REPORT FROM THE COMMISSION Cyprus Report prepared in accordance with Article 126(3) of the Treaty on the Functioning of the European Union
Date: 2019-06-05
Institutions: Directorate-General for Economic and Financial Affairs, European Commission
Subjects: Cyprus, budget deficit, budget policy, budgetary control, budgetary expenditure, gross domestic product, macroeconomics, public debt, stability pact, structural adjustment

EN 

  EN 

   EUROPEAN COMMISSION  Brussels, 5.6.2019  COM(2019) 530 final  REPORT FROM THE COMMISSION Cyprus  Report prepared in accordance with Article 126(3) of the Treaty on the Functioning of the European Union  
 
 
REPORT FROM THE COMMISSION 

Cyprus 

Report prepared in accordance with Article 126(3) of the Treaty on the Functioning of 
the European Union 

1. 

INTRODUCTION  

Article 126 of the Treaty on the Functioning of the European Union (the Treaty) lays down 
the excessive deficit procedure (EDP). That procedure is further set out in Regulation (EC) 
No  1467/97  on  speeding  up  and  clarifying  the  implementation  of  the  excessive  deficit 
procedure1,  which  is  part  of  the  Stability  and  Growth  Pact  (SGP).  Specific  provisions  for 
euro-area Member States under the EDP are laid down in Regulation (EU) No 473/20132. 

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 
it is sufficiently diminishing and approaching the reference value at a satisfactory pace.3 

Article 126(3) of the Treaty provides that, if a Member State does not fulfil the requirements 
under one or both of those criteria, the Commission has to prepare a report. That report must 
also  “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”. 

1 

2 

3  

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”, adopted by the Economic and Financial Committee on 5 July 2016, available at: 
http://ec.europa.eu/economy_finance/economic_governance/sgp/legal_texts/index_en.htm . 
Regulation (EU) No 473/2013 of the European Parliament and of the Council on common provisions 
for monitoring and assessing draft budgetary plans and ensuring the correction of excessive deficit of 
the Member States in the euro area (OJ L 140, 27.5.2013, p. 11). 
The  concepts  of  'sufficiently  diminishing'  and  'satisfactory  pace'  are  defined  in  Article  2(1a)  of 
Regulation  (EC)  1467/97  as  being  fulfilled  if  “the  differential  [of  the  debt  ratio]  with  respect  to  the 
reference value has decreased over the previous three years at an average rate of 1/20th per year as a 
benchmark”. The Regulation then provides that “the requirement under the debt criterion shall also be 
considered  to  be  fulfilled  if  the  budgetary  forecasts  of  the  Commission  indicate  that  the  required 
reduction in the differential will occur over the three-year period encompassing the two years following 
the final year for which data is available”. Regulation (EC) 1467/97 further provides that “the influence 
of  the  cycle  on  the  pace  of  debt  reduction”  should  be  taken  into  account.  Those  elements  have  been 
translated into a debt reduction benchmark, as set out in the Code of Conduct on the SGP and endorsed 
by  the  Council.  Compliance  with  the  debt  benchmark  is  assessed  on  the  basis  of  three  different 
configurations: the backward-looking, the forward-looking and the debt reduction benchmark adjusted 
for the impact of the cycle. 

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This report, which represents the first step in the EDP, analyses Cyprus' compliance with the 
deficit  and  debt  criterion  of  the  Treaty,  with  due  regard  to  the  economic  background  and 
other relevant factors.  

Data  notified  by  the  Cypriot  authorities  on  29  March  20194  and  subsequently  validated  by 
Eurostat5 show that the general government headline deficit in Cyprus reached 4.8% of GDP 
in  2018,  while  debt  stood  at  102.5%  of  GDP,  above  the  3%  and  60%  of  GDP  Treaty 
reference  values,  respectively.  For  2019,  the  notification  planned  a  general  government 
headline surplus of 3.4% of GDP and a debt ratio of 95.9% of GDP. Cyprus’ 2019 Stability 
Programme,  which  was  received  by  the  Commission  on  30  April  2019,  plans  a  headline 
surplus of 3.0% of GDP and a debt ratio of 95.7% of GDP. 

The  notified  data  show  that  Cyprus  did  not  comply  with  the  deficit  criterion  in  2018  (see 
Table 1), as the general government headline deficit notified was larger than the 3%-of-GDP 
reference value. According to the Commission 2019 spring forecast, released on 7 May 2019, 
Cyprus  is  expected  to  comply  with  the  deficit  criterion  in  2019  and  2020,  as  its  headline 
balance is projected to achieve a surplus of 3% of GDP and 2.8% of GDP, respectively. On 
the  basis  of  the  scenario  included  in  the  Stability  Programme,  Cyprus  is  also  expected  to 
comply  with  the  deficit  criterion  as  of  2019,  with  a  projected  headline  surplus  of  3.0%  of 
GDP in 2019 and 2.6% of GDP in 2020.  

Cyprus' non-compliance with the deficit criterion in 2018 provides evidence of a prima facie 
existence of an excessive deficit for the purposes of the SGP before, however, considering all 
factors as set out below.  

