Business & Economy

CYPRUS: Fiscal Council calls for a state reserve fund

24 October, 2018

To guard against overspending, the Fiscal Council has called on the government to create a mechanism binding part of the existing reserve and primary surpluses to serve the public debt.

Presenting its Autumn Report, Council president Demetris Georgiades, said that due to the level of public and private debt and risks to the Cypriot economy, it strongly believes the government should consider the creation of a mechanism which withholds part of the high primary surpluses being recorded.

Such a mechanism could take the form of a Sinking Fund.

He said that the Council warned the government that the temporary increase in government revenue should not lead to state spending which could not be covered in the future.

"While such mechanisms are not to be taken into account while calculating the country’s compliance to existing regulations over public debt, they will provide evidence of Cyprus' commitment to fiscal discipline with a positive impact on credit ratings and the cost of borrowing for the government,” said Georgiades.

“It will also improve the attractiveness of Cyprus as an investment destination. Such a development will also be consistent with the suggestions of European officials calling on EU Member States, especially those with high public debt, to create reserves to deal with unforeseen risks, " he added.

Georgiades quoted the Vice President of the European Commission Valdis Dombrovskis in saying: “So far we have been operating in a very low interest rate environment and the monetary policy has been very accommodating. So, the question was how to ensure full smooth adjustment and minimise any negative impact of the policy normalisation on the financial sector and the real economy”.

Georgiades added that Dombrovskis called the creation of reserve funds “the first line of defence”. He pointed out that low savings are a threat for the adequacy of the state’s pension fund.

ESTIA Scheme

Talking on potential risks for the Cyprus economy, he referred to the entity which is to manage the entire banking system’s NPLs.

He said such an agency needed to be managed by specialised technocrats, to have a distinctively separate role from the exercise of social policy (ESTIA Scheme), and to be out of reach from political interventions.

He also said that in general the legislative framework needs to be upgraded and the legal process should be accelerated with stricter regulations, transparency and control.

Regarding the ESTIA scheme to help homeowners who have defaulted on their mortgage, Georgiades noted that the criteria of the scheme should be made fairer and copy standards of other social support schemes, so as to avoid any possible moral hazard.

Georgiades argued that the scheme’s current criteria are not socially fair, as they could include individuals with an income of EUR 50,000 and property other than the mortgaged first home but exclude a family of six with a total income of EUR 51,000 without any other property.

He said the “Investment for citizenship” scheme cannot continue forever, as it is already coming under scrutiny from the EU.

He added that its possible termination may lead to some negative effects on a series of production sectors.

The Council, acknowledging the importance of timely assessing risks arising from the very high public debt, has joined forces with Professors Andreas Konsilio of the University of Palermo in Italy and Stavros Zenios of the University of Cyprus in order to develop a model which will detect risks deriving from public debt.

At the same time, the Council is making efforts to collect data from other independent Fiscal Councils of EU countries, aiming to extend the study to other EU Member States.

According to the Council, Cyprus is not expected to have any problems in servicing the public debt, that is in meeting the mixed financing needs.

However, due to the level of public debt and hence the high gross financing needs, if the medium-term average nominal GDP growth rate is significantly reduced from the currently projected 4.5% to 2% due to possible internal and external threats, then there is a probability that Cyprus will have difficulties in servicing public debt.

The ratio of public debt to GDP is expected to be 111.4% in 2018 and drop below 100% in 2020.