Cyprus’ national Fiscal Council this week called for immediate planning to gradually address the government’s debt to the Social Security Fund, amidst ongoing surplus reports in the general government finances.

The Fiscal Council states that although public finances are showing continuous surpluses, the persistent issue of the central government’s reliance on Social Security Fund revenues is reaching a critical point that demands attention.

“The central government has been recording deficits from February to the end of the first half of the year, which are funded through what is commonly referred to as the ‘reserve,’” the report stated.

The Fiscal Council noted that while the situation is not worsening compared to previous years, it indicates a growing trend of increased operational expenses. Additionally, the central government’s borrowing from the Social Security Fund in the first half of the year has already approached the total amount borrowed in 2022.

Highlighting the long-term financing of the central government through loans from the Social Security Fund, the Fiscal Council emphasised that this has led to a total debt exceeding €10 billion.

This debt must be taken into account in assessments of the Social Security Fund’s sustainability. The report also warned that this debt represents a steadily increasing financial burden on the budget and one of the most significant risks to public finances.

The report questions at what point a non-reversible tipping point is reached, and it suggests that the answer may come from the forthcoming sustainability report of the Social Security Fund, expected to be completed in September.

Furthermore, the report noted that the repayment of this debt will be gradual but will constitute a permanent and increased expense that will exert additional financial pressure on the government, limiting the fiscal space for discretionary policies.

“Even more concerning is the ethical risk (structural incentives) posed to successive governments and political leadership, which collectively never treated the issue as serious,” the report observed.

It added that although this practice is allowed by accounting standards, it represents an imbalance and distortion, particularly as it continues to grow.

Moreover, the report points out that due to financing deficits of the central government from the Social Security Fund, national resources are “diverted from potential development expenditures and investments towards operational expenses that continuously expand without tangible benefits to the economy and society”. The report added that this has raised concerns about the overall impact on the economy.

“The absence of ‘hard constraint’ in the government’s budget is a serious weakness of the Republic of Cyprus and a significant deviation from best practices,” the council stated.

Regarding the country’s GDP growth, the Fiscal Council noted that the reduction in the economic growth potential intensifies concerns about the stabilisation of government revenues.

It is also noted that the estimates of the Strategic Framework for Fiscal Policy 2024-2026 and the Stability Programme are based on the assumption that growth will be at 2.8 per cent and inflation at 3.2 per cent, two estimates that may be overturned, reducing revenues and exerting pressure for an increase in expenses.

Adding a positive note to the increase in expenses is attributed to the increase in funds for co-financed projects.

However, the council highlighted the delay in fulfilling obligations for the second and third tranche of the Support and Recovery Plan (SAAP) as well as the increase in operating expenses, which has an accumulative nature for the coming years.

“The potential improvement in fiscal indicators for July should not be seen as an indication that the trend has reversed, as there are significant upcoming expenses that are not yet recorded due to the failure to adopt more modern accounting software,” it noted, adding that in several cases, expenses until the first semester have exceeded expected levels based on historical trends.

Furthermore, the council estimates that while government revenues will exceed the target by 7.4 per cent, the same will happen with government expenses, which are expected to significantly exceed the target of a 7.9 per cent increase. The former faces downward pressures, while the latter faces upward pressures.

Specifically, in the first semester, revenues are increasing by 14.9 per cent, and expenses by 9.8 per cent, giving the impression that a surplus margin is being maintained, as reported.

However, the trend that is emerging is more problematic, with revenues increasing by 12.1 per cent and expenses by 11.6 per cent, and these figures do not include high expenses for which there is commitment or policy decisions, as noted in the report.

“Therefore, we consider it very likely that expenses will increase more rapidly and, at the same time, the growth in revenues will slow down in the coming months if existing policy commitments are implemented,” the council stated.

Furthermore, it noted that government expenses continue to rise, reiterating concerns about the absence of plans and estimates of expenses for which there is a decision, commitment, or planning, but which have not yet been completed.

Thus, an increase in total government expenses should be expected, in addition to the increase in mandatory expenses already reflected.

The report pointed out that the increase in expenses compared to the existing budget could amount to up to €279.9 million, with the only possible reduction in the amount arising from the transfer of certain expenses to 2024 or the non-fulfilment of policy commitments.

Moreover, the Fiscal Council noted that the achievement of the target set in the Strategic Framework for Fiscal Policy 2024-2026 is highly questionable, where public debt will be reduced to 81.1 per cent, with a primary surplus of €931 million and a surplus of €567 million.

To achieve the goals of the Strategic Framework for Fiscal Policy, surpluses of approximately €360 million must be secured in the next semester, including the “loan” from the Recovery and Resilience Plan (RRP), as it reports. As for the primary surplus, it falls short of the targets by €532.7 million (based on the Strategic Framework for Fiscal Policy and the Stability Programme).

“Even more significant, however, is the possible failure to achieve the target of reducing debt to 60.1 per cent by 2026 in view of the new fiscal rules under discussion at the European level,” the Fiscal Council said.

Therefore, achieving the 2023 targets through the transfer of expenses to the next or subsequent years is not a sufficient solution to the issue at hand, it stated.

Overall, the Fiscal Council reports that the economic trajectory is subject to significant pressures, which are not surprising due to the monetary policy that translates into credit restraint and a reduction in total demand.