While its debt ratio is above 60% of GDP in 2018, Cyprus complied with the transitional debt 
rule in 2018 and is projected to comply with the debt reduction benchmark in 2019 and 2020. 
This suggests that Cyprus complies with the debt criterion for the purposes of the SGP. 

Table 1. General government deficit and debt (% of GDP)  

The Commission has therefore prepared this report to comprehensively assess the departure 
from the deficit criterion and examine whether the launch of an excessive deficit procedure is 
warranted. Section 2 of the report examines the deficit criterion. Section 3 examines the debt 
criterion.  Section  4  deals  with  public  investment  and  other  relevant  factors,  including  the 

4  According to 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://ec.europa.eu/eurostat/web/government-finance-statistics/excessive-deficit-procedure/edp-
notification-tables. 

5  Eurostat  news  release  No  67/2019,  https://ec.europa.eu/eurostat/documents/2995521/9731224/2-23042019-

AP-EN/bb78015c-c547-4b7d-b2f7-4fffe7bcdfad  

2 

COMSPCOMSPGeneralgovernmentbalance0.31.8-4.83.032.82.6Generalgovernmentgross debt105.595.8102.596.495.789.989.1Source: 2019 Stability Programme (SP) and Commission 2019 spring forecast (COM)20192020201620172018 
 
 
                                                            
assessment of  the  adjustment  path  towards  the Medium-Term  Budgetary  Objective  (MTO). 
The report takes into account the Commission 2019 spring forecast. 

2. 

DEFICIT CRITERION 

Cyprus’  general  government  headline  balance  switched  from  a  surplus  of  1.8%  of  GDP  in 
2017 to a deficit of 4.8% in 2018. The latter includes the 8.3% of GDP one-off impact of the 
government support for the sale and orderly winding down of the Cyprus Cooperative Bank. 
Net of one-offs, the headline balance amounted to a surplus of 3.5% of GDP in 2018. 

According  to  the  Commission  2019  spring  forecast,  the  general  government  balance  is 
expected to return to a surplus of 3.0% of  GDP in 2019. In 2020, the Commission forecast 
projects a headline surplus of 2.8% of GDP under a no-policy-change assumption.  

The multiannual trajectory included in the Stability Programme is for headline surpluses over 
the forecast horizon. In particular, the Stability Programme plans a headline surplus of 3.0% 
of  GDP  in  2019  and  2.6%  of  GDP  in  2020.  Thus,  the  Stability  Programme  and  the 
Commission 2019 spring forecast project similar headline surpluses for 2019. For 2020, the 
slight difference between the Commission forecast and the Stability Programme projections 
stems  from  the  macroeconomic  assumptions,  more  dynamic  revenue  based  on  track-record 
and more conservative assumptions on expenditure in the Commission forecast.   

The general government headline deficit reached 4.8% of GDP in 2018, which is well above 
and not close to the Treaty reference value of 3% of GDP.  

The  excess  over  the  3%-of-GDP  reference  value  in  2018  is  not  exceptional,  as  it  neither 
results from an unusual event nor from a severe economic downturn for the purposes of the 
Treaty  and  the  SGP.  The  Commission  2019  spring  forecast  projects  a  continued  strong 
growth in 2019, at 3.1%, and some slowdown in 2020, to 2.7%. 

The excess over the 3%-of-GDP reference value is temporary for the purposes of the Treaty 
and  the  SGP.  In  particular,  the  budgetary  forecasts  as  provided  by  the  Commission  
and  the  Stability Programme indicate  that  the  general government balance will return to 
surpluses as of 2019, thus not exceeding the reference value. 

In sum, the 2018 deficit was above and not close to the 3%-of-GDP Treaty reference value. 
The  excess  is  considered  to  be  not  exceptional,  although  temporary  for  the  purposes  of  the 
Treaty and the SGP. The analysis thus suggests that  prima facie the deficit criterion for the 
purpose of the Treaty and Regulation (EC) No 1467/1997 is not fulfilled based on the 2018 
outturn data before, however, consideration is given to all relevant factors set out below. 

3. 

DEBT CRITERION 

The  general  government  gross  debt-to-GDP  ratio  increased  to  102.5%  in  2018,  partly 
reversing the sharp decrease to 95.8% of GDP in 2017. That increase was mainly due to the 
issuance of a series of government bonds in April and July 2018 related to the government 
support  measures  for  the  sale  and  orderly  winding  down  of  the  Cyprus  Cooperative  Bank, 
which  amounted  to  15%  of  GDP  (EUR  3.2  billion).  That  development  was  reflected  in  a 
sizeable  positive  stock-flow  adjustment  in  2018,  representing  a  level-shift  upwards  for  the 
government  debt  trajectory.  However,  the  debt-to-GDP  ratio  in  2018  increased  by  only  7 
percentage  points  of  GDP  from  the  previous  year,  as  the  strong  underlying  fiscal 
performance,  the  snowball  effect  and  active  debt  management  operations  partially 

3 

 
 
compensated  for  the  Cyprus  Cooperative  Bank-related  debt  increase.  Debt  dynamics  are 
discussed in more detail in Section 4.3. 

