30 May 2012

Council Recommendation on the National Reform Programme 2012 of Cyprus

The objective of the budgetary strategy outlined in the Stability 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 Stability Programme confirms the previous MTO of a balanced budget in structural terms, which adequately reflects the requirements of the Stability and Growth Pact. The 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 budget balance1, the average annual fiscal effort planned at 1.5 per cent 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 per cent of GDP benchmark of the Stability and Growth Pact both according to the Commission services 2012 spring forecast and the Stability Programme.

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 number of non-performing loans (NPLs) extended to Greek borrowers. Total exposure of the consolidated Cypriot banking sector to Greece is very high. The 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 per cent of all domestic deposits, has so far not been satisfactory.

It can be concluded that Cyprus is affected by imbalances. In particular, macro-economic 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. In particular, 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, growth prospects are dim which further hinders the relatively slow unwinding of imbalances.

Council Recommendation (6.7.12)

Commission Proposal

Commission Staff Working Paper

In-Depth Review

National Reform Programme

Stability Programme (April 2012)

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