By Fiona Mullen
Director, Sapienta Economics Ltd
The European Commission’s alleged decision last week to remove Cyprus from the excessive deficit procedure (EDP) is a puzzling one.
I say alleged, because it is not quite that simple, as will become clear. But the Commission’s decision has still confused many, leading to accusations that the Commission has taken the pressure off Cyprus just as the government’s will to reform will be at its weakest because of legislative elections in May.
The last time Cyprus was put under an EDP was in 2004, when Cyprus had run up a budget deficit of 6.3% of GDP in the previous year, or even more according to revised Eurostat data.
It took more than two years and a very sharp reduction in the budget deficit, to 2.4% of GDP in 2005 and 1.2% of GDP in 2006, before Cyprus was taken off that list.
This time, the European Commission recommended that Cyprus be put on the excessive deficit list on June 15, 2010, because the country had reported a budget deficit in 2009 of 6.1% of GDP (now revised to 6.0%).
The European Council (the heads of government) duly approved this on July 13, 2010 and Cyprus was put under official EDF watch.
Now, just a few months later, when Cyprus has merely brought the deficit down to 5.3% in 2010 according to the finance ministry’s latest estimates, when Standard and Poor’s has already downgraded us and Moody’s and Fitch are threatening to follow on the basis of our fiscal performance, we already appear to be off the hook.
So what is the Commission up to?
Not a conspiracy
First, since we are in Cyprus, we have to dispense with the conspiracy theories.
This is nothing to do with the January visit of Germany’s Chancellor, Angela Merkel, her clear support for President Christofias in the peace negotiations and evident lack of confidence in Turkey.
The report on Cyprus and other EDP countries published on January 27 comes from the Commission, an institution of bureaucrats that jealously guards its independence from the politicians (just look at the disagreements in their respective legal services over the legal basis for the direct trade regulation).
Second, if we read the text closely, Cyprus has not in fact been removed from the EDP.
The “Communication from the Commission to the Council on action taken” published on January 27, says “On the basis of currently available information, it appears that Cyprus has taken action representing adequate progress towards the correction of the excessive deficit within the time limits set by the Council.”
What was that time limit?
The short-term time limit was the end of 2010, when Cyprus was asked to “take necessary measures to reduce the 2010 deficit to at most 6% of GDP”.
Since the government managed to shave a few percentage points off the deficit (in fact, when the Commission prepared its report, it looked like the deficit had been cut by only 0.1 pp to 5.9% of GDP), this short-term goal was met.
The benchmarks will get harder
Now, one can argue that this target was too easy. But this is less to do with Cyprus specifically than the general loosening of standards that France and other big-hitting members forced on the Commission some years ago, in the golden days before fiscal problems in one member state started to affect interest rates paid in another.
But Cyprus’s longer-term target of “bringing an end to the situation of an excessive government deficit by 2012” remains in place and has other conditions.
As well as cutting the budget deficit in 2010, the government has been asked to “define an expenditure-driven consolidation strategy, in order to bring the deficit below the reference value [3% of GDP] by 2012”.
So far, the government has concentrated mainly on tax increases rather than on expenditure cuts to achieve its goals.
The Commission noted that “the bulk of the fiscal consolidation measures adopted by Cyprus have been on the revenue side despite the Council recommendation for an expenditure-driven consolidation strategy.”
Therefore, by the time the Commission reports again, it will probably want to see evidence of more action on the expenditure side.
For the government, this means tough negotiations with the PASYDY public-sector trade union.
Another request is to “ensure an average annual fiscal effort of at least 1.5% of GDP over the period 2011-2012” and to “accelerate” deficit-reduction if economic conditions are better than expected.
This means that the goals will get harder. In 2010, the government cut the deficit by 0.7 percentage points. It has to achieve more than double that in 2011 and 2012.
While the Commission thinks that the government has taken measures to achieve this, it also says “there are risks to the achievement of the deficit targets, mainly stemming from the
standard practice of adopting supplementary budgets during the course of the year, but also due
to possible slippages in social transfers and the impact of the wage indexation (COLA) on the
public wage bill.”
In other words, it knows only too well that the government will come under all kinds of pressure to relax its targets throughout the year.
Last, but not least, the Commission has asked Cyprus “to improve the longterm sustainability of public finances by implementing reform measures to control pension and health care expenditure in order to curb the projected increase in age-related expenditure.”
These are the most difficult reforms for any government to implement but are essential if we are not to see the country go bankrupt just as we enter old age.
In sum, it is only if Cyprus manages to bring the deficit to below 3% of GDP by 2012 and looks like it can keep it there, will we finally be free of the excessive deficit procedure.
