European Commission forecasts and the outlook for the Cyprus economy  

By Andreas Charalambous and Omiros Pissarides

At regular intervals, the European Commission undertakes an assessment of the economies of the member countries of the EU. This process, known as ‘European Semester’, constitutes the bedrock for the Commission’s country specific recommendations on fiscal and policy reforms. The European governments are committed to follow these recommendations while, in severe cases of non-compliance, the EU framework foresees the imposition of sanctions.

The evaluation and recommendations of the Commission for Cyprus are particularly important this year, since they will lay the foundation for the absorption of over €2bn in funds over the next years in the context of the EU – Next Generation programme, facilitating the country’s adaptation to the challenging post pandemic period.

The assessment reiterates that the repercussions of the pandemic have been less pronounced for Cyprus than originally expected. On the basis of the Commission forecasts, the shrinking of the economy was confined to -6 per cent in 2020, unemployment increased relatively modestly to 8 per cent and the fiscal deficit reached 6 per cent, compared to the much higher levels projected initially. At the same time, public debt exhibited an upward trend, which is, however, anticipated to be reversed over the next years.

The main factors leading to an amelioration of negative repercussions included the timely adoption of strict measures against the pandemic in March 2020, as well as the contained decline in private consumption, reflecting the perception that the pandemic would be a temporary phenomenon and preventing a steep downward reduction in consumption expenditures. The government liquidity and other support measures, in line with the European Council guidelines, also played a positive role.

However, the Commission’s assessment also brings to the surface structural weaknesses, which act as constraints to the necessary adaptation of the economy to the current challenges in a sustainable manner. Private debt remains at excessively high levels and continues to negatively impact banks’ balance sheets. Private and public investments constitute only a relatively low share of GDP and are mainly directed towards low throughput construction projects. Labour productivity is on a declining trend for a number of years while the current account of the balance of payments, generally acknowledged as a reliable indicator for long term competitiveness, is in deficit.

As reflected in a number of other Commission reports, Cyprus lags behind in sectors which are crucial for its future growth potential, such as the green economy and modern technology. In fact, our country’s performance concerning the utilisation of renewable energy, recycling, innovation and research and development remains much below EU averages.

Taking the above into account, in its recommendations addressed to Cyprus, the Commission is expected to reiterate the need for a radical structural reform agenda, identifying public sector reform, justice system reform and facilitation of the access of small and medium enterprises to financing as among those needing urgent action. Moreover, the Commission’s recommendations will likely identify the upgrading of the sectors of environment and technology as priorities.

Cyprus should react with a positive spirit by preparing and putting into implementation a far-reaching reform programme, aimed at advancing the green and digital transformation agendas. An ambitious public investment programme should be placed at the core of such a reform effort. In this context, the favourable financing conditions in international sovereign debt markets due to the prolonged period of low interest rates, as well as the generous funding which can be secured from the EU – New Generation funds, represent an important opportunity which should not be missed.

Andreas Charalambous is an economist and a former director at the Ministry of Finance.
Omiros Pissarides is the Managing Director of PricewaterhouseCoopers Investment Services