Recommendation for a COUNCIL RECOMMENDATION on Cyprus’s 2012 national reform programme and delivering a Council opinion on Cyprus’s stability programme for 2012-2015
Date: 2012-05-30
Institutions: European Commission
Subjects: Cyprus, budget deficit, budgetary equilibrium, competitiveness, credit union, free competition, health expenditure, job mobility, retirement conditions, youth unemployment

EUROPEAN COMMISSION 

Brussels, 30.5.2012  
COM(2012) 308 final 

Recommendation for a 

COUNCIL RECOMMENDATION 

on Cyprus’s 2012 national reform programme  

and delivering a Council opinion on Cyprus’s stability programme for 2012-2015 

{SWD(2012) 308 final} 

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Recommendation for a 

COUNCIL RECOMMENDATION 

on Cyprus’s 2012 national reform programme  

and delivering a Council opinion on Cyprus’s stability programme for 2012-2015 

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(2) thereof, 

Having  regard  to  Regulation  (EU)  No  1176/2011  of  the  European  Parliament  and  of  the 
Council  of  16  November  on  the  prevention  and  correction  of  macroeconomic  imbalances2, 
and in particular Article 6(1) thereof, 

Having regard to the recommendation of the European Commission3, 
Having regard to the resolutions of the European Parliament,4  

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) 

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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 
action 
to  boost  Europe’s  potential  for  sustainable  growth  and 
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 

OJ L 209, 02.08.1997, p. 1 
OJ L 306, 23.11.2011, p. 25 
COM(2012)308 final 
P7_TA(2012)0048 and P7_TA(2012)0047 

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(3) 

(4) 

(5) 

(6) 

(7) 

(8) 

Member States5, which together form the ‘integrated guidelines’. Member States were 
invited  to  take  the  integrated  guidelines  into  account  in  their  national  economic  and 
employment policies. 

On 12 July 2011, the Council adopted a recommendation on Cyprus’s national reform 
programme  for  2011  and  delivered  its  opinion  on  Cyprus’s  updated  stability 
programme for 2011-2014. 

On 23 November 2011, the Commission adopted the second Annual Growth Survey, 
marking  the  start  of  the  second  European  Semester  of  ex-ante  and  integrated  policy 
coordination,  which  is  anchored  in  the  Europe  2020  strategy.  On  14  February  2012, 
the  Commission,  on  the  basis  of  Regulation  (EU)  No  1176/2011,  adopted  the  Alert 
Mechanism  Report6,  in  which  it  identified  Cyprus  as  one  of  the  Member  States  for 
which an in-depth review would be carried out. 

On 2 March 2012, the European Council endorsed the priorities for ensuring financial 
stability,  fiscal  consolidation  and  action  to  foster  growth.  It  underscored  the  need  to 
pursue growth-friendly fiscal consolidation, to restore normal lending conditions to the 
economy,  to  promote  growth  and  competitiveness,  to  tackle  unemployment  and  the 
social consequences of the crisis, and to modernise public administration. 

On 2 March 2012, the European Council also invited the Member States participating 
in  the  Euro  Plus  Pact  to  present  their  commitments  in  time  for  inclusion  in  their 
stability or convergence programmes and their national reform programmes. 

On 7 May 2012, Cyprus submitted its stability programme covering the period 2012-
2015  and,  on  10  May  2012,  its  2012  national  reform  programme.  In  order  to  take 
account  of  their  interlinkages,  the  two  programmes  have  been  assessed  at  the  same 
time.  The  Commission  has  also  assessed,  in  an  in-depth  review  under  Article  5  of 
Regulation  (EU)  No  1176/2011,  whether  Cyprus  is  affected  by  macroeconomic 
imbalances.  The  Commission  concluded  in  its  in-depth  review7  that  Cyprus 
experiences an internal imbalance due to its banking sector and the indebtedness of the 
corporate sector and an external and an internal imbalance on its fiscal dynamics and 
competitiveness, although not excessive. 