The Commission 2019 spring forecast expects a steady debt reduction in the coming years, to 
96.5% of GDP in 2019 and below 90% in 2020.  

According to the Stability Programme, debt-to-GDP ratio is projected to sharply decline over 
2019-2022, mainly due to projected high primary surpluses (above 4.0% of GDP) and strong 
nominal  GDP  growth.  Government  debt  is  projected  to  decrease  to  95.7%  of  GDP  in  2019 
and  further  to  below  90%  in  2020.  The  difference  from  the  Commission's  projection  at 
unchanged policy mainly stems from more optimistic projections of growth and inflation and 
a lower stock-flow adjustment. 

Table 2: Compliance with the debt reduction benchmak 

Following the abrogation of the excessive deficit procedure in 2015, Cyprus was subject to a 
three-year  transition  period  to  comply  with  the  debt  reduction  benchmark.  That  transition 
period started in 2016 until 2018. As of 2019, since government debt is projected to remain 
above 60% of GDP, the debt reduction benchmark is applicable.  

The  notified  data  show  that  Cyprus  made  sufficient  progress  towards  compliance  with  the 
debt  reduction  benchmark  in  2018  (see  Table  2),  as  the  change  in  the  structural  balance  is 
estimated  to  have  exceeded  the  required  minimum  linear  structural  adjustment  (MLSA)  in 
2018 (by 4.3% of GDP).  

According to the Commission  2019 spring forecast, Cyprus is also forecast to comply with 
the debt reduction  benchmark in  2019 and 2020, as  its  debt-to-GDP ratio is expected to  be 
below the benchmark, with a negative gap to the debt benchmark of 6.5% of GDP and 4.7% 
of GDP, respectively.  

4 

COMSPCOMSP95.8102.596.495.789.989.1-6.5-9.1-4.7-8.70.20.7-1.2-3.7Source: 2019 Stability Programme (SP), Commission 2019 spring forecast (COM), Comission calculations.Notes:2020Gross debt ratio 3 Applicable only during the transition period of three years from the correction of the excessive deficit for EDP that were ongoing in November 2011.4 Defines the remaining annual structural adjustment over the transition period which ensures that - if followed – Member State will comply with the debt reduction benchmark at the end of the transition period, assuming that COM (SP) budgetary projections for the previous years are achieved.2017Gap to the debt benchmark 1,2Structural adjustment 3To be compared to:Required adjustment 41 Not relevant for Member Sates that were subject to an EDP procedure in November 2011 and for a period of three years following the correction of the excessive deficit.2 Shows the difference between the debt-to-GDP ratio and the debt benchmark. If positive, projected gross debt-to-GDP ratio does not comply with the debt reduction benchmark.20182019 
 
  
On the basis of the scenario included in the Stability Programme, Cyprus is also expected to 
comply  with  the  debt  criterion  in  2019  and  2020.  Cyprus  is  expected  to  meet  the  debt 
reduction benchmark, as illustrated by a negative gap to the debt benchmark of 9.1% of GDP 
and 8.7% of GDP, respectively. 

Cyprus thus complies with the debt criterion as defined in the Treaty and in Regulation (EC) 
No 1467/97.  

4. 

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 all other relevant factors, including the medium-term economic and budgetary 
position  of  the  Member  State”.  Those  factors  are  further  clarified  in  Article  2(3)  of 
Regulation  (EC)  No  1467/97,  which  also  provides  that  “any  other  factors  which,  in  the 
opinion  of  the  Member  State  concerned,  are  relevant  in  order  to  comprehensively  assess 
compliance with the deficit and debt criteria and which the Member State has put forward to 
the Council and to the Commission” need to be given due consideration.  

According to Article 2(4) of Regulation (EC) No 1467/97, the relevant factors shall be taken 
into account when assessing compliance on the basis of the deficit criterion. However, if the 
ratio of the government debt to GDP exceeds the reference value, those factors shall be taken 
into account in the steps leading to the decision on the existence of an excessive deficit (as 
provided  for  in  paragraphs  4,  5  and  6  of  Article  126  of  the  Treaty)  only  if  the  following 
double condition is fully met, namely that the general government deficit remains close to the 
reference  value  and  its  excess  over  the  reference  value  is  temporary.  Hence,  since  the 
government debt-to-GDP ratio is 102.5% of GDP and the deficit is 4.8% of GDP, and thus 
not close to the Treaty reference value, the relevant factors cannot be taken into account in 
the steps leading to the decision on the existence of an excessive deficit for Cyprus. 

According  to  Article  2(6)  of  Regulation  (EC)  No  1467/97,  if  the  Council  decides  that  an 
excessive deficit exists in a Member State, the relevant factors shall be taken into account in 
the subsequent procedural steps, in particular in establishing a deadline for the correction of 
the excessive deficit and eventually extending that deadline.  

The  following  subsections  consider  in  turn  (1)  the  medium-term  budgetary  position, 
including  an  assessment of  compliance with  the required adjustment towards the MTO and 
the development of public investment; (2) the developments in the medium-term government 
debt  position,  its  dynamics  and  sustainability;  (3)  the  medium-term  economic  position;  (4) 
other factors considered relevant by the Commission; and (5) other factors put forward by the 
Member State. 

