Fiscal risks to Cyprus’ outlook have increased considerably due to the uncertainties surrounding the sale of the Cyprus Co-operative Bank and the associated government bond issuance, the European Commission said in its post-programme surveillance report.
“The macroeconomic situation and outlook remain very positive although the risks to the outlook have increased,” the European Commission said.
The government has issued €2.35 billion in government bonds to facilitate the sale of the performing operations of the CCB to Hellenic Bank, as part of a wider strategy to reduce the high stock of non-performing loans in the banking sector.
However, the Commission pointed out that the transaction has increased the risk to the island’s economic outlook.
“The forecast is subject to uncertainties mainly in relation to the financial sector developments, in particular on the budgetary impact of the government`s transaction related to the CCB,” the report added.
Given Cyprus’ remarkably strong fiscal performance, sizeable surpluses, and the one-off nature of the increase in Cyprus’ public debt, the Commission believes that public debt will decline steadily after spiking at 105.7% of GDP in 2018.
“Nevertheless, a continuous prudent budgetary policy remains essential, especially in view of increased downside risks; it is crucial to ensure that temporary revenue windfalls do not give rise to permanent increases in expenditure and to safeguard fiscal sustainability in line with the requirements of the Stability and Growth Pact,” the report added.
According to the report, fiscal risks are associated also with public payroll growth. The Commission pointed out that “compensation of employees may suffer upward pressure, which may have significant budgetary implications and potential spill-over effects in the private sector.”
The Commission noted that Cyprus’ forecast for sizeable budgetary surpluses in 2018 and 2019, are subject “to uncertainties mainly in relation to the financial sector developments, in particular on the budgetary impact of the government`s transaction related to the CCB.”
According to the Commission, additional risks to the fiscal outlook relate to the fiscal impact of healthcare reform and the public payroll growth trend once the collective agreement expires.
The Commission also pointed out that “renewed structural reform commitment by all national stakeholders is key to maintain growth over the medium term and safeguard fiscal sustainability.”
The report also highlighted that need for a swift completion of the justice system reform is “given its significant impact on the functioning of the economy and its strong link to the reduction of NPLs.”