for faster deficit and 
debt  reduction.  Ensure  progress  towards  the  Medium  Term  Objective  by  at  least 
0.5%  of  GDP  annually.  Accelerate  the  phasing-in  of  an  enforceable  multiannual 
budgetary  framework  with  a  binding  statutory  basis  and  corrective  mechanisms,  as 
from  the  preparation  of  the  2012  Budget,  as  well  as  Programme  and  Performance 
Budgeting. 

(2) 

Strengthen  further  the  prudential  framework  for  supervision  of  banks  and 
cooperative credit societies to ensure early detection of risks. 

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SEC(2011) 721. 
Foreseen in Article 5(3) of Council Regulation (EC) No 1466/97. 

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(3) 

(4) 

(5) 

(6) 

(7) 

Improve  the  long-term  sustainability  of  public  finances  by  implementing  reform 
measures to control pension and healthcare expenditure in order to curb the projected 
increase in age-related expenditure. For pensions, extend years of contribution, link 
retirement age with life expectancy, while taking care to address the high at-risk-of-
poverty  rate  for  the  elderly.  For  healthcare,  take  further  steps  to  accelerate 
implementation of the national health insurance system.  

Reform,  in  consultation  with  social  partners  and  in  accordance  with  national 
practices,  the  system  of  wage  bargaining  and  wage  indexation  to  ensure  that  wage 
growth better reflects developments in labour productivity and competitiveness.  

Take  further  steps,  within  the  reforms  planned  for  the  vocational  education  and 
training system, to match education outcomes to labour market needs better, notably 
by  setting  up  a  post-secondary  vocational  education  and  training  institute.  Take 
measures to increase the effectiveness of the vocational training system by increasing 
the  incentives  for  and  improving  access  to  vocational  education  and  training, 
especially for the low-skilled, women and older workers. 

Abolish  remaining  obstacles  to  the  establishment  and  free  provision  of  services  in 
sector-specific legislation by October 2011 in order to create more opportunities for 
growth and jobs in the services sector.  

Introduce measures to increase competition in network services by allowing greater 
freedom  to  set  prices.  Establish,  by  2012,  a  water  management  plan  and  a  price-
setting scheme reflecting cost efficiency and equity concerns in order to ensure more 
sustainable management of water resources. 

Done at Brussels, 

For the Council 
The President 

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