CELEX: 52013DC0284
Language: en
Date: 2013-05-07 00:00:00
Title: Recommendation for a COUNCIL RECOMMENDATION with a view to bringing an end to the situation of an excessive government deficit in Cyprus

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		52013DC0284
		
			Recommendation for a COUNCIL RECOMMENDATION with a view to bringing an end to the situation of an excessive government deficit in Cyprus /* COM/2013/0284 final */
			
				
		
		
			
			   	Recommendation for a
COUNCIL RECOMMENDATION
with a view to bringing an end to the
situation of an excessive government 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(7) thereof,
Having regard to the
recommendation from the European Commission,
Whereas:
(1)       According to Article 126 of
the Treaty on the Functioning of the European Union
(TFEU) Member States shall avoid excessive government deficits.
(2)       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.
(3)       On 13 July 2010, the
Council decided, in accordance with Article 126(6) TFEU that an excessive
deficit existed in Cyprus[1]
and issued a Recommendation to correct the excessive deficit by 2012 at the
latest, in accordance with Article 126(7) TFEU and Article 3 of Council
Regulation (EC) No 1467/97 of 7 July 1997 on speeding up and clarifying the
implementation of the excessive deficit procedure. 
(4)       On 27 January 2011, the
Commission concluded in a Communication to the Council that Cyprus had taken effective action in compliance with the Council recommendation of 13 July 2010 to
bring its government deficit below the 3% of GDP reference value and considered
that no additional steps under the excessive deficit procedure were necessary.
(5)       On 11 January 2012, the Commission
confirmed in a second Communication to the Council that Cyprus had taken effective action in compliance with the Council recommendation of 13 July 2010 to
bring its government deficit below the 3% of GDP reference value and considered
that no additional steps under the excessive deficit procedure were necessary.
(6)       According to Article 3(5)
of Regulation (EC) No 1467/97, the Council may decide, on a recommendation from
the Commission, to adopt a revised recommendation under Article 126(7) TFEU, if
effective action has been taken and unexpected adverse economic events with
major unfavourable consequences for government finances occured after the
adoption of the initial recommendation. The occurrence of unexpected adverse
economic events with major unfavourable budgetary effects shall be assessed
against the economic forecast underlying the Council recommendation.
(7)       In accordance with Article
126(7) of the TFEU and Article 3 of Council Regulation (EC) No 1467/97, the
Council is required to make recommendations to the Member State concerned with
a view to bringing the situation of excessive deficit to an end within a given
period. The recommendation has to establish a maximum deadline of six months
for effective action to be taken by the Member State concerned to correct the excessive
deficit. Furthermore, in a recommendation to correct an excessive deficit the
Council should request the achievement of annual budgetary targets which, on
the basis of the forecast underpinning the recommendation, are consistent with
a minimum annual improvement in the structural balance, i.e. the
cyclically-adjusted balance excluding one-off and other temporary measures, of at
least 0.5% of GDP as a benchmark.
(8)       On the basis of an
in-depth review of the nature, origin, and severity of macroeconomic
developments in Cyprus, the Commission concluded in May 2012 that Cyprus was experiencing very serious imbalances, in particular as regards the external
position, public finances, and the financial sector, which needed to be
urgently addressed. The situation in the Cypriot banking sector was seen to
threaten the sustainability of the country's position. On the external side,
the current account balance exhibited sizeable and persistent decifits, linked
to a gradual erosion of price/cost competitiveness, while the international
investment position was found to be a cause for concern. Moreover, the
situation in the Cypriot banking sector was seen to threaten the sustainability
of the country's position. On the internal side, the highly leveraged private sector,
with the outstanding debt level of non-financial corporations and very high
household indebtedness were a source of concern. In addition, government
finances have swung to annual deficits and widened even as the economy
recovered from recession, with recent efforts to correct the excessive deficit
found to possibly not be sufficient. The public debt has progressively been
above the Treaty-based threshold and was expected to increase sharply. 
(9)       On 10 July 2012, the
Council addressed country-specific recommendations to Cyprus based, inter alia, on the assessment of Cyprus's national reform programme and Cyprus's stability programme covering the period 2012-15. The first recommendation calls
for the rigorous implementation of the budgetary strategy in 2013 and beyond. It
also calls for an acceleration of the phase-in of an enforcable multianuual
budgetary framework with a binding staturory basis and corrective mechanism.
This framework should be reinforced also by the implementation of programme and
performance budgeting. Given the inefficiencies in the tax administration and
the tax collection, measures improving tax compliance and combating tax evasion
need to be adopted.