4.1.  Medium-term budgetary position  

The  ex-post  assessment  of  Cyprus’  compliance  with  the  preventive  arm  finds  that  the 
structural balance reached a surplus of 2.0% of GDP in 2018, well above the medium-term 
objective of a balanced budgetary position in structural terms. According to the Commission 
2019  spring  forecast,  Cyprus  is  expected  to  remain  above  its  medium-term  budgetary 
objective in 2019 and 2020. 

5 

 
 
 
Headline, structural balance and adjustment towards the MTO  

Headline balance 

Cyprus' headline balance fell to a deficit of 4.8% of GDP in 2018, from a surplus of 1.8% of 
GDP in 2017 and 0.3% of GDP in  2016. The revenue-to-GDP ratio rose by 0.8 percentage 
points of GDP, on the back of strong economic growth, including the buoyant tax intake, and 
favourable  labour  market  developments.  The  expenditure-to-GDP  ratio  increased  by 
7.3 percentage points of GDP, mostly due to the impact of the government support measures 
for  the  sale  and  orderly  winding  down  of  the  Cyprus  Cooperative  Bank.  The  Commission 
2019  spring  forecast  projects  a  general  government  surplus  of  3.0%  of  GDP  in  2019  and 
2.8% of GDP in 2020. The Stability Programme targets a headline surplus of 3.0% of GDP in 
2019 and a 2.6% of GDP in 2020.  

MTO and structural balance 

Cyprus’ structural balance reached a surplus of 2.0% of GDP in 2018, up from 1.3% of GDP 
in 2017 and 1.1% of GDP in 2016. The 2018 structural balance was therefore well above the 
MTO of a balanced budgetary position in structural terms.  

According  to  the  Commission  2019  spring  forecast,  the  structural  surplus  is  expected  to 
narrow to 1.1% of GDP in 2019 and 0.7% of GDP in 2020, partly explained by the widening 
of  the  positive  output  gap.  On  the  basis  of  the  information  in  the  Stability  Programme,  the 
recalculated structural balance is projected at 1.5% of GDP in 2019, 1.0% of GDP in 2020 
and  to  narrow  further  over  the  programme  horizon.  Both  the  Commission  2019  spring 
forecast  and  the  Stability  Programme  expect  the  structural  balance  to  remain  above  the 
medium-term  objective  in  2019  and  2020.  The  divergence  compared  to  the  Commission 
forecast  is  due  to  the  difference  in  the  planned headline  surplus  and  a  narrower  output  gap 
projection resulting in a narrower cyclical adjustment. 

Public investment  

After its trough of 2.1% of GDP in 2014, public investment in Cyprus increased to 2.7% of 
GDP in 2017, bringing it in line with the EU average. Public investment rose further to 5.5% 
of  GDP  in  2018,  although  the  increase  is  mostly  explained  by  the  inclusion  in  the  general 
government sector of two new entities (i.e. Sedipes and Kedipes) resulting from the sale and 
orderly winding down of the Cyprus Cooperative Bank. In particular, those entities recorded 
an  investment  of  around  EUR  670  million,  corresponding  to  the  fixed  assets  received  as 
collateral  from  the  former  Cyprus  Cooperative  Bank.  As  a  share  of  total  government 
expenditure, public investment in Cyprus reached 7.3% in 2017 and 12.4% in 2018. 

According  to  the  2019  Stability  Programme,  public  investment  is  projected  to  decrease  to 
around 2.0% of GDP over the forecast horizon.  

The  government’s  main  investment  priorities  are  outlined  in  the  Government  strategy 
statement. In accordance with the NRP for 2019, the overall aim of the strategy is to increase 
growth  potential,  improve  competitiveness  and  safeguard  the  long-term  sustainability  of 
growth. In order to make Cyprus more attractive to investors, emphasis is placed on reforms 
that  aim  to  create  an  efficient  business  environment,  facilitate  investment,  promote  better 
regulation and streamline procedures. Other priorities relate to reforms aiming to increase the 
efficiency  of  the  public  sector,  promote  SMEs  and  entrepreneurship  and  improve  the 
efficiency  of  justice  delivery.  Those  reforms  are  also  reflected  in  the  country-specific 
recommendations.  Looking  forward,  investment  (both  public  and  private)  is  expected  to  be 

6 

 
 
channelled  in  the  areas  of  energy,  tourism,  shipping,  industry,  education,  health,  justice, 
research and innovation, digitalisation and environment.  

4.2.  Medium-term government debt position  

Despite its increase in 2018 due to banking support measures, partly reversing the decrease 
of  2017,  government  debt  is  projected  to  steadily  decline  as  of  2019  due  to  projected 
continued high primary budget surpluses and strong nominal GDP growth.  However, fiscal 
risks  are  still  present,  according  to  the  Commission  fiscal  sustainability  analysis.  In 
particular,  the  high  government  debt  makes  Cyprus  vulnerable  to  potential  financial  or 
economic  shocks.  These  risks  are  somewhat  mitigated  by  the  contained  medium-term 
financing needs and improved financial market perceptions of Cypriot sovereign risk. 