Based  on  the  assessment  of  the  2012  stability  programme  pursuant  to  Council 
Regulation  (EC)  No  1466/97,  the  Council  is  of  the  opinion  that  the  macroeconomic 
scenario underpinning the budgetary projections in the programme appears optimistic 
in  2012-2014.  Although  incorporating  a  major  downward  revision  of  the  growth 
outlook,  the  macroeconomic  scenario  underpinning  the  budgetary  projections  in  the 
programme remains subject to downside risks, relating in particular to the evolution of 
domestic  demand  in  2012-2013.  The  objective  of  the  budgetary  strategy  outlined  in 
the  programme  is  to  correct  the  excessive  deficit  by  2012  and  to  reach  the  medium-
term  budgetary  objective  (MTO)  by  2014,  and  to  stay  at  MTO  in  2015.  The 
programme  confirms  the  previous  MTO  of  a  balanced  budget  in  structural  terms, 
which  adequately  reflects  the  requirements  of  the  Stability  and  Growth  Pact.  The 

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Council Decision 2012/238/EU of 26 April 2012 
COM(2012) 68 final 
SWD(2012)152 final 

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planned  correction  of  the  excessive  deficit  is  in  line  with  the  deadline  set  by  the 
Council recommendation issued in the context of the Excessive Deficit Procedure on 
13 July 2010. Based on the (recalculated) structural deficit,8 the average annual fiscal 
effort  planned  at  1.5%  of  GDP  for  the  period  2011-2012  is  equal  to  the  effort 
recommended  by  the  Council.  The  envisaged  progress  towards  the  MTO  in  2013  is 
sufficient as it is higher than the 0.5% of GDP benchmark of the Stability and Growth 
Pact both according to the Commission's 2012 spring forecast and the programme. The 
growth  rate  of  government  expenditure,  taking  into  account  discretionary  revenue 
measures, is in line with the expenditure benchmark of the Stability and Growth Pact 
in 2013-2014, but not in 2015. There are risks accompanying the budgetary targets of 
the  programme  linked  to  the  macroeconomic  scenario  appearing  optimistic  in  2012-
2014 and the planned consolidation effort in 2013, party relying on not fully specified 
measures.  According  to  the  programme,  the  debt-to-GDP  ratio,  which  amounted  to 
71.6% in 2011, is to increase to 72.1% in 2012 before gradually dropping to 65.4% in 
2015.  In  terms  of  the  debt  reduction  benchmark  of  the  Stability  and  Growth  Pact, 
Cyprus will be in a transition period in the years 2013-2015 and the plans presented in 
the  programme  would  ensure  sufficient  progress  towards  compliance  with  the  debt 
reduction benchmark. However, there are risks attached to this projection linked to the 
possible rescue operations of financial corporations. 

(9) 

Tax  administration  is  inefficient  as  administrative  costs  in  relation  to  revenue 
collection  in  Cyprus  are  very  high.  Tax  collection  is  relatively  low.  Particularly,  tax 
administration expenditure as a share of GDP and the administration costs in relation 
to net revenue collection are high and on a rising trend. Measures to encourage a move 
away  from  informal/undeclared  work  and  tackle  tax  evasion  are  necessary. 
Furthermore, initiatives to render tax collection more efficient should be reinforced.  

(10)  Given the wide exposure of Cyprus’s banking institutions to the Greek economy, the 
banks’  asset  performance,  profitability,  capital  and  liquidity  buffers  have  been 
negatively  affected  by  the  restructuring  of  the  Greek  government  debt,  and  by  the 
increasing non-performing loans (NPLs) extended to Greek borrowers. Total exposure 
of  the  consolidated  Cypriot  banking  sector  to  Greece  is  very  high.  The  Cyprus 
Parliament  adopted,  on  14  December  2011,  two  bills  to  strengthen  the  financial 
system’s  resilience  against  banking  crises.  However,  progress  with  the  strengthening 
of  supervision  of  the  cooperative  credit  societies,  which  hold  about  40 %  of  all 
domestic deposits, has so far not been satisfactory. 

