CELEX: 52010SC0741
Language: en
Date: 2010-06-15 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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EN    EN
 ---pagebreak---                   EUROPEAN COMMISSION
                                                   Brussels, 15.6.2010
                                                   SEC(2010) 741 final
                                  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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 ---pagebreak---                                          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 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)     The 2005 reform of the Stability and Growth Pact sought to strengthen its
           effectiveness and economic underpinnings as well as to safeguard the sustainability of
           the public finances in the long run. It aimed at ensuring that in particular the economic
           and budgetary background was taken into account fully in all steps in the EDP. In this
           way, the Stability and Growth Pact provides the framework supporting government
           policies for a prompt return to sound budgetary positions taking account of the
           economic situation.
   (4)     The Council has decided on [13 July 2010], in accordance with Article 126(6) of the
           Treaty, that an excessive deficit exists in Cyprus.
   (5)     In accordance with Article 126(7) of the Treaty and Article 3 of Council 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), the Council is also
           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 deadline of six months at the most for effective
           action to be taken by the Member State concerned to correct the excessive deficit as
           well as a deadline for the correction of the excessive deficit, which should be
           completed in the year following its identification unless there are special
           circumstances. In deciding whether special circumstances exist, “relevant factors” as
           clarified in Article 2(3) of Regulation (EC) No 1467/97 should be taken into account.
   1
           OJ L 209, 2.8.1997, p. 6.
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 ---pagebreak---        Furthermore, in a recommendation to correct an excessive deficit the Council should
       request the achievement of a minimum annual improvement in the structural balance,
       i.e. the cyclically-adjusted balance excluding one-off and other temporary measures, of
       0.5% of GDP as a benchmark.
   (6) Special circumstances, which are relevant for the greater flexibility in the application
       of the EDP introduced with the 2005 reform of the Stability and Growth Pact, are
       deemed to exist in the case of Cyprus. In 2009, for the first time in 35 years, economic
       activity contracted. The recession reflected a significant fall in domestic demand and
       an adverse external environment. In particular, high household indebtedness together
       with tighter lending conditions, a worsening labour market outlook and negative
       confidence effects led to a decline in private consumption. In parallel, investment
       recorded a strong correction, amidst a fall in foreign demand for housing, low capacity
       utilisation and restructuring of corporate balance sheets. Moreover, exports of goods
       and services, especially tourism, plummeted as a consequence of the financial crisis
       and the global slowdown, in particular the much lower growth prospects of the main
       trading partners (United Kingdom, Euro Area, Russia). The deficit in 2009 is a
       consequence of both the economic downturn and the stimulus measures taken in line
       with the EERP by the Cypriot authorities. The existence of special circumstances
       authorises the Council to allow the correction of the excessive deficit in a medium-
       term framework.
   (7) In the years prior to the crisis and in a context of good economic times, supported by
       an asset boom and buoyant tax receipts, Cyprus was able to build up budgetary
       surpluses and reduced its gross debt ratio to 48.4% of GDP in 2008 (from 70.2% in
       2004). In 2009, however, the economic crisis weighed heavily on public finances. As a
       result, the budget balance plunged from a surplus of 0.9% of GDP in 2008 to a deficit
       of 6.1% of GDP in 2009. This was also the result of a number of discretionary
       measures in response to the economic downturn (in line with the EERP) and of rather
       large composition effects on account of a much less tax-rich GDP growth pattern. The
       deficit is projected to widen further to 6.2% of GDP in 2010 according to the March
       2010 EDP notification presented by the Ministry of Finance. However, the budgetary
       projections of the Commission services’ spring 2010 forecasts indicate that the
       budgetary deficit would reach about 7% of GDP in 2010. Potential extra-budgetary
       measures still under discussion with uncertain or no information on their modalities
       and timing of implementation, were not incorporated.
   (8) Considering the special circumstances and the EERP framework, an average annual
       fiscal effort is recommended. The fiscal effort should take into account all factors
       relevant for achieving the fiscal policy objectives, starting with the level of the general
       government deficit and gross debt as well as other indicators, such as the current
       account position, the level of contingent liabilities of the financial sector, interest
       payments, risk premia and the expected change in age-related expenditure in the
       medium term. In calculating the average annual fiscal effort, the 2011 deficit in the
       Commission services' spring 2010 forecast is taken as the starting point. The total
       fiscal effort needed to reach the nominal deficit target of 3% by the deadline is then
       calculated by assuming a gradual closure of the output gap by 2015.