Debt dynamics 

After declining considerably (by  almost 10 percentage points of GDP) to 95.8% of GDP at 
the end of 2017, government debt rose to 102.5% of GDP in 2018. That increase was mainly 
due to the one-off government support for the sale and orderly winding down of the Cyprus 
Cooperative Bank, in particular the issuing of a series of government bonds in April and July 
2018,  which  amounted  to  15%  of  GDP  (EUR  3.2  billion).  The  transaction  represented  a 
level-shift  upwards  in  Cyprus’  government  debt.  However,  the  debt-to-GDP  ratio  in  2018 
increased  by  only  7  percentage  points  of  GDP  compared  to  2017,  as  the  strong  underlying 
fiscal performance, the snowball effect (i.e. changes in the debt-to-GDP ratio related to  the 
difference  between  nominal  growth  and  the  interest  rate)  and  active  debt  management 
operations partially compensated for the Cyprus Cooperative Bank-related debt increase. The 
latter entailed repaying part of the debt from the accumulated cash balances, in particular the 
government  fully  repaid  the  debt  owed  to  the  Central  Bank  of  Cyprus  (amounting  to  EUR 
483 million or 2.3% of GDP) in December 2018. 

According  to  the  Commission  2019  spring  forecast,  the  debt-to-GDP  ratio  is  expected  to 
steadily  decline  to  96.4%  of  GDP  in  2019  and further to  below  90%  of  GDP  in  2020.  The 
decrease  is  mainly  explained  by  projected  high  primary  budget  surpluses  of  around  5%  of 
GDP and strong nominal GDP growth.  

According to the Stability Programme, government debt is projected to sharply decline over 
2019-2022. Government debt is projected to sharply decrease to 95.7% of GDP in 2019 and 
further to below 90% in 2020. The Commission 2019 spring forecast projects the debt decline 
in 2019 to be somewhat smaller than the Stability Programme projection, mainly due to more 
conservative projections of growth and inflation and a higher stock-flow adjustment (in the 
form of accumulation of financial assets). 

Interest expenditure 

In line with the general trend in the euro area, interest rates on Cypriot debt instruments are at 
historical  lows.  The  7-year  bond  reached  yields  of  around  0.9%  at  the  end  of  April  2019, 
while the yield of the 10-year bond stood at around 1.4%, reaching record low levels since 
2015. Based on notified data, the implicit interest rate declined in recent years, from 3.0% in 
2015 to 2.4% in 2018. It is projected to remain around 2.4% in 2019.  

Debt sustainability 

The  Cypriot  authorities  have  been  using  favourable  market  conditions  to  refinance  the 
outstanding debt against much lower rates at considerably longer maturity.  

7 

 
 
 
The fiscal sustainability analysis points to fiscal risks in the short term, although the projected 
large primary surplus should enable a significant reduction of government debt in 2019 and 
thus  somewhat  mitigate  that  risk.  The  S0  indicator  signals risks  of  fiscal  stress  over  a  one-
year  horizon.6  In  particular,  the  vulnerabilities  come  from  both  fiscal  and  financial-
competitiveness sides. It is mainly explained by the one-off banking support measures which 
led to the deterioration of several fiscal variables, such as the primary balance and the net and 
gross government debt in 2018, as well as by the high private sector debt. Finally, financial 
market  perceptions  of  Cypriot  sovereign  risk  have  improved,  further  mitigating  short-term 
risks. 

In the medium and long term, Cyprus faces medium fiscal sustainability risks. The negative 
value of the S1 sustainability gap indicator points to the fact that no upfront fiscal adjustment 
effort  is  needed  to  reduce  the  debt  below  the  reference  value  of  60%  of  GDP  by  2033, 
pointing therefore to a low risk in the medium term. However, the debt sustainability analysis 
shows that the debt-to-GDP ratio would decline to slightly above the critical 60% threshold 
by 2029, pointing to a medium risk.7 Over the long-term, Cyprus is deemed to be at medium 
fiscal sustainability risk. The S2 sustainability gap indicator shows a low risk, while the DSA 
indicates a medium risk in the long term due to vulnerabilities linked to the high debt burden. 

The risks indicated above and the high level of government debt underscore the importance 
of  maintaining  fiscal  discipline  over  the  medium  to  long  term  and  sustaining  growth-
enhancing structural reforms in order to ensure a declining trajectory of the government debt. 

4.3.  Medium-term economic position 

Despite the implementation of several structural reforms, potential growth in Cyprus remains 
constrained, as legacy issues persist, such as the very large share of non-performing loans in 
the financial sector and high private and public indebtedness. Cyprus made some progress in 
addressing the 2018 CSRs, in particular by implementing important measures in the context 
of a comprehensive strategy to reduce non-performing loans, easing the access to finance for 
the  SMEs  and  preparing  the  implementation  of  the  first  phase  of  the  national  health 
insurance system. 

