Cyprus

   

Economic Policies

#36
Key Findings
With considerable reform needs remaining despite its recent progress, Cyprus falls into the bottom ranks internationally (rank 36) with regard to economic policies. Its score in this area has improved by 1.1 point relative to 2014.

Cyprus exited its bailout program in 2016. Its progress since that time has been generally good, although a renewed banking crisis and resulting bailout during the period indicated continuing financial-sector fragility. The country is seeking a new model enabling it to recover its role as an attractive investment center.

Growth has persisted at moderately high levels, driven by tourism, large construction projects and private consumption, but economic diversification is badly needed. Unemployment rates have continued to fall, but remain above pre-crisis levels. Youth unemployment remains a problem. Crisis-era public-sector wage cuts are being gradually reversed.

Tax evasion and avoidance remain problems. The tax system plays very little redistributive role. Recent budgets have focused on deficit and debt reductions. The banking bailout pushed public debt levels back above 100% of GDP, but small budgetary surpluses are expected to reduce this over time.

Economy

#39

How successful has economic policy been in providing a reliable economic framework and in fostering international competitiveness?

10
 9

Economic policy fully succeeds in providing a coherent set-up of different institutional spheres and regimes, thus stabilizing the economic environment. It largely contributes to the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
 8
 7
 6


Economic policy largely provides a reliable economic environment and supports the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
 5
 4
 3


Economic policy somewhat contributes to providing a reliable economic environment and helps to a certain degree in fostering a country’s competitive capabilities and attractiveness as an economic location.
 2
 1

Economic policy mainly acts in discretionary ways essentially destabilizing the economic environment. There is little coordination in the set-up of economic policy institutions. Economic policy generally fails in fostering a country’s competitive capabilities and attractiveness as an economic location.
Economic Policy
4
Some 30 months after Cyprus exited its bailout program, its creditors, the European Commission, European Central Bank and IMF, praised the successful implementation of policies which secured a quick recovery, sustained growth and robust fiscal performance, in a relatively improved environment. Nonetheless, the country still rates low in competitiveness and lost four places in the “doing business” index of the World Bank.

Following the failure of its economic system in 2011, Cyprus continues to search for a new model. It offers important assets to investors, such as a quality services sector, a favorable taxation system, good geographic location and EU membership. However, it still needs to step up reforms and upgrade its infrastructure, technological readiness, health and education systems, and the legal environment.

The implementation of reforms as well as efforts to reestablish confidence and stabilize the financial system has yielded a downsized financial sector governed by stricter rules. Policy responses to the default of the Cooperative Bank in mid-2018 further shrank the banking sector; it remains fragile, though new rules related the NPLs and other issues may benefit it.

Economic performance in 2018 continued to rely on traditional sectors, though diversification based on sustainability is much needed. Tourism growth, large construction projects, and private consumption pushed growth to over 4% in 2017 and 2018, which was above IMF’s forecast of 3.6% for 2017 and 3.75% for 2018. However, the creditors continue to warn that risks and major challenges are weighing over economic sustainability. These require reforming the public sector, improving public management, privatizing state-owned enterprises and reforming the judiciary. The creditors also note the continued risks from the still very high NPLs ratio, high private and public debt, and higher levels of uncertainty regarding the external environment. Finally, the IMF notes that the high dependency of growth on investments through the citizenship-by-investment scheme poses risks to sustainability.

The urgency of the Cooperative Bank crisis forced collaboration between the government and the parliament to adopt long overdue regulations. There is, however, no indication that the same level of collaboration will continue, in particular on broader issues, such as the aforementioned much needed reforms of the public service and other sectors.

Citations:
1. Lenders call on Cyprus to maintain fiscal discipline and speed up reforms, Cyprus Mail, 28 September 2018, https://cyprus-mail.com/2018/09/28/lenders-call-on-cyprus-to-maintain-fiscal-discipline-and-speed-up-reforms/
2. Cyprus in the Global Competitiveness Report 2018, World Forum http://reports.weforum.org/global-competitiveness-report-2018/country-economy-profiles/#economy=CYP
3. World Bank, Doing business index 2019, Cyprus, http://www.doingbusiness.org/en/data/exploreeconomies/cyprus#

Labor Markets

#32

How effectively does labor market policy address unemployment?