   (9) Against this background, it is appropriate to consider the correction of the excessive
       deficit in a medium-term framework with a deadline for the correction of 2012. In
       particular, in view of the high external and domestic imbalances, a credible and
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 ---pagebreak---         sustainable adjustment path would require Cypriot authorities to strengthen the fiscal
        strategy in 2010 with measures to control current expenditure, to reduce the deficit to
        below 6% of GDP in 2010, and take timely action to define an expenditure-driven
        consolidation strategy. To this effect, the Cypriot authorities should ensure an average
        annual fiscal effort of 1¾% of GDP over the period 2010-2012; specify the measures
        that are necessary to achieve the correction of the excessive deficit by 2012, cyclical
        conditions permitting, and accelerate the reduction of the deficit if economic or
        budgetary conditions turn out better than currently expected. In its stability programme
        submitted to the Commission and the Council on 1 April 2010, Cyprus committed to
        reduce its deficit to 4.5% of GDP in 2011 and 3.4% of GDP in 2012. Therefore, the
        additional effort requested to Cyprus in this recommendation compared to the initial
        plan of the Cypriot authorities is considered to be doable and necessary. The budgetary
        consolidation should also contribute to bringing the government gross debt ratio back
        on a declining path that approaches the reference value at a satisfactory pace by
        restoring an adequate level of the primary surplus.
   (10) In the recent past, Cyprus' budgetary framework has been improved with the adoption
        of the Financial Management Accounting System (FIMAS). As from 2006, Cyprus
        also enacted the gradual adoption of a three-year medium term budgetary framework
        (MTBF) and as from 2007 it introduced a Programme and Performance Budgeting
        (PPB). Nevertheless, the new framework is still phasing in and is only foreseen to be
        fully in place in 2012. Therefore, its impact could become effective only in the
        medium-term. The new framework's timely implementation would be critical for a
        successful and lasting consolidation of public finances. The existing practice of
        adopting supplementary budgets during the course of the year has implied an increase
        in current expenditure beyond the intended reallocation of funds. Once the new
        budgeting framework is fully implemented, it is expected to end this practise and lead
        to a more effective and efficient budgeting process and contribute to containing
        expenditure by ministry according to the ceilings set. At the same time, the new
        budgeting process would set a sound basis for reallocating expenditure in favour of
        growth enhancing activities.
   (11) The long-term budgetary impact of ageing is significantly above the EU average,
        mainly as a result of a relatively high increase in pension expenditure as a share of
        GDP over the coming decades partly due to the fact that the pension scheme is still in
        a maturing phase. A pension reform introduced in April 2009 would slightly reduce
        the increase in pension expenditure and, more significantly, raise the social security
        contribution rates. The reform should improve the long-term balance of the pension
        system and reduce risks to sustainability, however without having an effect on the
        overall assessment. The budgetary position in 2009 compounds the budgetary impact
        of population ageing on the sustainability gap. Improving the primary balance over the
        medium term and implementing further measures aimed at curbing the substantial
        increase in age-related expenditure, especially pension and healthcare expenditure,
        would contribute to reducing the risks to the sustainability of public finances, which
        were assessed in the Commission 2009 Sustainability Report2 as high.
   2
        In the Council conclusions from 10 November 2009 on sustainability of public finances "the Council
        calls on Member States to focus attention to sustainability-oriented strategies in their upcoming stability
        and convergence programmes" and further "invites the Commission, together with the Economic Policy
        Committee and the Economic and Financial Committee, to further develop methodologies for assessing
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 ---pagebreak---    (12) According to data notified by the Cypriot authorities in April 2010, general
        government gross debt was 56.2% of GDP in 2009. This increase was mainly the
        result of the significant deterioration in the primary balance and debt-increasing
        "snowball" effects on the back of falling nominal GDP. Stock-flow adjustments also
        had a negative contribution to the debt level equivalent to about 1 percentage point of
        GDP, due to accumulation of government assets at the end of the year in order to meet
        debt maturity obligations arising early in January of 2010, as well as, differences
        between cash and accruals. For 2010, Cyprus notified a planned debt of 62% of GDP,
        thus exceeding the 60% of GDP Treaty reference value (the April 2010 stability
        programme plans a slightly lower figure (61%) and foresees a further increase to
        63.2% of GDP in 2011). In view of the downward risks to the macroeconomic
        scenario and the budgetary targets, the evolution of the debt ratio may be less
        favourable than planned. The Commission services spring 2010 forecast projects debt
        to rise further to 62.3% of GDP in 2010 and 67.6% in 2011, on the back of a
        deteriorated primary balance.