(11)  Cyprus  faces  challenges  in  ensuring  the  long-term  sustainability  of  public  finances, 
notably  in  the  area  of  pensions.  Cyprus  implemented  two  important  structural 
measures  to  reform  its  pension  system.  However,  while  the  measures  adopted  are 
relevant  and  credible,  the  response  of  Cyprus  is  not  sufficiently  ambitious  to  secure 
sustainability  and  adequacy,  and  improve  the  system’s  fairness  in  the  longer  term. 
Measures are still required to maintain the employability of workers within enterprises 
and  underpin  the  increase  in  the  effective  retirement  age.  In  terms  of  poverty  of  the 
elderly,  Cyprus  has  only  partly  addressed  their  high  at-risk-of-poverty  rate.  The 

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Cyclically  adjusted  balance  net  of  one-off  and  temporary  measures,  recalculated  by  the  Commission 
services  on  the  basis  of  the  information  provided  in  the  programme,  using  the  commonly  agreed 
methodology. 

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adopted  measures  are  insufficient  to  improve  the  short-term  adequacy  of  income  for 
pensioners at risk of poverty.  

(12) 

Inequity  and  inefficiencies  in  the  healthcare  sector  have  not  been  tackled  in  a 
meaningful manner. In spite of the recommendation given last year, no clear timeline 
for proceeding with the National Health Insurance System has been presented so far. 
This poses risks to the long-term control and sustainability of public finances and the 
quality of healthcare provided.  

(13)  The Cypriot government took some steps to respond to the 2011 recommendation on 
wage indexation (cost of living allowance - COLA),  notably by adopting  a two-year 
pay  freeze  in  the  broader  public  sector.  The  government  and  social  partners  also 
agreed to initiate a dialogue with the aim of reviewing the COLA system by the end of 
June 2012. A comprehensive reform of the system should be pursued, in consultation 
with  social  partners  and  in  accordance  with  national  practices,  with  a  view  to 
strengthening the link between real wages and productivity developments and making 
the system more equitable. This would not only support the country’s competitiveness, 
but would also lead to a more efficient allocation of labour. While these developments 
are first steps in the right direction, their relevance and credibility depend crucially on 
the  degree  of  ambition  and  enforcement  of  the  final  outcome  of  the  social  dialogue 
currently under way regarding the reform of the wage indexation system. 

(14)  The  worsening  of  the  macroeconomic  outlook  adversely  affected  the  Cypriot  labour 
market,  raising  the  unemployment  rate  and  causing  a  large  increase  in  youth 
unemployment. Cyprus has taken a number of positive steps to address this challenge. 
These measures are relevant but not ambitious enough, in particular in education and 
vocational  training  where  implementation  should  be  speeded  up.  Further  efforts  are 
required  for  resolving  youth  unemployment  as  well  as  for  the  re-skilling  and  up-
skilling  of  the  workforce  to  facilitate  the  necessary  transitions  in  the  labour  market, 
focusing in particular on those groups with a low participation rate in lifelong learning 
activities such as the low-skilled, unemployed and older workers.  

(15)  As  regards  the  service  sector,  Cyprus  transposed  the  Services  Directive  by  way  of  a 
horizontal  law  accompanied  by  a  number  of  sector-specific  amending  laws  and 
regulations. However, in some sectors (e.g. retail, tourism, and construction services) 
the  adoption  of  sector-specific  legislation  is  still  pending.  There  are  regulated 
professional services where fixed tariffs still exist, such as lawyers and architects. 

(16)  On the basis of the analysis in the in-depth review, it can be concluded that Cyprus is 
affected  by  imbalances.  In  particular,  macroeconomic  developments  in  the  current 
account, public finances and the financial sector require close monitoring and urgent 
economic policy attention in order to avert any adverse effects on the functioning of 
the  economy  and  economic  and  monetary  union.  More  specifically,  the  Cypriot 
economy  has  experienced  persistent  and  sizeable  current  account  deficits,  driven  by 
deficits  in  the  volume  of  trade  due  to  a  gradual  loss  in  price/cost  competitiveness, 
imbalances in the government finances that have swung to annual deficits which have 
widened  even  as  the  economy  recovered  from  recession,  and  increasing  private 
indebtedness. Particularly, non-financial corporations are very vulnerable due to their 
high  indebtedness  coupled  with  their  low  profitability,  resulting  to  a  significant 
increase in non-performing loans in this sector. Also, the high exposure of the banking 
sector  to  sovereign  Greek  bonds  and  the  Greek  economy  is  very  risky.  Moreover, 

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growth  prospects  are  dim  which  further  hinders  the  relatively  slow  unwinding  of 
imbalances.  