(10)     In view of increasingly severe
economic and financial conditions, the Cypriot authorities officially requested
financial assistance under the terms of a loan by the European Financial
Stability Facility / European Stability Mechanism (ESM) on 25 June 2012, as
well as from the International Monetary Fund (IMF), with a view to supporting
the return of the economy to sustainable growth, ensuring a
properly-functioning banking system and safeguarding financial stability in the
European Union and in the euro area. On 27 June 2012, the Eurogroup invited the
Commission, in liaison with the ECB, the Cypriot authorities, and the IMF to
agree on a macroeconomic adjustment programme, including the financing needs,
and to take appropriate action to safeguard financial
stability in the very challenging environment with a risk of spill-over effects
from sovereign market turbulence. On 16 March and 25 March 2013, the Eurogroup reached a political
agreement with Cyprus on a financial assistance and the key elements of a
programme. On 12 April 2013, the Eurogroup considered
that the necessary elements of the macroeconomic adjustment programme were in
place to launch the relevant national procedures for the formal approval of the
ESM financial assistance facility. On 25 April 2013, the Council adopted a
decision under Article 136 TFEU containing the main elements of the
macroeconomic adjustment programme to be implemented by Cyprus. On 26 April 2013, a Memorandum of Understanding consistent with the said decision
was signed by the Cypriot authorities and the Commission, acting on behalf of
the ESM.
(11)     More than a decade of
sustained and strong economic expansion in Cyprus came to an end in 2009. Economic
activity fell by 1¾%, with weak domestic demand and an adverse external
environment weighing strongly on growth. Economic activity recovered in 2010 with
real GDP growth of 1.1% and a growth of 1.5% was recorded in the first half of
2011. According to the Commission services’ 2010 Spring Forecast, which was
underlying the Council recommendation under Article 126(7) TFEU of 13 July
2010, the Cypriot economy was expected to grow by 1.3% in 2011. Despite a very good
tourist season in 2011, the recovery suffered a setback from the grave accident
in July 2011 that destroyed the Vasilico electricity producing plant,
accounting for half of total generating capacity. Moreover, the unwinding of very
serious private and public sector imbalances in the Cypriot economy resulted in
tightening financial and fiscal conditions, which compounded the negative
effect on economic activity, caused a high degree of economic uncertainty and
exacerbated the deterioration in labour market conditions. The continued
weakness of the international environment prevented external demand from
offsetting the impact on domestic demand. As a result, 2011 annual economic
growth turned out at 0.5%, close to one percentage point below the Commission forecast
at the time of the Council Recommendation. 2012 was beyond the forecast horizon
at the time of the Commision forecast underlying the Council recommendation.
However, under the hypothesis of a gradual closure of the negative output gap,
higher growth than in 2011 was expected for 2012. According the latest
Commission services' forecast, real GDP growth is expected to be -2.4% in 2012.

(12)     The general government deficit
reached 6.3% of GDP in 2011, increasing from 5.3% in 2010. The worsening of the
budget balance took place in spite of the fiscal consolidation measures in the 2011
Budget Law and three sets of further deficit-reducing measures adopted over the
course of 2011, which were insufficient to stem the deterioration of public
finances. The abovementioned series of economic events, notably the unwinding
of very serious private and public sector imbalances in the Cypriot economy,
form the background of the developments in public finances, including non-negligible
growth composition effects and higher debt financing cost implied by loss of
access to longer-term market financing.
(13)     According to the Commission
services' most recent forecast, the general government deficit is projected to
reach 6.3% of GDP in 2012. This projected deficit outturn is significantly
worse than previous Commission services' forecasts, in particular due to a
significant shortfall of both indirect and direct tax revenues (mostly due to
VAT, corporate taxation and social contributions) and higher expenditures due
to increasing unemployment and higher-than-expected early retirement. Compared
to the Commission services' 2013 Winter Forecast, the 2012 deficit was adjusted
upwards by around ½% of GDP due to an one-off expenditure relating to insurance
costs from the explostion at the Vasilico electricity producting plant in July
2011, payable in a period of four years but booked fully in 2012, as well as
the recording of a capital transfer for the capitalised interest payment on the
recapitalisation bond for Cyprus Popular Bank.
(14)     According to the Commission
services' most recent economic forecast, the structural deficit was 5.7% and 6.6%
of GDP in 2010 and 2011 respectively. It is expected to reach 6.6% of GDP in
2012. The Commission services' forecast underlying the Council Recommendation
in July 2010 pointed to an expected average potential growth of around 1% over
the adjustment period. Under the Commission services' most recent economic
forecast, the average potential output for the years 2011-2012 is now
considered to be negative (around -0.5%) and is estimated to remain negative over
2013-2016. Correcting for the downward revision of the potential output since
the Council Recommendation, the average fiscal effort over 2011-2012 would be around
0.5%. However, the estimated change in the structural balance was also severely
affected by unexpected revenue shortfalls, due to lower-than-projected final
domestic demand and lower imports, as well as the stronger deterioration in the
labour market. This led to major revenue shortfalls, notably in indirect taxes.