10
 9

Successful strategies ensure unemployment is not a serious threat.
 8
 7
 6


Labor market policies have been more or less successful.
 5
 4
 3


Strategies against unemployment have shown little or no significant success.
 2
 1

Labor market policies have been unsuccessful and rather effected a rise in unemployment.
Labor Market Policy
6
Unemployment rates continued to decline, falling from 10.3% in September 2017 down to 7.3% in the second quarter of 2018. The peak crisis rate was in August 2013 (17%); a sharp contrast to the 3.7% with near-full employment (76.5%) observed in 2008. In 2018, the broad public sector was employing 17.8% of workers, while the services sector accounted for 81.6%.

The regulatory framework protects labor rights and includes provisions preventing unlawful dismissal from employment. However, serious shortcomings are evident in its implementation. “Tripartism,” in the form of agreements between the state, businesses, and employees, made the labor market less flexible and is going through a period of tension. In mid-2018, the government amended the law on reductions of salaries and pensions in the broad public sector to gradually decrease cuts imposed in 2011 and 2012. All reductions will cease in January 2023. The private sector suffered severe cuts in salaries and benefits; salaries below the legal minimum wage were observed, as were instances of employment with no social benefits. The labor market is marked by distortions, where the public and banking sectors are privileged and “compete” with a relatively weak private sector which, additionally, is subject to sustained pressures on benefits by employers. While trade unions generally have a strong voice, their resistance to benefits cuts has weakened. Conversely, powerful public sector unions manage to secure their members’ benefits. Migrant EU and non-EU labor remain the most vulnerable groups, often exploited by employers, resulting in a widening economic gap. According to a survey, in mid-2018, non-Cypriot workers accounted for almost 19% of the employed; 11.4% were other-EU nationals and 7.5% third-country nationals.

The European Commission observed that participation in active labor market programs is significantly lower than the EU average. Also, the provision of services to employers and job seekers by the public employment service remains suboptimal.

Serious issues of concern are a high youth unemployment rate (17.9%, down from 25.3% in 2017) and long-term unemployment (2.5%). Women are affected slightly more than men. However, only 57.1% of women participate in the formal labor force and 52.8% were employed in 2018, compared to 67.2% and 62.4% for men. The labor force has declined since 2012, due to emigration of non-Cypriot labor. The previously mentioned figures demonstrate a clear improvement in the labor market, though short-term (15%) and part-time employment (12.1%) rates remain high.

Citations:
1. Survey of Labour Market, Q2-2018, Statistical Service ROC, 2018 http://www.mof.gov.cy/mof/cystat/statistics.nsf/All/75F22FCE3441C971C2257752003A3990/$file/LAB-LFS-Q218-EN-070918.xls?OpenElement
2. EU Commission Semester Report Cyprus, March 2018, https://ec.europa.eu/info/sites/info/files/2018-european-semester-country-report-cyprus-en.pdf

Taxes

#19

To what extent does taxation policy realize goals of equity, competitiveness and the generation of sufficient public revenues?

10
 9

Taxation policy fully achieves the objectives.
 8
 7
 6


Taxation policy largely achieves the objectives.
 5
 4
 3


Taxation policy partially achieves the objectives.
 2
 1

Taxation policy does not achieve the objectives at all.
Tax Policy
6
The Inland Revenue Department and the Value-Added Tax (VAT) Service merged into one authority, the Tax Department, in 2016. This fusion was part of reforms aiming to strengthen tax collection and processing mechanisms (e.g., auditing) while countering tax evasion and tax avoidance.

Cyprus’s tax system is comparatively uncomplicated, both with respect to individual provisions and structure. A high threshold for individual taxable income of €19,501 results in a low tax burden on labor. This is expected to increase given planned higher social insurance and medical insurance contribution rates. The VAT has been set to 19% since 2014. A special levy on salaries and a real-property tax imposed in 2013 were terminated in 2017. A levy on interest income for bank deposits set at 30% since April 2013 will be reduced to 17% in January 2019. Principles of equity are negatively affected by continued tax evasion and avoidance; a large share of the €2 billion overdue taxes may not be collectible.

