But a new fuel tax could still wreck euro plans
The government has revised down its forecast for the budget deficit in 2005, following better than expected results for the first nine months, showing a small budget surplus of CYP 19.5 mln (cash basis). However, now that the heat is off the budget, a new risk to the euro adoption target has emerged in the form of inflation.
The budget surplus for January-September was down from the CYP 49.6 mln recorded in January-June, but is still better than the deficit of 2.84% of GDP on a cash basis initially expected by the government for the whole of 2005.
The Ministry of Finance has shaved off just over 3 percentage points from its initial forecast, now forecasting a cash deficit of 2.52% of GDP excluding deficits of local authorities (which are normally quite small).
The budget is expected to slip into deficit in the last three months of the year as ministries rush to spend their budgets.
Total revenue and grants rose by 19.1% year on year in the first nine months, thanks partly to the tax amnesty but also to a rise of 20.5% in regular income tax receipts and a rise of 18.5% in VAT receipts.
Expenditure, on the other hand, rose by only 7.9%, thanks largely to a 12.8% drop in subsidies and a 58.7% drop in defence expenditure.
Fiscal criteria maybe no problem, but…
A deficit of just 2.5% of GDP in 2005 would put the government well on course to meet the fiscal conditions for adopting the euro.
Now that the government has officially declared January 2008 as its target for adopting the euro, the European Commission and the other resonsible bodies are likely to test whether Cyprus has met the four Maastricht criteria on the deficit and debt, inflation, interest rates and exchange rates in the middle of 2007 — two years after the Cyprus pound entered the Exchange Rate Mechanism (ERM2).
When assessing the budget, the authorities will look at the previous year’s data, which means that 2006 is the crunch year for Cyprus’ fiscal accounts.
…would a new petrol tax kill the euro?
However, that does not mean that we are home and dry. Cyprus must also have an inflation rate no higher than 1.5 percentage points above the three EU member states (not just euro area) with the lowest inflation rates (excluding those with deflation).
In other words, if 12-month inflation in those three is, say, only 1.6% by the middle of 2007, Cyprus’ harmonised inflation rate must be no higher than 1.6 + 1.5 = 3.1%.
With harmonised inflation already rising, this will be an extremely difficult target to meet if the government shifts road tax to fuel by the end of the year, as it is currently considering.
The price of petrol would rise by 10%, according to estimates, and could conceivably push inflation to well over 3% for many months, therefore also pushing up inflation into 2007 and the 12-month rate which the Commission will use to make its assessment.
This probably explains the government’s rush to impose the tax now, in the hope that, by the middle of 2007, the impact of the new tax will have diminished.
However, it is a high risk strategy for a government which has made adopting the euro a matter of national pride.
Fiona Mullen