Cyclical conditions, potential growth and inflation 

Cyprus was one of the European countries hit most severely by the economic crisis and, thus, 
requested  external  financial  assistance.  It  underwent  the  economic  adjustment  programme 
during  2013-2015  with  an  emphasis  on  the  financial  sector.  However,  legacy  issues 

6  

7  

For  further  information,  see  ‘Fiscal  Sustainability  Report  2018’,  European  Economy  Institutional 
Paper, No. 094. 
This debt sustainability analysis uses the Commission’s spring 2019 forecast (for 2019 and 2020) as a 
starting  point.  After  2020,  the  analysis  is  based  on  the  following  standard  assumptions  in  the 
Commission  methodology:  (i)  the  structural  primary  balance,  before  the  cost  of  ageing,  is  kept  at  a 
surplus of 2.7 % of GDP under the ‘no fiscal policy change’ assumption; (ii) inflation converges to 2.0 
%  by 2023  and  remains  stable  after  that; (iii)  the  real long-term  interest  rate on new  and  rolled-over 
debt converges linearly to 3 % (5 % in nominal terms) by the end of the 10-year projection period, in 
line  with  the  assumptions  agreed  with  the  Economic  Policy  Committee’s  (EPC)  Ageing  Working 
Group;  (iv)  real  GDP  grows  at  the  rate  projected  according  to  commonly  agreed  methods  with  the 
EPC’s Output Gaps Working Group until t+10, and then grows according to the European Commission 
— Ageing Working Group’s projections (average rate of around 1.5 % in 2018-2029); and (v) ageing 
costs develop according to the 2018 Ageing Report projections 

8 

 
 
                                                            
remained, as evidenced by the sale and orderly winding down of the second-largest bank (i.e. 
the Cyprus Cooperative Bank) in 2018. During 2012-2014, Cyprus experienced a recession, 
but  real  growth  resumed  since  2015.  From  2016  onwards,  Cyprus  has  been  in  a  strong 
cyclical  upswing,  with  an  annual  real  growth  at  above  4%  in  2016-2017  and  close  to  it  in 
2018. The labour market recovered strongly and employment lately grew by around 4% per 
year, while wages increased moderately. Unemployment fell from nearly 17% at the peak of 
the crisis to 7.1% in February 2019. Long-term unemployment has also recently contracted. 

Table 3: Macroeconomic and budgetary developments (% of GDP) 

Going  forward,  real  growth  is  expected  to  be  solid  on  the  back  of  domestic  demand,  more 
specifically private consumption and investment.  GDP growth is projected at 3.1%  in 2019 
and 2.7% in 2020, according to the Commission 2019 spring forecast. Inflation in Cyprus has 
been very subdued for several years and is expected to remain so. HICP is set to rise to 0.9% 
in  2019  (after  0.8%  inflation  in  2018)  and  further  to  1.1%  in  2020.  Despite  the 
implementation of several structural reforms, potential growth in Cyprus remains constrained, 
as  legacy  issues,  including  the  very  large  share  of  non-performing  loans  in  the  financial 
sector  and  high  private  and  public  indebtedness,  persist.  Potential  growth  is  estimated  at 
around 2%  in 2018-2020, with  capital  accumulation serving as  a  main positive contributor, 
followed by the total labour contribution (the latter driven by increasing employment). Total 
factor productivity, after years of negative contributions, is estimated to turn positive in 2019 
and 2020, but still very close to zero.  

The output gap is positive and increasingly so. It is projected to increase from 2.8% in 2018 
to 4.3% in 2020. 

9 

COMSPCOMSPReal GDP (% change)4.84.53.93.13.62.73.2Potential GDP (% change) 0.82.11.92.12.82.13.1Output gap (% of potential GDP)-1.50.82.83.83.04.33.1General government balance0.31.8-4.83.032.82.6Primary balance3.14.3-2.35.45.34.94.8One-offandothertemporarymeasures-0.10.0-8.20.00.00.00.0Governmentgrossfixedcapitalformation2.52.75.52.22.12.22Cyclically-adjusted balance1.11.3-6.21.11.50.71.0Cyclically-adjusted primary balance3.83.9-3.73.53.82.72.2Structural balance (i)1.11.32.01.11.50.71Structural primary balance 3.93.94.53.53.82.72.2Source: 2019 Stability Programme (SP) and Commission 2019 spring forecast (COM)Notes:(i) Cyclically-adjusted balance excluding one-off and other temporary measures.20192020201620172018 
 
 
 
 
Structural reforms  

In  the  national  reform  programme8  (NRP)  adopted  on  15  April  2019,  the  government  of 
Cyprus confirms its commitment to implement a wide-ranging structural reform programme 
that would help maintain sustainable growth in the long term. The main reform priorities as 
outlined in the NRP are focused on addressing the challenges identified in the 2018 Council 
country specific recommendations9 and the 2019 Cyprus country report10.    