   (13) Enhanced surveillance under the EDP will require regular and timely monitoring of
        the progress made in the implementation of the fiscal consolidation strategy. In this
        context, a separate chapter in the forthcoming updates of the Cypriot stability
        programme could usefully be devoted to this issue.
   (14) In general, in the view of the Council, budgetary consolidation measures should secure
        a lasting improvement in the general government balance, while being geared towards
        enhancing the quality of the public finances and reinforcing the growth potential of the
        economy.
   HAS ADOPTED THIS RECOMMENDATION:
   (1)    Recognising that Cyprus’ budgetary position in 2009 resulted from measures
          amounting to about 1½% of GDP in 2009, which is an adequate response to the
          downturn and were in line with the European Economic Recovery Plan, as well as
          from the free play of automatic stabilisers, Cyprus’ authorities should put an end to
          the present excessive deficit situation as rapidly as possible and at the latest by 2012.
   (2)    The Cypriot authorities should bring the general government deficit below 3% of
          GDP in a credible and sustainable manner by taking action in a medium-term
          framework. Specifically, to this end, the Cypriot authorities should:
        (a)     take necessary measures to reduce the 2010 deficit to below 6% of GDP and
                define an expenditure-driven consolidation strategy, in order to bring the
                deficit below the reference value by 2012;
        (b)     to this end ensure an average annual fiscal effort of at least 1¾% of GDP over
                the period 2010-2012, which should also contribute to bringing the government
                gross debt ratio back on a declining path that approaches the reference value at
                a satisfactory pace by restoring an adequate level of the primary surplus;
        the long-term sustainability of public finances in time for the next Sustainability report", which is
        foreseen in 2012.
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 ---pagebreak---           (c)      specify and rigorously implement the measures that are necessary to achieve
                   the correction of the excessive deficit by 2012, cyclical conditions permitting,
                   and accelerate the reduction of the deficit if economic or budgetary conditions
                   turn out better than currently expected.
   (3)      To limit risks to the adjustment, Cyprus should strengthen the binding nature of its
            medium-term budgetary framework as well as improve the monitoring of the budget
            execution throughout the year.
   (4)      Improve the long-term sustainability of public finances by implementing reform
            measures to control pension and health care expenditure in order to curb the
            projected increase in age-related expenditure.
   (5)      In addition, the Cypriot authorities should seize opportunities beyond the fiscal
            effort, including from better economic conditions, to accelerate the reduction of the
            gross debt ratio back towards the reference value.
   (6)      The Council establishes the deadline of [13 January 2011] for the Cypriot
            government to take effective action to specify the measures that will be necessary to
            progress towards the correction of the excessive deficit. The assessment of effective
            action will take into account economic developments compared to the economic
            outlook in the Commission services' spring 2010 forecast.
   The Cypriot authorities should report on progress made in the implementation of these
   recommendations in a separate chapter in the forthcoming updates of the stability
   programmes until the abrogation of the excessive deficit procedure.
   In addition, the Council highlights the importance of achieving the medium-term objective
   (MTO) for appropriate budgetary management of economic downturns. It therefore invites the
   Cypriot authorities to ensure that budgetary consolidation towards the medium-term objective
   for the budgetary position – a balanced budget in structural terms – is sustained after the
   excessive deficit will have been corrected. The adherence to the budgetary targets and the
   firm containment of expenditure over the medium-term could be improved by the full
   implementation, as envisaged, of an effective multi-annual budgetary framework.
   This recommendation is addressed to the Republic of Cyprus.
   Done at Brussels,
                                                  For the Council
                                                  The President
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