Cyprus

   

Economic Policies

#37
Key Findings
With considerable reform needs remaining despite its recent progress, Cyprus falls into the bottom ranks internationally (rank 37) with regard to economic policies. Its score in this area has improved by 1.1 point relative to 2014.

Growth has slowed somewhat from its 2018 rate, but remained strong at near 3%. While reforms have created a scaled-back financial sector governed by stricter rules, the sector remains fragile. Tourism, large construction projects and private consumption are driving growth.

The unemployment rate continued to decline to about 6.5%, with an overall employment rate of 62.8%. The youth unemployment rate remains high, though it has shown steep declines. Public-sector wage cuts have been gradually restored. The debt-to-GDP ratio has fallen to around 95%.

High taxable-income thresholds result in a low tax burden on labor, and a dependence on corporate and value-added taxes. However, the low flat rate of 12.5% for companies allows for aggressive tax planning. Tax evasion and tax avoidance are widespread. Developing effective financial-market oversight has proven difficult, and reports have exposed corruption in the citizenship program for investors.

Economy

#37

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
In 2019, Cyprus sustained strong growth and robust fiscal performance within an improved financial and economic environment. Nonetheless, reports by its creditors, the IMF, the ECB and the European Commission, as well as by other institutions stress that risks and weaknesses persist. Progress to improve the country’s low competitiveness rating remained marginal.

As an EU member with a strong services sector and favorable taxation system, Cyprus is attractive to investors . However, significant reforms are still needed to upgrade the country’s infrastructure, and improve its technological readiness, the education system and the overall legal environment.

The implementation of reforms as well as efforts to reestablish confidence and stabilize the financial system have yielded a scaled down financial sector governed by stricter rules. The banking sector is fragile and shrunk further as a result of the country’s former central bank, Cooperative Bank, defaulted on its debt in mid-2018. Having privatized some of its NPLs, the bank might benefit from new rules relating to NPLs.

Economic performance in 2019 continued to rely on traditional sectors which the EU and Cyprus Fiscal Council warn cannot guarantee long-term growth. Tourism, large construction projects and private consumption have driven growth; expected at around 2.9% in 2019, compared to 4.1% in 2018. While confident about the capacity of Cyprus to repay its debt, creditors added the new national healthcare scheme and the eventual disorderly hard Brexit as additional risks. They suggest that a stronger economy offers opportunities for long-due reforms. The IMF cites broader civil service and civil procedure reforms, privatizations and the introduction of an e-justice system as worthy policy objectives.

Though some NPLs have been removed from banks, very high ratios remain. Private and public debt could hamper bank access to sovereign markets. A large current account deficit and external financing needs make Cyprus vulnerable, but the improved composition of external liabilities and large gross external assets mitigates such risks according to the IMF.

Signs of improvement in the collaboration between the government and parliament in 2019 may benefit renewed efforts to promote reforms in the public sector. It is, however, too early to predict their outcome.

Citations:
1. IMF, Cyprus: Third Post-Program Monitoring Discussions-Press Release and Staff Report, June 2019, https://www.imf.org/~/media/Files/Publications/CR/2019/1CYPEA2019001.ashx
2. Cyprus in the Global Competitiveness Report 2019, World Forum http://reports.weforum.org/global-competitiveness-report-2019/economy-profiles/#economy=CYP
3. World Bank, Doing business index 2019, Cyprus, http://www.doingbusiness.org/en/data/exploreeconomies/cyprus#
4. European Commission, European Economic Forecast. Autumn 2019, https://ec.europa.eu/info/sites/info/files/economy-finance/ip115_en_0.pdf

Labor Markets

#31

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
The Cypriot labor market continued to improve in 2019. The unemployment rate declined from 7.3% to 6.5% in the second quarter of 2019, following an EU trend. This decline shows significant progress since August 2013, when unemployment stood at 17%. It does, however, continue to contrast with the rate seen in 2008 of 3.7%, near-full employment conditions (76.5%). The labor force in 2019 was 62.8% of the population. The broader public sector employs 17.8% of the labor force. Per sector employment in 2019 was as follows: 18.1% in industry, 2.5% in agriculture and 79.4% in the services sector (81.6% in 2018). In 2018, the proportion of young people not in education, employment or training (17.4%) was among the highest in the EU.

