The government budget for 2022 presented to the House of Representatives on October 7 calls for the overall deficit to be reduced substantially from an estimated 5 per cent of GDP in 2021 to 1.1 per cent next year. This projected deficit results from an estimated increase of government revenues of 4.9 per cent and a most questionable reduction in government expenditure of 4 per cent in 2022. Furthermore, it is stated by Finance Minister Constantinos Petrides that the budget aims to “correct” the public finances by reducing the ratio of government debt to GDP from 107.7 per cent at end-2021 to 100.9 per cent by end-2022.
However, these budgetary estimates do not seem feasible as inflationary and political pressures are likely to affect the ultimate composition of budget expenditures and revenues approved for 2022 and will be particularly important in determining the actual execution of the budget.
Moreover, as the budget is a contract between citizens and the state it is important as well to ascertain whether tax revenues and borrowed funds are being raised efficiently and fairly and are spent in delivering high quality public services.
Unrealistic assumptions
The underlying assumptions made on price prospects and on real GDP growth are critical to the budget estimates for 2022, but also for the base budget estimates for 2021.
Prices
The assumption that consumer prices and presumably the GDP deflator will increase by only 2 per cent on average in 2021 and fall to 1.5 per cent in 2022 seems most unrealistic as prices have been rising at a much faster rate in recent months and are likely to spiral upwards further as supply shortages and higher import prices impact on the Cyprus economy. But, Petrides stated last week that “regarding inflationary trends the consensus view sees these as transient”. Moreover, the finance ministry appears to have based its price estimates for different budget items solely on developments in and prospects for consumer prices.
For Cyprus over the 12 months to September 2021 consumer prices have risen by 3.6 per cent, electricity prices have increased by 39.4 per cent, petroleum product prices are up by 21.1 per cent, and the materials construction price index has risen by 14.9 per cent. Furthermore, with severe supply shortages continuing and shipping costs at record high levels, elevated prices are likely to be sustained well into 2022. And with these higher prices certain government expenditures can be expected to rise markedly with the cost of development projects reflecting increased prices of fuel and materials for construction and government current expenditures entailing greater outlays on higher-priced goods and services.
In addition, elevated prices are likely to indirectly cause government expenditures to increase through the provision of financial assistance including possibly subsidies to consumers and businesses most adversely affected by soaring prices, especially of energy products.
Also, with Cost of Living Adjustments (CoLA) expected to be greater than assumed because of higher rates of inflation the outlay for the budget of government wages and salaries and pensions in 2022 is likely to be greater, especially if there is a restoration of six-monthly CoLA.
Real GDP growth
Supply problems, external financing difficulties and the possible depressing impact of higher prices on the volume of consumer spending are factors that could reduce the real GDP growth rate to below the assumed budget estimate of 4.0 per cent for 2022. On the other hand, a return to the 2019 level of tourist arrivals could raise the growth rate, offsetting somewhat these negative factors.
Political pressures
As 2022 is a pre-presidential election year there will be greater political pressures on the design and execution of the budget.
Budget design
The ruling political party, Disy, will be pressing for expanding current expenditures geared to gaining electoral support through among other things again increasing the wage and salary bill with more appointments and higher remuneration of public sector employees. Also, the Disy-backed government will be reluctant to raise taxes to fund expenditure overruns and is likely to just borrow more and pass the financing burden onto taxpayers after the presidential election. In this connection it is noted that in a pre-presidential election year the government would be very reluctant to broaden the tax base and make serious efforts to combat tax evasion that could particularly upset its wealthy supporters.
And in seeking to gain approval for the budget from certain other horse-trading political parties the government is likely to agree to their requests for higher expenditures for certain items. In addition, the main opposition party, Akel, most likely will be requesting higher outlays for education, healthcare and more support for vulnerable groups hurt by the ongoing upsurge in energy and other prices.
Budget execution
What is worrisome to apolitical economists and to Akel and the Green party is that as the budget year unfolds populist current expenditures are likely to be boosted and leave little financial and institutional capacity for implementing development projects and effecting progress in the “green” transition. That is, in executing the budget the government is likely to become increasingly concerned about maintaining the status quo including providing continued support for the tax-incentivised and credit-fuelled property sector rather than undertaking promised investments and reforms under the Recovery and Resilience plan. In consequence development expenditures which are budgeted to increase by 10 per cent in 2022 are not likely to be more than 70 per cent implemented, as has been the case in recent years.
Overall assessment and risks
In view of the aforementioned inflationary and political pressures it is difficult to see how total government expenditures in 2022 can be contained let alone be in line with the budgeted decline of 4 per cent. And with tax policies if anything less burdensome on the corporate and property sectors and with continued weak efforts against tax evasion it may be even problematic for the government to attain the estimated growth rate of 4.9 per cent for revenue in 2022. Thus, it seems highly improbable that the government deficit can be reduced to anyway near the budgeted target of 1.1 per cent of GDP. In addition, uncertainty on the extent of the increase in the deficit in Gesy accounts for 2022 adds to the risk that the deficit target will be largely under-achieved and the government will not be able to bring about a substantial decline in its debt to GDP ratio.
However, attaining government deficit and debt targets should be of secondary importance and even the European Commission appears intent at this stage on allowing countries to deviate from meeting pre-Covid fiscal rules. The prime objective of the government budget should be to incorporate policies that contribute to the socio/economic welfare of Cyprus citizens through the delivery of high-quality services. But the policies behind the 2022 budget appear to be more of the same with expenditures geared to boosting unnecessary current expenditures (e g. appointments of advisors and employees to help with political objectives) as against outlays on enhancing the quality of the systems of education, healthcare and taxation including the recruitment of staff who can improve related institutional capacity.
Besides budget policies continue to be based on an increasingly regressive taxation system with virtually no taxation of wealth and turning a blind eye toward the prolific tax evasion and debt defaulting of the rich political and business “elite”. Furthermore, the extreme favouring of government employees in income and benefits remuneration as well as regressive tax policies are promoting the further widening of inequalities in income, wealth and employment opportunities.
Leslie G Manison is an economist and financial analyst, specialising in macroeconomic policy analysis, bank viability assessments and international financial relations. He is a former senior economist at the International Monetary Fund, an ex-advisor in the Cyprus finance ministry and a former senior advisor at the Central Bank of Cyprus