Taking these effects into account, the overall adjusted fiscal effort is
estimated at around 2.4% of GDP on average, well above the required average
annual fiscal effort over 2011-2012 of at least 1½% of GDP recommended by the
Council. Cyprus can therefore be considered to have taken effective action in
line with the Council Recommendation.
(15)     The 2012 Budget Law adopted
on 16 December 2011 incorporated an expenditure-driven consolidation strategy
consisting of mainly (i) contributions from public sector employees to their
pensions combined with a freeze of emoluments in the broader public sector for
two years (ii) inclusion of new public sector employees in the general pension
scheme under the social security fund instead of in the more generous public
sector pension scheme, (iii) a better targeting of social transfers, iv) cuts
in selected government expenditure categories, (v) a hike of the VAT rate from
15% to 17%, (vi) a temporary contribution on gross earnings of private sector
employees and pensioners and (vii) an increase in the tax rate on deemed
dividend distribution. The aforementioned fiscal projections include also consolidation
measures taken by the Cypriot authorities for the remaining part of 2012 after
a provisional agreement with programme partners on fiscal policies in November
2012, in particular a scale reduction in emoluments of public and broader
public sector pensioners and employees sector. In sum, Cyprus adopted consolidation measures in 2011-2012 with an estimated direct
deficit-reducing impact of more than 5½% of GDP. This bottom-up assessment of
the fiscal consolidation measures taken in the years 2011-2012 confirms the
conclusion that effective action has been taken by Cyprus. 
(16)     Gross public debt rose to 71.1%
of GDP in 2011, compared to 67.6% of GDP projected in the Commission services'
2010 Spring Forecast underlying the Council recommendation under Article 126(7)
TFEU of 13 July 2010. Debt developments were mostly driven by the
higher-than-expected deficit outcomes, lower-than-expected growth, and Cyprus's difficulties in accessing international markets to cover its financing needs, which
resulted in increases in the borrowing costs. These factors, together with the government's
participation in the recapitalisation of one commercial bank in June 2012, led
to an increase in the general government debt to about 85.8% of GDP in 2012. In
the next years, the government debt will inevitably increase further, reflecting
the weak growth and substantial fiscal financing needs. In 2013-14, the
government debt will increase further upon receipt of the financial assistance.
The debt-to-GDP ratio is forecast to peak at around 128% of GDP in 2015 before
declining thereafter on the back of sustainable primary surpluses and the
return to positive real GDP growth rates.
(17)     Considering all these
factors and in particular the substantial deterioration in the budgetary
position resulting from the worse-than-expected economic downturn and the
weaker overall position of the economy than envisaged at the time of the
original Council recommendation under Article 126(7) TFEU implies that a new
deadline for correction of the excessive deficit by Cyprus is warranted. Granting
four additional years for the correction of the excessive deficit is necessary
in view of the projected distance to the 3% of GDP reference value at end-2012
and the adverse macro-economic circumstances.
(18)     Under the Commission
services' most recent economic forecast for nominal GDP growth, the primary
general government balance is projected to attain a deficit of 2.4 % of GDP in
2013, a deficit of 4.3 % of GDP in 2014, a deficit of 2.1 % of GDP in 2015 and
a surplus of 1.2% of GDP in 2016, while the headline general government deficit
is projected to reach 6.5% of GDP for 2013, 8.4% of GDP for 2014, 6.3% of GDP
for 2015 and 2.9% of GDP in 2016. For monitoring
purposes, and in view of the limited control of the Cypriot authorities over
interest payments, the macroeconomic adjustment
programme to be implemented by Cyprus sets primary balance fiscal targets.
(19)     In order to ensure a
sustainable correction of the excessive deficit, the appropriate adjustment
path shall be established and evaluated on the basis of an overall assessment
with the structural balance as the reference and with a minimum annual
improvement in the structural balance of at least 0.5 % of GDP as a benchmark. Fully-specified
consolidation measures of about 4¾% of GDP in 2013 are projected to result in
an improvement in the structural fiscal balance of around 1.3% of GDP in 2013. For
2014, the adopted consolidation measures amount to around 1¾% of GDP and are estimated
to improve the structural balance by 0.3% of GDP in 2014while the improvement
of the structural balance is estimated at 0.7% of GDP in 2015 and 1.8% of GDP
in 2016. 
(20)     The adjustment for 2013-16
contains measures to reduce the growth in expenditure mainly on the public
sector wage bill and social benefits, and to increase revenue in partiuclar by
increasing VAT rates, excise duties, tax rate on interest income, property and
corporate taxation. Fiscal consolidation should be maintained over the medium
term by containing expenditure growth, improving the structure of taxation and
undertaking fiscal-structural measures.