(17)  Cyprus  has  made  a  number  of  commitments  under  the  Euro  Plus  Pact.  These 
commitments, and the implementation of the commitments presented in 2011, relate to 
improving  competitiveness,  improving  the  employment  rate,  the  sustainability  of 
public  finances,  and  strengthening  financial  sustainability.  The  Commission  has 
assessed  the  implementation  of  the  Euro  Plus  Pact  commitments.  The  results  of  this 
assessment have been taken into account in the recommendations. 

(18) 

(19) 

(20) 

In  the  context  of  the  European  Semester,  the  Commission  has  carried  out  a 
comprehensive  analysis  of  Cyprus’s  economic  policy.  It  has  assessed  the  stability 
programme and national reform programme, and presented an in-depth review. It has 
taken into account not only their relevance for sustainable fiscal and socio-economic 
policy in Cyprus but also their observance 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.  Its  recommendations  under  the  European 
Semester are reflected in recommendations (1) to (7) below.  

In  the  light  of  this  assessment,  the  Council  has  examined  Cyprus’s  2012  stability 
programme, and its opinion9 is reflected in particular in recommendation (1) below. 

In the light of the results of the Commission’s in-depth review and this assessment, the 
Council  has  examined  Cyprus’s  2012  national  reform  programme  and  Cyprus’s 
stability  programme.  Its  recommendations  under  Article  6  of  Regulation  (EU)  No 
1176/2011 are reflected in particular in recommendations (1), (2) and (7) below, 

HEREBY RECOMMENDS that Cyprus should take action within the period 2012-2013 to: 

1. 

2. 

3. 

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Take additional measures to achieve a durable correction of the excessive deficit in 
2012.  Rigorously  implement  the  budgetary  strategy,  supported  by  sufficiently 
specified measures, for the year 2013 and beyond to ensure the achievement of the 
medium-term  budgetary  objective  (MTO)  by  2014  and  compliance  with  the 
expenditure  benchmark  and  ensure  sufficient  progress  with  the  debt  reduction 
benchmark.  Accelerate  the  phasing-in  of  an  enforceable  multiannual  budgetary 
framework with a binding statutory basis and corrective mechanism. Take measures 
to  keep  tight  control  over  expenditure  and  implement  programme  and  performance 
budgeting as soon as possible. Improve tax compliance and fight against tax evasion. 
. 

Harmonise  the  supervision  of  the  cooperative  credit  societies  in  line  with  the 
standards applied for the commercial banks. Strengthen regulatory provisions for the 
efficient recapitalisation of the financial institutions in order to limit exposure of the 
financial sector to external shocks. 

Further  improve  the  long-term  sustainability  and  adequacy  of  the  pensions  system 
and  address  the  high  at-risk-of-poverty  rate  for  the  elderly.  Align  the  statutory 
retirement age with the increase in life expectancy.  

Under Article 5(2) of Council Regulation (EC) No 1466/97. 

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4. 

5. 

6. 

7. 

Complete and implement the national healthcare system without delay, on the basis 
of  a  roadmap,  which  should  ensure  its  financial  sustainability  while  providing 
universal coverage.  

Improve the skills of the workforce to reinforce their occupational mobility towards 
activities  of  high  growth  and  high  value  added.  Take  further  measures  to  address 
youth  unemployment,  with  emphasis  on  work  placements  in  companies  and 
promotion  of  self-employment.  Take  appropriate  policy  measures  on  the  demand 
side to stimulate business innovation. 

Remove  unjustified  obstacles  in  services  markets,  in  particular  by  improving  the 
implementation  of  the  Services  Directive  in  service  sectors  with  the  most  growth 
potential  (including  tourism)  and  by  opening  up  the  provision  of  professional 
services. 

Improve  competitiveness  including  through  the  reform  of  the  system  of  wage 
indexation, in consultation with social partners and in line with national practices, to 
better reflect productivity developments. Take steps to diversify the structure of the 
economy. Redress the fiscal balance by restraining expenditure.  

Done at Brussels, 

For the Council 
The President 

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