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, remains a useful procedure, though it is going through a period of tension. Cuts to salaries and pensions imposed since 2011 in the broad public sector will gradually decrease, with all reductions ceasing in January 2023. The private sector also suffered severe cuts in salaries and benefits; in addition, there remain instances of salaries below the legal minimum wage and of employment with no social benefits. Distortions in the labor market persist, with the privileged public and banking sectors “competing” with a relatively weak private sector. In addition, there are sustained pressures on benefits from private employers. The resistance of strong trade unions to benefits cuts appears to have weakened, due in part to employees accepting cuts to avoid a loss of employment. In contrast, powerful public sector unions remain successful in securing their members’ benefits. Migrant EU and non-EU labor remain the most vulnerable groups, often exploited by employers, resulting in a widening economic gap. They accounted for 20.6% of the employed in mid-2019, of which 12.6% were other-EU and 8.0% third-country nationals.

The European Commission has observed low efficiency in the country’s employment services, which remains a challenge. The Commission notes the need for reinforcing outreach and activation support for access to employment.

Despite improvements, serious issues of concern remain. These include a high youth unemployment rate (14.9%, compared to 17.9% in 2018) and significant long-term unemployment (2.2%). Also, women are affected slightly more than men. Only 57.4% of women participate in the formal labor force and 53.6% were employed in 2019, compared to 68.6% and 64.2% for men. Finally, persisting high rates of short-term (15%) and part-time (11.5%) employment are also problematic. The long-term sustainability of public employment service capacity remains an issue, as additional staff were recruited for only 2 years.

Citations:
1. Survey of Labour Market, Q2-2019, Statistical Service ROC, 2019 https://www.mof.gov.cy/mof/cystat/statistics.nsf/All/84335198B5D80A9FC2258316004762F0/$file/Labour_Force_Survey-Q219-EN-050919.doc?OpenElement
2. EU Commission Semester Report Recommendations, Cyprus, July 2019, https://ec.europa.eu/info/sites/info/files/file_import/2019-european-semester-country-specific-recommendation-commission-recommendation-cyprus_en.pdf

Taxes

#17

How effective is a country’s tax policy in realizing goals of revenue generation, equity, growth promotion and ecological sustainability?

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 2016 merger of the departments handling income and VAT taxes into the Tax Department aimed at strengthening tax collection and processing mechanisms (e.g., auditing) as well as fighting tax evasion and avoidance. These goals remain unfulfilled.

Cyprus’s tax system is comparatively uncomplicated, both with respect to individual provisions and structure. Revenues from direct and social taxes are relatively low as they are affected by a high threshold of taxable income offset at €19,501. This results in a low tax burden on labor and an increased dependency on corporate and value-added taxes. A levy on salaries and a real-property tax imposed in 2013 were terminated in 2017, while a levy of 30% on interest income from bank deposits is in force since April 2013.

There is a high reliance on corporate and value-added taxes from non-diversified, buoyant economic activities. Although the impact on the economy from this income has been highly beneficial, the European Commission doubts its sustainability and warns that it cannot guarantee sufficient financial resources in the long-run. Sufficiency is also affected by tax collection problems, with €2 billion overdue taxes appearing uncollectible and many years delays in the clearance of tax declarations.

Tax equity is to some extent achieved through the progressive increase in individual income-tax rates from 20% to 35%. However, widespread tax evasion and tax avoidance, and a flat rate of 12.5% for companies are negatively affecting equity. They allow aggressive tax planning and benefit liberal professions and highly profitable companies – both pay a lower tax share than the share paid by employees. The Commission continued in 2019 to stress the need for Cyprus to revise tax system structures and tackle factors that enable aggressive tax planning.

While the low rate of corporate tax allows the country to remain competitive, it is unclear whether the benefits linked to this outperform the risks posed for companies, and the negative effects on equity, tax avoidance and tax evasion resulting from aggressive tax planning. It is indicative that Cyprus signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit-Shifting with numerous reservations.

After 2017, redistribution and the promotion of ecological sustainability via the tax system have been encouraging. However, there is scope for a redesign of the structure of environmental taxation to improve climate and environmental policies, which are very problematic in Cyprus.

Citations:
1. European Commission Post Program Surveillance Report Cyprus, June 2018, https://ec.europa.eu/info/sites/info/files/economy-finance/ip104_en_pps_cy.pdf
2. Tax debt to State fall in Q3 2018, Cyprus Mail, 16 January 2019, https://cyprus-mail.com/2019/01/16/tax-debts-to-state-fall-in-q3-2018/

Budgets

#30

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
7
The Law on Fiscal Responsibility and Fiscal Framework of 2014 provided for budget design and implementation processes that meet the strategic targets set by the government. This required the administration to gradually acquire strategic-planning capacities. Assigned to the minister of finance, the process and oversight, from design to implementation, produced positive results, with large fiscal surpluses and a reduction in the public debt. Performance was also assisted by tax, tourism and other buoyant revenues.