(21)     In light of the substantial
additional consolidation in 2013 and the adverse and highly uncertain
macroeconomic conditions, inter alia due to the imposition of temporary capital
controls, loss of confidence and financial sector instability, an ex-ante obligation
of further fiscal consolidation measures for 2014 (additional to the measures
adopted in December 2012 with effect from 1 January 2014) was not considered
appropriate. However, an obligation of the Cypriot authorities to stand ready
to preserve the programme objectives by taking additonal measures in the event
of underperformance of revenues or higher social spending, taking into account
adverse macroeconomic effects, is laid down in the economic and financial
adjustment programme. 
(22)     In 2014, the structural
balance is estimated to improve by 0.3% of GDP on the basis of agreed fiscal consolidation
measures that have remained unchanged compared to those that were laid down in
the November 2012 draft MoU. The estimated structural effort in 2014 is
therefore, based on the most recent Commission services' forecast, slightly
below the minimum annual improvement in the structual balance of at least 0.5%
of GDP as a benchmark. This level of improvement should nevertheless be
considered acceptable in the current exceptional situation of highly uncertain
macroeconomic conditions with significant shifts in actual and estimated
potential output, structural balance estimates being more uncertain and subject
to variation over time than under more stable macroeconomic conditions. The
Commission services' Winter 2013 forecast took into account the consolidation measures
for 2014 and indicated an improvement in the structural balance from 2013 to
2014 of around 1.4% of GDP. The lower improvement of the structural balance in
2014 now estimated – in spite of an unchanged set of consolidation measures –
can be explained by (i) the deterioration of the tax base of the 2013 revenue
measures, which implies that some of these measures are projected to have a
decreasing impact in 2014; (ii) the downward revision of the impact of some of
the consolidation measures already taken for 2014 due to the worse
macroeconomic conditions throughout the programme period; (iii) a projected
reduction of revenue collection in 2014 of some tax measures, the revenue of
which (e.g. collection of income taxation and VAT) depends on economic activity
of 2013 and (iv) the fact that the standard elasticity used to determine the
split between the cyclical component and the structural balance may lead to underestimating
the true underlying fiscal effort. A bottom-up view of discretionary
consolidation measures, item-by-item, is an important element of an assessment
of the fiscal policy stance. It may, in particular under highly uncertain
macroeconomic conditions, give a useful complementary view of the true
underlying fiscal effort. The amount of fiscal consolidation measures is on
average above 3% of GDP for the years 2013-2014. Albeit significant, the
corresponding improvement in the structural balance is only around ¾% of GDP on
average. 
(23)     Monitoring of progress on
implementation of Cyprus's EDP commitments will be carried out at regular
intervals. In the event of underperformance of revenues or higher social
spending needs, Cyprus should stand ready to take additional measures to
preserve the attainment of fiscal targets. 
(24)     Cyprus fulfils the
conditions for the extension of the deadline for correcting the excessive general
government deficit as laid out in Article 3(5) of Regulation (EC) No 1467/97 on
speeding up and clarifying the implementation of the excessive deficit
procedure,
HAS ADOPTED THIS RECOMMENDATION:
(1)                   
Cyprus should put an end
to the present excessive budget deficit situation by 2016.
(2)                   
In order to bring the headline government
deficit below the 3% of GDP reference value by 2016, Cyprus should achievethe headline
general government deficit targets of 6.5% of GDP in 2013, 8.4% of GDP in 2014,
6.3% of GDP in 2015, and 2.9% of GDP in 2016.
(3)                   
To this end, Cyprus should rigorously implement
the 2013 Budget Law and the agreed additional consolidation measures, which
should amount to at least EUR 351 million in 2013. Cyprus should fully implement the fiscal measures for 2014 that were adopted in December
2012, amounting to at least 270 million EUR in 2014. Cyprus should monitor the
budgetary effect of consolidation measures taken on a monthly basis and stand
ready to preserve fiscal targets by taking additional measures in the event of
underperformance of revenues or higher social spending, taking into account
macroeconomic circumstances.
(4)                   
Cyprus should maintain fiscal consolidation over
the medium term, converging towards its medium-term
budgetary objective of a balanced budget in structural terms, by containing
expenditure growth, improving the structure of taxation and undertaking fiscal-structural measures. 
(5)                   
The Council establishes the deadline of 3 months
for the Cypriot authorities to take effective action and, in accordance with
Article 3(4a) of Council Regulation (EC) No 1467/97, to report in detail the
consolidation strategy that is envisaged to achieve the targets.
Beyond the report foreseen in
recommendation (5) and also in parallel to the financial adjustment programme, Cyprus should report on progress made in the implementation of these recommendations every
three months as well as in a separate chapter in the stability programme, until
full correction of the excessive deficit has taken place.
This Recommendation is addressed to the Republic of   Cyprus.
Done at Brussels, 
                                                                       For
the Council
                                                                       The
President
[1]               OJ L 186, 20.07. 2012, p. 30.