Benefits provided to businesses have, over time, made Cyprus very attractive to international companies. The European Commission noted in 2018 that further regulation is necessary to address the phenomena of aggressive tax planning by companies. It also noted that the buoyant character of corporate tax revenues might induce risks if used for long-term expenditures.

Tax equity is to some extent achieved through the progressive increase in individual income-tax rates from 20% to 35%. However, the flat rate for companies leaves room for distortions: it may benefit some liberal professions and highly profitable companies that pay a lower tax share than the share paid by high income individuals.

The European Commission observed in 2017 that the tax-benefit system was the least effective in reducing inequalities; it noted some improvements in 2018.

Citations:
1. European Commission Semester Report Cyprus, March 2018, https://ec.europa.eu/info/sites/info/files/2018-european-semester-country-report -cyprus-en.pdf
2. Almost €2 billion owed in overdue taxes, Cyprus Mail, 21 September 2018, https://cyprus-mail.com/2018/09/21/almost-e2-billion-euros-owed-in-overdue-taxes/

Budgets

#25

To what extent does budgetary policy realize the goal of fiscal sustainability?

10
 9

Budgetary policy is fiscally sustainable.
 8
 7
 6


Budgetary policy achieves most standards of fiscal sustainability.
 5
 4
 3


Budgetary policy achieves some standards of fiscal sustainability.
 2
 1

Budgetary policy is fiscally unsustainable.
Budgetary Policy
6
The implementation of the 2014 Law on Fiscal Responsibility and Fiscal Framework launched a budget design process that meets strategic targets set by the government. This led the administration to gradually acquire strategic planning capacities. Provisions of the law for oversight (by the Minister of Finance) from design to implementation aim to reduce the risk of a new economic crisis. Prospects for 2019 appeared positive, with the maintenance of large fiscal surplus and reduction of the public debt, albeit from buoyant revenues.

Post-program surveillance reports included a number of warnings against loosening the strict spending discipline and for keeping public wages tuned to GDP growth and more structural reforms to enhance reviews of spending. A 2018 amendment provided for existing salary cuts in the public sector to be gradually reversed by January 2023.

The aim of the 2019 budget is to consolidate growth and reduce the public debt, which, after falling below 100% in 2018, has risen to 104% after the government issued new bonds to support the Cooperative Bank. A modest budgetary impact is expected from the gradual reestablishment of public sector salaries which began in 2018, the reduction or cancelling of various taxes, and other measures.

GDP was expected to grow by 4% in 2018 compared to 4.2% in 2017 and by 3.8% in 2019. The debt-to-GDP ratio, which jumped to 104% in mid-2018, was expected to recede again below 100% in 2019, according to the Finance Ministry. The ministry projects fiscal surplus at 3.0% of GDP for 2019 compared to above 1.0% in 2018.

Citations:
1. Cabinet passes budget, slashes defense levy (Updated), Cyprus Mail, 13 September 2018, https://cyprus-mail.com/2018/09/13/cabinet-approves-2019-budget/
2. IMF, Cyprus: Staff Concluding Statement of the 2018 Article IV Mission, 5 October 2018, https://www.imf.org/en/News/Articles/2018/10/05/mcs10518-cyprus-staff-concluding-statement-of-the-2018-article-iv-mission
3. EC-ECB Staff statement following the fifth post-programme surveillance mission to Cyprus, https://www.ecb.europa.eu/press/pr/date/2018/html/ecb.pr180928.en.html

Research, Innovation and Infrastructure

#36

To what extent does research and innovation policy support technological innovations that foster the creation and introduction of new products?