The  2019  Cyprus  country  report  concluded  that  overall  the  Member  State  has  made  some 
progress in addressing the 2018 country-specific recommendations. More specifically, there 
has  been  substantial  progress  in  implementing  important  measures  in  the  context  of  a 
comprehensive  strategy  aimed  to  reduce  non-performing  loans,  including  by  strengthening 
the legal frameworks of insolvency, foreclosure and the sale of loans. Cyprus has made some 
progress  with  regards  to  access  to  finance  for  the  SMEs,  by  launching  new  financial 
instruments  and  preparing  the  implementation  of  the  first  phase  of  the  national  health 
insurance  system.  Only  limited  progress  has  been  made  in:  (i)  reforming  the  public 
administration  and local  governments,  (ii) implementing  planned  privatisation  projects, (iii) 
addressing inefficiencies in the judicial system, (iv) establishing a reliable system to transfer 
and  issue  title  deeds,  (v)  improving  the  effectiveness  of  the  public  employment  services  in 
outreaching  young  people  and  (vi)  reforming  the  education  system.  No  progress  has  been 
made  with  regards  to  the  strengthening  of  the  supervision  of  insurance  companies  and 
pension funds and the simplification of administrative procedures for major investments.            

Furthermore,  in  February  2019,  the  Commission  concluded  that  Cyprus  was  experiencing 
excessive macroeconomic imbalances, namely high stock of private, public and external debt 
and  non-performing  loans  in  a  context  of  still  relatively  high,  even  though  declining, 
unemployment and weak potential growth. 

4.4. 

Other factors considered relevant by the Commission  

To preserve financial stability, the government adopted several measures to support the sale 
and orderly winding down of the Cyprus Cooperative Bank. Those support measures to the 
financial  sector  pushed  the  general  government  balance  into  deficit  in  2018  and  increased 
government  debt  in  2018,  as  discussed  in  sections  4.2  and  4.3.  In  particular,  the  one-off 
banking  support  measures  affected  negatively  the  general  government  balance  by  8.3%  of 
GDP (EUR 1.7 billion) in 2018.11 Furthermore, the issuance of a series of government bonds 

8  

9  
10  

11  

report.  https://ec.europa.eu/info/sites/info/files/file_import/2019-european-

National  reform  programme  Cyprus  2019.  https://ec.europa.eu/info/sites/info/files/2019-european-
semester-national-reform-programme-cyprus-en.pdf  
https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32018H0910(12)&from=EN  
2019  Cyprus  country 
semester-country-report-cyprus_en.pdf  
The EUR 1.7 billion impact of the banking support measures related to the Cyprus Cooperative Bank 
on the general government fiscal accounts for 2018 is mainly calculated as follows: (i) a capital transfer 
of EUR 710 million, as a result of the acquisition value (EUR 2.17 billion) minus the real economic 
value of the non-performing loans received by the new entities (EUR 1.46 billion, resulting from the 
real economic value of the nominal value of non-performing loans, i.e. 20.94% of EUR 6.97 billion); 
(ii)  an  investment  of  around  EUR  670  million,  which  corresponds  to  the  fixed  assets  received  as 
collateral from the former Cyprus Cooperative Bank; (iii) the guarantee received by Hellenic Bank (i.e. 
capital  transfer)  of  EUR  155  million,  and  (iv)  the  Voluntary  Redundancy  Scheme  (early  retirement 
compensation) for Cyprus Cooperative Bank’s employees (i.e. capital transfer) of EUR 133 million. 

10 

 
 
                                                            
related to those support measures impacted the government debt by 15% of GDP (EUR 3.2 
billion). 

Among the other factors considered relevant by the Commission, particular consideration is 
given to financial contributions to fostering international solidarity and achieving the policy 
goals of the Union, the debt incurred in the form of bilateral and multilateral support between 
Member  States  in  the  context  of  safeguarding  financial  stability,  and  the  debt  related  to 
financial  stabilisation  operations  during  major  financial  disturbances  (Article  2(3)  of 
Regulation (EC) No 1467/97).  

Article  12(1)  of  Regulation  (EU)  No  473/2013  requires  that  this  report  considers  also  "the 
extent  to  which  the  Member  State  concerned  has  taken  into  account  the  Commission's 
Opinion  on  the  country's  Draft  Budgetary  Plan,  as  referred  in  Article  7(1)"  of  the  same 
Regulation. The Commission Opinion on Cyprus' Draft Budgetary Plan for 2019 concluded 
that Cyprus was compliant with the provisions of the SGP in 2018 and 2019 and invited the 
authorities  to  implement  the  2019  budget.12  The  budget  was  adopted  by  Parliament  on  14 
December  2018  without  major  changes  compared  to  the  Draft  Budgetary  Plan.  Among  the 
few supplementary measures approved for the 2019 budget, the reduction of excise duty on 
fuels was the measure with the highest estimated impact of -0.3% of GDP on the revenue side 
in 2019. 

4.5. 

Other factors put forward by the Member State  

On  31  May  2019,  the  Cypriot  authorities  transmitted  a  letter  with  relevant  factors  in 
accordance with Article 2(3) of Regulation (EC) No 1467/97. The analysis presented in the 
previous sections already broadly covers the key factors put forward by the authorities. 

