Commission forecast for Cyprus

13 May 2011

Moderate and rebalanced recovery in 2010 is expected to continue in 2011, and to gain momentum in 2012. The external imbalance weighs on the economic recovery and so does the fiscal deficit.

The recovery of economic activity is projected to continue into 2011 and to gain momentum in 2012. During this period, the contribution of the external sector in growth composition is set to gain ground. Exports of goods and services, mainly financial and business services, should pick up in line with a rebound in global trade and an improved Outlook in Cyprus' main trading partners.

Given this economic outlook, the challenge for the Cypriot economy is to achieve a balanced growth path, leading to further correction of the large negative balance on the external account, in a context of higher potential growth.

Public finances in Cyprus deteriorated substantially as a result of the global economic crisis and discretionary fiscal stimulus measures, as well as rather large composition effects due to a less tax-rich GDP growth pattern. As economic growth rebalances towards a more export-oriented pattern, this may complicate consolidation efforts.

The budgetary deficit in 2010 declined to 5.3 per cent of GDP from 6 per cent the previous year. This is lower than the estimated outturn in the 2011 Budget Law for a deficit of 5.9 per cent. In 2010 however, revenues benefited from a one-off factor of almost ¾ pp of GDP, associated with the profit on an interest swap agreement and a transfer of higher-than-usual Central Bank profits. The structural deficit fell to about 5 per cent in 2010 from 5¾ per cent of GDP in 2009. These changes reflect higher revenues, which were partially offset by higher expenditure. On the one hand, direct tax revenues benefited from the lagged impact of the deemed dividend distribution fee. Indirect tax revenues were supported by rise in the excise duties of petroleum products imposed in mid-2010, while social contribution revenues were boosted by the first full-year impact of the increased contribution rates adopted in the first half of the 2009 as part of the pension reform. On the other hand, current expenditure continued to rise, despite the containment of public consumption and interest payments, on the back of rising social outlays due to the increase in unemployment benefits and the enactment of other social policy measures.

Based on the no-policy-change assumption, the deficit is set to subside marginally to 4.9 per cent of GDP in 2012, due to minor savings on the public wage bill from the lower contribution from the COLA and the social outlays in line with an improvement in the labour market. With still moderate growth and an increasing deficit, the debt-to-GDP ratio should remain on a rising trend and reach about 64 per cent of GDP by 2012.

Full forecast (Greece)

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