Praise for the country’s economic performance in post-program surveillance reports also included warnings: these urged against loosening the strict spending discipline and for promoting structural reforms to enhance spending reviews.

The 2020 budget aims at consolidating growth and further reducing the public debt, keeping it below 100%. A modest budgetary impact expected from the gradual reestablishment of public sector salaries could develop into a major risk following a court decision declaring the benefit cuts unconstitutional. In addition, sustaining the partly implemented national health system as well as insecurity from buoyant revenues may increase the risks.

GDP was expected to grow by 2.9% in 2019 compared to 3.9% in 2018. The debt-to-GDP ratio was expected to recede to 95.2% (IMF) or 93.8% (EU) in 2019.

Citations:
1. European Commission, European Economic Autumn Forecast, November 2019, https://ec.europa.eu/info/sites/info/files/economy-finance/ip115_en_0.pdf
2. IMF Downgrades projections for Cyprus, Cyprus Mail, 15 October 2019, https://cyprus-mail.com/2019/10/15/imf-downgrades-projections-for-cyprus/
3. European Commission Country Specific Recommendations, Cyprus, https://ec.europa.eu/info/sites/info/files/file_import/2019-european-semester-country-specific-recommendation-commission-recommendation-cyprus_en.pdf

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 in Cyprus is underdeveloped. The EU observes that the largest R&D expenditure lies with higher education, while public and private expenditure is among the lowest in the Union. This contrasts with the situation EU-wide, where the share of expenditure from business is higher. This notwithstanding, Cyprus ranks first in the EU in terms of per capita funds from Horizon 2020.

The shaping of a coherent policy on research is the target of a new scheme for the National Council for Research and Innovation. The Council of Ministers also appointed a chief scientist to orchestrate and grow the country’s research and innovation ecosystem. The latest development is a decision taken in September 2019 to set-up a ministry for innovation and digital policy, subject to a vote by the House of Representatives.

Cyprus’s capability for innovation, according to the 2019 edition of the Global Competitiveness Index, scored 46.3 points compared to 44.7 in 2018, while in R&D it progressed to 34.7 from 33.9 points. The country ranks 43rd out of 141 countries in this assessment.

If the R&D expenditure target for 2020 remains at 0.5% of GDP, which is the lowest in the EU, it would offer very little prospects for substantial progress.

Citations:
1. Global Competitiveness Index 2019, Cyprus, Innovation, http://reports.weforum.org/global-competitiveness-report-2019/economy-profiles/#economy=CYP
2. European Commission Semester Country Specific Recommendations, Cyprus, June 2019, https://ec.europa.eu/info/sites/info/files/file_import/2019-european-semester-country-specific-recommendation-commission-recommendation-cyprus_en.pdf
3. Cyprus National Board for R&I, https://www.nbri.gov.cy/

Global Financial System

#41

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
3
Developing effective monitoring of the market and enforcement of international standards have been major challenges for Cyprus. Its status as a financial center since the 1980s complicated the pursuit of a clearer regulatory framework. The work conducted by specific institutions, such as the Securities and Exchange Commission and the Unit for Combating Money Laundering (MOKAS), and stricter frameworks and policies against money laundering did not erase risks and vulnerabilities. It remains difficult to assess the extent to which specific measures have decreased money laundering and corruption.

Amendments to laws on money laundering and terrorism-related activities that aimed to align with EU directives have strengthened the deterrence regime. Among measures that have enhanced the work of competent authorities 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. Laws passed in mid-2018 aim at facilitating the resolution of challenges related to NPLs while attempting to protect indebted households.

Following the European Commission’s Report on Citizenship by Investment (January 2019) naming Cyprus as problematic, rules for the scheme changed. An October 2019 Reuters investigative report revealed serious corruption linked with the scheme, including the involvement of the church. Transparency International notes that Cyprus does not appear to take into account an applicant’s source of funds or wealth when analyzing applications.

Citations:
1. European Commission report on Citizenship by Investment, January 2019, https://ec.europa.eu/info/sites/info/files/com_2019_12_final_report.pdf
2. Georgiades plays down citizenship scheme, Cyprus Mail, 5 November2019, https://cyprus-mail.com/2019/11/05/georgiades-plays-down-value-of-citizenship-scheme/
3. Khmer Riche, Reuters special report, 16 October, 2019, https://www.reuters.com/investigates/special-report/cambodia-hunsen-wealth/
4. Transparency International/Global Witness, European Getaway, https://www.transparency.org/whatwedo/publication/golden_visas
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