10
 9

Research and innovation policy effectively supports innovations that foster the creation of new products and enhance productivity.
 8
 7
 6


Research and innovation policy largely supports innovations that foster the creation of new products and enhance productivity.
 5
 4
 3


Research and innovation policy partly supports innovations that foster the creation of new products and enhance productivity.
 2
 1

Research and innovation policy has largely failed to support innovations that foster the creation of new products and enhance productivity.
R&I Policy
4
Research and development programs in Cyprus mainly commenced with the creation of the country’s first university in 1992 and expanded with the growth of other tertiary-education institutions. Higher education records the largest R&D expenditure, while funding of private- and state-owned research centers remains low. This contrasts with the situation EU-wide, where the share of expenditure from business is higher. Notwithstanding, Cyprus ranks first in the EU in terms of per capita funds from Horizon 2020.

After many years without a coherent policy on research, the Council of Ministers announced in fall 2018 the establishment of a new scheme for the National Council for Research and Innovation. A former minister and academic was appointed as its head, but information on this new scheme and its advisory body, the Cyprus Scientific Council, remains limited.

Cyprus’s capability for innovation, according to the 2018 edition of the Global Competitiveness Index, scored 44.7 points, compared to 44.6 in 2017, while in R&D it slipped from 33.9 points to 33.4. The EU notes the very low investment of both the state and private sector in R&D, placing Cyprus last in the EU28.

The country’s R&D target for 2020 remains 0.5% of GDP, the lowest in the EU, offering little prospect for substantial progress.

Citations:
1. Global Competitiveness Index 2018, Cyprus, Innovation, http://reports.weforum.org/global-competitiveness-report-2018/country-economy-profiles/#economy=CYP
2. European Commission Cyprus Economy Semester Report, March 2018, https://ec.europa.eu/info/sites/info/files/2018-european-semester-country-report-cyprus-en.pdf

Global Financial System

#40

To what extent does the government actively contribute to the effective regulation and supervision of the international financial architecture?

10
 9

The government (pro-)actively promotes the regulation and supervision of financial markets. It demonstrates initiative and responsibility in such endeavors and often acts as an international agenda-setter.
 8
 7
 6


The government contributes to improving the regulation and supervision of financial markets. In some cases, it demonstrates initiative and responsibility in such endeavors.
 5
 4
 3


The government rarely contributes to improving the regulation and supervision of financial markets. It seldom demonstrates initiative or responsibility in such endeavors.
 2
 1

The government does not contribute to improving the regulation and supervision of financial markets.
Stabilizing Global Financial System
4
Beginning in the 1980s, Cyprus developed as an important financial center. Prior to EU membership, effective monitoring of the market and enforcement of international standards had been a major challenge. It remained a challenge even after a clearer regulatory framework assigned institutions with specific tasks, with key bodies being the Securities and Exchange Commission and the Unit for Combating Money Laundering (MOKAS). Following the 2013 economic collapse, the country’s banking system implemented a stricter framework against money laundering. Risks and vulnerabilities do remain, however, mainly emanating from international business activities, in particular banking and real-estate transactions. Legal constraints on dealers of foreign currency, restrictions on foreign ownership of property and the limited role of cash in transactions have minimized laundering risks.

Amendments to laws on money laundering and terrorism-related activities have aimed to align with EU directives. These further strengthen the deterrence regime, enhancing the powers of financial-sector-supervisory authorities to ensure legal compliance. One deterrence measure is the seizing of property acquired through unlawful activities. Since January 2017, Cyprus is a signatory to the Common Reporting Standard for information exchange.

Bank-oversight mechanisms have also been enhanced to avoid past transgressions, when institutions simply failed to follow rules governing large exposures and minimum capital and liquidity, resulting in the taking on of unsustainable levels of non-performing loans (NPLs). New laws passed in mid-2018 aim at facilitating the resolution of challenges related to NPLs while attempting to protect indebted households.

In its March 2018 semester report, the European Commission observed a high degree of compliance with the EU supervisory framework. However, a report by Transparency International in October 2018 pointed to the increased potential for corruption through the citizenship by investment scheme.

Citations:
1. European Commission semester report, Cyprus, March 2018, https://ec.europa.eu/info/sites/info/files/2018-european-semester-country-report-cyprus-en.pdf
2. A European Getaway, Inside the Murky World of Golden Visas, Transparency International, 2018, https://www.globalwitness.org/documents/19468/REPORT_European_Getaway_Inside_the_Murky_World_of_Golden_Visas_10_October_2018.pdf
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