European Commission explains concerns on potential budgetary deviation in document sent to the Council

The Commission is of the opinion that the Draft Budgetary Plan of Cyprus, which is currently under the preventive arm and subject to the transitional period to make sufficient progress towards compliance with the debt reduction benchmark, is “broadly compliant with the provisions of the Stability and Growth Pact” and identifies extensively the potential sources and reasons for deviation from these targets.

This explanation is the overall conclusion presented in the EC Staff Working Document (SWD 2017 512 final) on “the Commission Opinion of 22.11.2017 on the Draft Budgetary Plan of Cyprus” [C(2017) 8012 final].

According to the document, communicated to the Council of the Member States, the Commission says that, “based on the Commission 2017 autumn forecast, there is a risk of some deviation from the Medium Term Objective in 2017 and in 2018”.

EC states that “Cyprus is projected to be compliant with the debt criterion in 2017 and 2018” and “the Commission invites the authorities to stand ready to take the necessary measures within the national budgetary process to ensure that the 2018 budget will be compliant with the Stability and Growth Pact, and to carefully monitor expenditure developments in the short and medium term, due to the risks associated with increases in expenditure being financed by temporary revenue windfalls”.

According to the same document, “the Commission is also of the opinion that Cyprus has made some progress with regard to the structural part of the fiscal recommendations contained in the Council Recommendation of 11 July 2017 in the context of the 2017 European Semester and invites the authorities to make further progress”.

“A comprehensive assessment of progress made with the implementation of the country-specific recommendations will be made in the 2018 Country Reports and in the context of the country specific recommendations to be proposed by the Commission in May 2018”, says the EC.

Furthermore on the sources of potential deviation, the Commission notes that “taxes on labour and on income of corporations in Cyprus are among the lowest in the EU” and “given that these taxes are the most distortionary, the tax structure in Cyprus is less detrimental to growth”. However, “Cyprus decided in 2016 to eliminate the tax on immovable property, with full effect from 2017 onwards”. “This represents a drawback”, says the Commission, “as it narrowed the tax base and reduced the fiscal space for financing additional growth enhancing reforms or consolidating the social welfare system and safety net”.

According to the Draft Budgetary Plan, “Cyprus is expected to make sufficient progress towards compliance with the debt reduction benchmark in 2017 and 2018”. “This is consistent with the assessment based on the Commission 2017 autumn forecast”, says the Commission. “The expected decline in Cyprus debt-to-GDP ratio mostly owes to the debt- decreasing impact of the favourable path of the general government balance in 2017 and 2018, as well as real GDP growth and a pick-up in inflation”.

The same document states that “in 2017, the (recalculated) structural balance is estimated to exceed the MTO by 0.4% of GDP”. “However, the structural balance is improved by significant revenue windfalls, in the absence of which the MTO would not be achieved”, the Commission clarifies. “The revenue windfalls mainly relate to high revenue buoyancy, underpinned by the favorable macroeconomic situation and the positive developments in the labour market”.

The Commission states that “according to the information provided in the Draft Budgetary Plan, the expenditure benchmark points to a risk of significant deviation from the applicable (real) reference rate (gap of 1.4% of GDP)”.

“Following an overall assessment and taking into account the low estimates of potential GDP growth, the expenditure benchmark still points to a risk of significant deviation”, says the Commission.

Further explains that “the structural balance is positively impacted by sizeable revenue windfalls and negatively by the rise in nationally financed public investments, pointing to a risk of some deviation from the requirements”.

“Thus, according to the Draft Budgetary Plan, the overall assessment points to a risk of significant deviation in 2017 based on the expenditure benchmark”.

Based on the Commission 2017 autumn forecast, Cyprus is also expected to remain above its MTO in 2017. However, “following an overall assessment and after taking into account the above-mentioned factors impacting on the expenditure benchmark and the structural balance, as well as differences in deflators, Cyprus is expected to be at risk of some deviation on both the expenditure benchmark and the structural balance pillars”.

“Expenditure developments should be monitored very carefully in the short and medium term, especially due to the risks associated with increases in expenditure financed by temporary revenue windfalls”, says the Commission and explains that “experience suggests that a build-up of additional expenditure financed by such windfalls is very difficult and costly to revert”.

The Commission states in the same document that “in 2018, according to the information provided in the Draft Budgetary Plan, the expenditure benchmark points to a risk of significant deviation from the required (nominal) reference rate (gap of 0.5% of GDP)”. The (recalculated) structural balance points to a risk of some deviation from the MTO (gap of 0.2% of GDP). However, “following an overall assessment and taking into account the differences in potential growth rates, revenue shortfalls, as well as dynamics of investment and interest expenditures impacting on 2018, both the expenditure benchmark and the structural balance pillars point to a risk of some deviation”. Commission staff further notes. “This conclusion is confirmed based on the Commission 2017 autumn forecast”, they stress.

Source: Cyprus News Agency