Government more interested in pleasing credit-rating agencies than citizen welfare

By Les Manison

In presenting the government budget for 2023 to the House of Representatives the minister of finance, Constantinos Petrides, stated that “the budget was prepared in a climate of great uncertainty intensified by the effects of the Covid-19 pandemic and Russia’s invasion of Ukraine”. However, despite these uncertainties the proposed 2023 budget is quite unrealistic in being based on very optimistic assumptions as to the growth of the economy and a large decline in the rate of inflation to 3 per cent next year. Furthermore, the budget fails to allocate sufficient funds to deal with ongoing problems such as in providing assistance to households and businesses to counter the cost of living crisis. In fact, the latest ‘World Economic Outlook’ publication of the IMF highlights the need for “fiscal policy to alleviate cost of living pressures”[1].

Moreover, in executing and preparing government budgets the primary concern of the Cyprus authorities appears to be pleasing credit-rating agencies with numbers showing budget surpluses and falling public debt ratios rather than carefully assessing the impact of fiscal policies on overall economic performance and the welfare of citizens. Thus, budgets tend to be biased toward pursuing fiscal austerity.

Macroeconomic assumptions and budget implications

Against the background of austere policies that are projected to lower real government expenditures by around 4 per cent and produce an overall surplus in 2022 the proposed government budget for 2023 estimates a higher surplus of 1.7 per cent of GDP. With the budget being based on the optimistic assumption that prices will increase by a modest 3 per cent in 2023 there is the greater risk of the economy experiencing a serious downturn. Indeed, if the rate of inflation in 2023 turns out to be much higher than 3 per cent and the government keeps to its budgeted expenditure targets based on the assumption of relatively low inflation, real expenditure and incomes would decline and present the government with difficult choices.

Should it keep to its expenditure targets in order to achieve its planned budgetary surplus, and in effect continue to pursue fiscal austerity? Should it cut back on real development expenditures and real outlays for assisting households and businesses to help shield them from soaring prices and costs as it has done this year? In fact, it is noted that prices during 2022 have risen well above the original “incredible” official forecast of 1.5 per cent for this year.

Or should budget expenditure estimates be substantially revised upwards in line with more realistic estimates of the inflation rate? The latter choice could be quite destabilising at a time when real private incomes and domestic demand are likely to fall and reduce the increase in tax revenues in 2023. In this situation pressures on government finances would result in forcing the government to borrow much more than it intended leading to a reversal in the planned downward path of the public debt ratio.

Against the headwinds of continued relatively high rates of inflation and a marked deceleration in the growth of European economies, that among other things could adversely affect external receipts from tourism, the assumption or forecast of real GDP increasing by 3.5 per cent in 2023 appears to be very optimistic. With the rate of increase of incomes expected to continue to lag behind price rises, savings being depleted, and financial conditions tightening, real consumption and investment demand of the private sector are likely to be curtailed and along with flat or reduced tourist expenditures contribute to weak growth or even recession in 2023.

According to the budget forecasts the unemployment rate is projected to decline from an estimated 7.0 per cent in 2022 to 6.4 per cent in 2023. However, with the unemployment rate having risen in recent months and the prospect that the Cyprus economy will slowdown by much more than officially forecast the unemployment rate is likely to rise in 2023.

Inadequate budget allocations

The composition of budget government expenditures does not appear to be adequate for dealing with the difficult problems facing struggling businesses and households. Minister Petrides has admitted that during the current year the government did not have sufficient funds to provide adequate social benefits to suffering households and businesses. Yet budgeted funds allocated to the Ministry of Labour and Social Insurance in 2023 are decreased by €4 million. Surely, funds available for assisting households and businesses adversely affected by rampant inflation as well as for the expected rise in the number of unemployed persons should be substantially increased, with benefits raised in line with the rate of inflation and, most importantly, quickly disbursed.

In sharp contrast are the greatly elevated allocations of funds for the Ministries of Defence and Interior for 2023 with increases of €55 million and €39 million, respectively. It seems that enhancing the welfare of foreign companies selling defence and security equipment and materials is more important than trying to maintain the living standards of the majority of citizens of Cyprus.

Inadequate institutional capacity

Even if funds are available the Cyprus government lacks the institutional capacity to effectively implement on time certain public services, programmes and projects. The Ministry of Labour and Social Insurance does not seem to have the capacity to efficiently process and disburse social benefits to eligible applicants with lags in actual payments often around six months. And use of EU funds is frequently delayed and sometimes cancelled by the failure of government employees to undertake proper project evaluations and by inefficiencies and corruption in the awarding of contracts by the Tenders Review Authority. Indeed, over many years budgetary performance in Cyprus has been highlighted by the very low rate in implementing development projects.

Thus, given in particular the prevailing cost of living crisis and the much trumpeted ‘Cyprus Tomorrow’ plan entailing 56 reforms and 74 investment projects, there is a pressing need to use budgeted funds for enhancing significantly the institutional capacity of the government by recruiting competent staff and increasingly digitising operations. But, it is questionable whether the budget for 2023 includes funds allocated to boost institutional capacity beyond the usual increases in the employment of many politically loyal casual workers and advisors[2] and further miniscule advances in e-government.

Government revenue

The proposed budget projects an increase in government revenue of 6.5 per cent in 2023 assuming that nominal incomes rise by around 6.6 per cent and that there is no change in tax rates during the coming year. However, in view of the need to revise budget expenditures substantially upwards to take account of higher-than-officially-forecast prices and to allocate more funds to households and businesses and to counter the cost of living crisis and for improving the institutional capacity of the government, the resultant total expenditures in 2023 would considerably exceed government revenues. This situation should call for measures to boost public revenues in order to avoid the government having to borrow large amounts externally.

Moreover, as repeatedly stated the tax base needs to be broadened through the introduction of a high-yielding property tax, an increase in the progressivity of personal income taxes, and a combatting of prolific tax evasion so as to substantially raise government revenues enabling the Cyprus government to have the funds to finance a social welfare state compatible with those of advanced European countries. Furthermore, as indicated above the government needs to enhance its capacity and competence to effectively absorb EU funds, particularly grants, for implementing the large multitude of investments and reforms required to support the inclusive and equitable growth of a “greener” Cyprus economy.

While measures to change tax rates and introduce new taxes would not be appropriate prior to the Presidential elections, budgetary funds should be allocated to radically improve the grossly inefficient tax administration so as begin without delay serious efforts to combat widespread tax evasion[3].

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

[1] See International Monetary Fund, “World Economic Outlook”, October 11, 2022

2 The quality of the institutional capacity of the government is diminishing with the employment of nearly one thousand casual workers over the last 12 months (398 in September alone) replacing the 782 decline in the number of permanent employees.

3 At the end of the first quarter of 2022 according to the Cyprus Taxation Commissioner there was over €2.9 billion in tax arrears, equivalent to around 12 per cent of GDP. This is the tip of the iceberg as many persons earning over €12.000 per year and a great number of persons deriving part of their income from work in the informal economy, such as school teachers giving out-of-school lessons, do not even submit the required tax returns.