The  Cypriot  authorities  highlight  the  fact  that  the  fiscal  performance  in  Cyprus  remains 
strong  and  the  excess  over  the  3%-of-GDP  reference  value  in  2018  is  entirely  due  to  the 
temporary  government  support  measures  to  the  Cyprus  Cooperative  Bank.  Furthermore, 
according to the letter, the one-off measures provided to the Cyprus Cooperative Bank were 
deemed necessary for financial stability reasons, as they facilitated the bank’s exit from the 
financial market through an orderly wind down and a partial sale of the bank’s activities to 
another banking institution. 

More  specifically,  the  authorities  state  that  the  general  government  fiscal  position 
deterioration in 2018, from a surplus of 1.8% of GDP in 2017 to a deficit of 4.8% of GDP in 
2018, was exclusively due to the one-off banking support measures provided to the Cyprus 
Cooperative  Bank.  The  authorities  also  point  to  the  fact  that,  excluding  those  one-off 
measures, the general government headline balance was in surplus of around 3.4% of GDP in 
2018,  recording  an  improvement  of  1.6  percentage  points  of  GDP  compared  to  the  year 
before  and  a  positive  deviation  by  0.5  percentage  points  of  GDP  from  the  target  set  in  the 
2019  Draft  Budgetary  Plan.  The  structural  budget  position  improved  in  2018,  reaching  a 
surplus of 2% of GDP compared to a surplus of 1.3% in 2017. 

12  

However,  the  Commission  Opinion  underlined  that  both  the  Draft  Budgetary  Plan  for  2019  and  the  
Commission  2018  autumn  forecast  did  not  yet  include  the   deficit-increasing  (one-off)  impact  
on  the  general  government  balance  in  2018  from  the banking  support measures  related  to  the  
Cyprus  Cooperative  Bank. 

11 

 
 
                                                            
Finally,  according  to  the  letter,  the  general  government  headline  deficit  is  expected  to  be 
corrected  in  2019.  In  particular,  the  general  government  headline  balance  is  projected  to 
return to a surplus of around 3% of GDP in 2019 and 2.8% of GDP in 2020, reflecting the 
normalisation of the economic activity and the improving labour market. The letter states that 
the  structural  balance  is  projected  to  remain  in  surplus  over  the  period  2019-2020, 
overachieving the medium-term budgetary objective. 

 5. 

CONCLUSIONS  

General government gross debt is above the 60%-of-GDP reference value since 2011 and was 
notified at 102.5% of GDP in 2018. The Commission 2019 spring forecast and the Stability 
Programme expect a steady debt reduction in 2019, to below 100% of GDP. Cyprus complies 
with  the  transitional  debt  rule  in  2018  and  is  projected  to  comply  with  the  debt  reduction 
benchmark in 2019 and 2020. This suggests that the debt criterion in the Treaty is fulfilled. 

Following the general government headline surpluses of 0.3% of GDP in 2016 and 1.8% of 
GDP in 2017, the general government headline balance in Cyprus reached a deficit of 4.8% 
of GDP in 2018, much above the Treaty reference value of 3% of GDP. In the absence of the 
8.3%  of  GDP  one-off  impact  of  the  banking  support  measures,  the  general  government 
balance  would  have  amounted  to  a  surplus  of  3.5%  of  GDP  in  2018.  According  to  the 
Commission  2019  spring  forecast  and  the  Stability  Programme,  the  general  government 
headline balance is projected to return to surpluses of around 3% of GDP in 2019 and above 
2.5% of GDP in 2020, in compliance with and well below the reference value (by more than 
5.5 percentage points of GDP). The excess over the reference value in 2018 is not exceptional 
although  temporary  within  the  meaning  of  the  Treaty  and  the  SGP.  This  suggests  that  the 
deficit criterion as defined in the Treaty is prima facie not fulfilled in 2018.  

In line with the Treaty, this report also examined the relevant factors. Those relevant factors 
include  the  fact  that  the  general  government  headline  deficit  in  2018,  including  the  excess 
over the reference value, was entirely due to the 8.3% of GDP one-off impact of the banking 
support measures, which also contributed to the increase of the general government debt in 
2018. Furthermore, the structural balance reached a surplus of 2.0% of GDP in 2018 and is 
expected  to  remain  above  the  medium-term  objective  of  a  balanced  budgetary  position  in 
structural terms in 2019 and 2020. However, since the government debt-to-GDP ratio exceeds 
the  60%  reference  value  and  the  double  condition  is  not  met  -  i.e.  that  the  deficit  remains 
close to the reference value and that its excess over the reference value is temporary  - those 
relevant  factors  cannot  be  taken  into  account  in  the  steps  leading  to  the  decision  on  the 
existence of an excessive deficit for Cyprus.  

At  the  same  time,  Cyprus  is  expected  to  be  fully  compliant  with  all  requirements  of  the 
Stability and Growth Pact in 2019 and 2020, including the projected overachievement of the 
medium-term  budgetary  objective  and  the  projected  sizeable  general  government  surplus, 
thus ensuring compliance with the deficit criterion and the debt reduction benchmark. In light 
of  the  above,  the  opening  of  an  excessive  deficit  procedure  would  not  serve  a  meaningful 
purpose  for  fiscal  surveillance.  Therefore,  the  Commission  considers  that  further  steps 
leading to a decision on the existence of an excessive deficit should not be taken.  

12