Cyprus’ fiscal balance has made a remarkable recovery from recent shocks, with current fiscal surpluses exceeding pre-pandemic levels, according to rating agency Morningstar DBRS.

The agency attributed this improvement to strong revenue growth, primarily driven by rising social security contributions and higher corporate tax revenues due to a broader tax base.

“Government revenues have benefited not only from cyclical favourable conditions but also from structural improvements on the revenue side,” the agency said.

Unlike most other Eurozone countries, public revenues in Cyprus have grown at a faster pace than nominal GDP in recent years.

The share of total public revenue in Cyprus increased significantly from 39.4 per cent of GDP in 2019 to 43.3 per cent in 2023, while the ratio remained generally unchanged for the Eurozone.

In a report titled ‘Cyprus: Public Finances Benefit from Strong Revenue Growth’, DBRS highlighted that increasing social security contributions and higher corporate taxes were the main drivers of the rise in public revenues.

The rating agency also emphasised that favourable fiscal developments were a key factor in the recent trend change from ‘Stable’ to ‘Positive’ for the Republic of Cyprus, which holds a BBB (high) rating.

“The fiscal outcomes in Cyprus have improved significantly in recent years,” DBRS stated.

It added that after recording deficits due to the pandemic in 2020 and 2021, Cyprus’ general government fiscal balance turned into a surplus of 2.7 per cent of GDP in 2022 and 3.1 per cent in 2023.

This improvement, beyond the lifting of pandemic-related economic support measures, is mainly attributed to the surge in public revenues.

“Nominal tax revenues and social security contributions were boosted by the strong economic recovery and robust employment growth,” the agency underlined.

Moreover, total general government revenues grew by an average of 13.2 per cent in 2022 and 2023, outpacing public expenditure growth of 6.8 per cent.

Looking ahead, DBRS referenced IMF projections indicating that the relative size of state revenues in Cyprus will remain at this higher level, contributing to anticipated favourable fiscal performance.

The general government budget surplus is forecasted to reach 3.1 per cent of GDP in 2024 and 3.2 per cent in 2025.

DBRS highlighted that the improvement in public finances mainly stemmed from two types of revenue: social security contributions and income tax revenue.

Both categories of revenue increased by approximately 1.7 percentage points of GDP each between 2019 and 2023, compared to a mere 0.5 percentage point increase for indirect taxes, such as VAT.

“The financial position of the social security system has been strengthened by favourable developments in the labour markets in recent years, as the strong increase in employment of both Cypriots and non-EU foreigners boosted social security revenues,” the agency stated.

The number of contributors to Cyprus’ social insurance fund rose by 11.9 per cent between 2019 and 2023.

DBRS also pointed out that social security revenues would continue to benefit from regular increases in contribution rates, with the next hike scheduled for January 2024. Contribution rates will rise every five years by 1.3 percentage points until 2039.

Additionally, DBRS remarked that the long-term financial position of the Social Insurance system will benefit from the automatic adjustment of the retirement age in line with life expectancy changes.

What is more, DBRS said that the increase in government revenues from income tax is largely attributed to the rise in corporate tax revenues.

Corporate taxes represent a significant source of public revenue, accounting for 6.6 per cent of GDP in 2022, up from 5.6 per cent in 2019.

In comparison, personal income taxes amounted to just 2.9 per cent of GDP in 2022.

The rating agency also explained that the increase in corporate tax revenues stemmed not only from favourable cyclical conditions but also from the expansion of the tax base.

Many foreign companies, particularly in the Information and Communication Technology (ICT) sector, relocated their operations to Cyprus.

Finally, the agency noted that in recent years, the Cypriot government launched various programmes, including the headquarters relocation policy, offering incentives for businesses to move their activities to Cyprus through measures such as tax breaks.