Filenews 24 December 2024 - by Theano Thipoulou
Seven elements of resilience and nine elements of risk are distinguished for the Cypriot economy in the final report 2024 of the Fiscal Council, which was published yesterday.
The overall picture of public finances is positive but with structural weaknesses. The economy is driven by strong economic growth, low unemployment and normalising inflation, despite islands of continued price increases, mainly in services and domestic products, mainly food and industrial.
Government debt remains on a declining path, with the consolidated surplus achieved at high rates throughout the duration of the MTF, until 2027. Despite the increased risks that arise, mainly exogenously, the achievement of the goals set is within radius."
The good...
In its report for 2024, the Fiscal Council refers to the resilience elements of the economy and records:
- Continuous fiscal surpluses, with high growth rates of government revenues
- Reduction of debt and debt servicing costs, with easy access to markets and low bond yields, broad-based growth (supported by many sectors of the economy), reinforcing the assessment of resilience.
- Strengthening exports in services, with the economy taking advantage of geopolitical developments, stabilization of inflation, strong outlook for European tourism for 2025, with Cyprus being able to take advantage of the expected new increase in demand.
And the dangerous...
The risk elements focus on:
- Increases in inelastic expenditure, of a permanent nature and on the basis of temporary and non-recurring increases in government revenues
- Political pressure to increase spending due to upgrades and surpluses
- Back-loaded planning to contain spending, which involves the risk of implementation, especially in a pre-election year.
- Potential conversion of provident funds into pension funds, strong social pressures due to pressures on households and SMEs, decline in the effectiveness of social spending, with higher expenditure, but with less impact
- Delay and laxity in tackling energy and climate change, with the risk of requiring greater investment spending in the coming years. The last two elements of danger concern generalized European anaemia, with persistently low growth rates in the EU, which cannot leave Cyprus unaffected. The inability to base growth in the short, medium and long term on the relationship with the wider European economy will require a new growth strategy.
The general picture of difficulty in introducing substantial reforms, as well as delays in the implementation of the investment programme, temporarily reinforce the positive expenditure picture, but create serious second-round weaknesses.
Caution is needed...
The report of the Fiscal Board notes as a general conclusion that "government debt remains on a declining path, with the consolidated surplus achieved at high rates throughout the duration of the MTF (Medium-Term Fiscal Framework), until 2027. Despite the increased risks that arise, mainly exogenously, the achievement of the goals set is within radius, it is noted. However, there is significant implementation risk, mainly due to the frontloaded investment planning, which implies that achieving the targets requires a reduction in expenditure in the final years of the MDA.
Back-loaded spending cuts are dangerous in nature, the Council stresses. The risk, moreover, is exacerbated by a possible increase in spending in an election year. Moreover, the fact that the obligations of the Republic will be completed in 2028, while the Medium-Term Fiscal Framework will be completed in 2027, implies that the fulfilment of the obligations of the Republic, without revisions, will require another year of expenditure containment, in particular net primary expenditure.
Given the increased risks to growth, mainly due to exogenous factors, the back-loaded nature of expenditure containment planning is an important factor in the vulnerability of public finances to adverse developments. Despite the debt reduction, an overspending overrun is likely to lead to action by the European Commission. The fact that such a likely scenario poses difficult decisions in 2027, another election year, also increases the political risk in planning."
Prudent attitude by the Ministry of Finance
The Fiscal Council indicates that "despite the prudent stance taken by the Ministry of Finance in relation to public expenditure, but also in spite of the effort that seems to have been made in relation to the 2024 Budget to contain certain categories of expenditure, the increase in inelastic expenditures continues, including the payroll of the Republic. Through this development, there is no risk to the sustainability of public finances, at least in the short and medium term."
However, the balance of expenditure is threatened due to the reduced quality of the general government expenditure mix, increasing Cyprus' vulnerability to adverse developments.
In addition, the fiscal space enjoyed by the executive to undertake policy expenditure on the basis of social, national or other needs is limited. In any event, the resulting risks are of a political and social nature. Public debt itself remains on a positive trajectory and there is no question of debt sustainability on the horizon of the analyses. However, the increase in imbalances should be addressed as early as possible, to avoid politically and socially painful decisions in later years when the structural issues that arise begin to mature.
Increased spending did not improve services
According to the Fiscal Council report, "concern about the expenditure mix remains high, given the new increases recorded in inelastic spending, in which the upward trend is maintained. Moreover, the analysis of individual inelastic expenditures leads to the conclusion that their reversal will be practically and politically difficult and that, worse, they have a cumulative and inherently incremental character for the coming years (e.g. wage bill)."
The Fiscal Council states that "it seems, however, that the Ministry of Finance has made an effort to limit the growth rate of inelastic spending, as the trajectory of increases in inelastic spending is slightly limited compared to last year's Budget, at least as a percentage of the total expenditure of the Republic."
However, the course of inelastic spending remains a cause for concern, as the Fiscal Council points out, as it hovers around 60% of total expenditure, increasing to 70% by 2027, thus limiting the fiscal "space" for the exercise of discretionary policy on the part of the executive.
Of these, personnel costs remain the main category of expenditure, reaching 31.7% of total state expenditure by 2027.
The 2024 report also notes "that increases in personnel costs are not in themselves prohibitive. However, we stress that the rate of growth, since it is not accompanied and driven by increases in the volume, speed or quality of services provided to the economy and society, is a dead burden for public finances. The objection to the continuous increases in inelastic expenditure, including operating expenditure, is that the increased expenditure, first, does not reflect any improvement in the services for which society pays and, second, deprives the executive of fiscal discretion without causing fiscal pressures.
