Saturday, 12 June 2010

EU: Updated stability programme Cyprus

Following the financial and economic crisis, what do the economic policy challenges look like for the governments in the EU (and the eurozone)?

How does economic policy coordination take place between the European Union and the member states?

The member states of the European Union shall avoid excessive government deficits. The Commission monitors the budgetary situation and discipline, especially the government deficit and government debt (Article 126 TFEU).

Cyprus is the latest member state to have completed one cycle of multilateral surveillance, from an updated stability programme to a Council opinion.

Cyprus joined the EU in 2004, and it adopted the euro currency in 2008.

Update submission

The Republic of Cyprus submitted its updated stability programme for 2009-2013 on 13 April 2010 (86 pages).

The government presented its views on the two-fold challenges for fiscal policy (page 7):

Undoubtedly, the biggest challenge facing policy makers at the current juncture is to address the economic slowdown, which has affected Cyprus considerably through falling external demand:

• The Government must put in place the elements for a sustainable recovery of growth, and the creation of new jobs in the medium term; and

• At the same time, prepare a strategy to reverse the deteriorating public finances and allow for the fiscal correction in the following years as required by the Stability and Growth Pact.

We are going to look at some of the policy challenges and the responses outlined by the government of Cyprus. Despite different circumstances in the individual member states, there are many similarities between the possible approaches and solutions, both short term and with regard to structural reforms.

Deficit reduction

Having stated the effects of the economic crisis on the Cypriot economy, the government concluded that a turnaround in revenues will not materialise in the short term, and without any corrective measures the deficit could widen further in 2010 (page 8):

Thus, the overriding priority of the Government is to contain the deficit in 2010 to around 6% of GDP – an ambitious goal taking into consideration the difficult environment that Cyprus is facing – and proceed with the fiscal consolidation thereafter, according to the requirements of the Stability and Growth Pact. To achieve this, the Government intends to introduce a number of policy measures which are necessary in view of the deteriorating revenue situation in 2009:

• Town planning amnesty for buildings constructed with minor irregularities opening the way for the issuance of a backlog of outstanding title deeds;

• A systematic attempt to curtail current expenditures;

• Public sector reforms that will address the growing size of the civil service and bring about a bridging of the benefit gap with the private sector. A modernization of the public sector is key and can result in leaner and more productive public services. Such a policy will limit expenditure growth and raise overall productivity;

• A reform of the system of social transfers in order to target benefits better and help more those in greater need.

Additionally, a number of structural fiscal reforms are underway which should lead to better planning of spending, easier control of expenditures and lead to considerable savings on interest expenditure:

• The implementation of a Medium-Term Budgetary Framework (MTBF), which will institutionalize expenditure rules, give more independence to spending ministries and, at the same time, increase their accountability;

• Further improvement of tax collection by addressing tax evasion and avoidance and strengthening tax administration;

• Enhancement of public debt and cash management systems.

Structural reforms

If curbing government spending is one part of the equation, the other part is to enhance economic growth (pages 9 to 10):

During this difficult time internationally, and domestically, it is especially important to continue with the implementation of structural reforms which will help maintain long-term growth at satisfactory levels and boost the economy’s agility and competitiveness. This is more pressing now given that the economy’s potential growth has been affected by the crisis.

Cyprus has already submitted an elaborate outline of structural reforms in its National Reform Programme (NRP). The implementation of these measures is an important pillar of this SP [stability programme], and the funding constitutes an important element of the proposed budget.

• Implementation of policies aimed at upgrading the physical infrastructure and improving the functioning of network industries will be intensified, taking into account environmental concerns. This “Green Agenda” will pave the way for growth in the longer term, but also boost economic activity in the short and medium term. A number of infrastructure projects will be accelerated in particular as part of the EU-led initiative to boost demand in view of the weakening economic activity especially in the construction sector;

• Reforms are being undertaken in the labour market, especially to boost supply of labour among females and address the high gender pay gap, increase employability and labour force adaptabil√≠ty—particularly through lifelong learning—and raise the employment rate. Enhancing human capital is also key in increasing productivity and boosting the economy’s potential growth. Development of human capital is especially important in an economy, dominated by the services sector;

• Furthermore, reforms are being carried out, aimed at strengthening competition, especially in the area of professional services, improving the overall business climate;

• Special emphasis will be put on streamlining the regulatory framework and cutting red tape;

• Another important area is reform of the healthcare system, in particular the reorganization of public hospitals and the gradual introduction of the National Health Insurance Plan. This, together with the recent reform of the social security system, are crucial for tackling the long-term sustainability of public finances;

• Finally, it is widely accepted that R&D and innovation and the wider utilisation of information technology and the attraction of foreign direct investment are important vehicles for boosting productivity and growth. A particular effort is being undertaken to coordinate more effectively government-funded academic and private sector research programmes, so as to encourage innovation. EU structural funds will finance a large part of the budget for Research, Technological Development and Innovation, while the institutional framework for R&D and innovation will be further enhanced. These efforts have been boosted by the special efforts coordinated by the Cyprus Investment Promotion Agency, aiming at attracting foreign direct investment in Cyprus.

These interesting questions are then discussed in considerable detail in the updated stability programme of Cyprus.

Ralf Grahn