“Spain and Cyprus are facing very serious imbalances not least in their financial sectors, which need to be addressed as a matter of urgency,” Economic and Monetary Affairs Commissioner Olli Rehn said, presenting the findings of in-depth reviews of the EU member-states’ economies in Brussels.
“In particular, macroeconomic developments as reflected in the current account, public finances and the financial sector require close monitoring and urgent economic policy attention in order to avert any adverse effects on the functioning of the economy and of economic and monetary un ion,” the Commission said of Cyprus.
Along with Cyprus and Spain, 10 other countries, including France, Italy, and the UK, are experiencing imbalances to varying degrees, the Commission said.
“The Commission concluded in its in-depth review that Cyprus experiences an internal imbalance due to its banking sector and the indebtedness of the corporate sector and an external and an internal imbalance on its fiscal dynamics and competitiveness, although not excessive.”
Corporations are very vulnerable due to their high indebtedness coupled with their low profitability, resulting in a significant increase in non-performing loans, the Commission said.
The Commission also highlighted the banking sector’s exposure to Greece, which is “very risky.”
“Moreover, growth prospects are dim which further hinders the relatively slow unwinding of imbalances,” the Commission said.
The Commission said Cyprus faced challenges in ensuring the long-term sustainability of public finances, notably in the area of pensions.
It said two important structural measures to reform the island’s pension system have been implemented but “while the measures adopted are relevant and credible, the response of Cyprus is not sufficiently ambitious to secure sustainability and adequacy, and improve the system’s fairness in the longer term.”
The Commission also recommended aligning the statutory retirement age with the rise in life expectancy.
The Commission also stressed that Cyprus should reform the cost of living allowance (CoLA) regime with a view to strengthen the link between real wages and productivity “and making the system more equitable.”
The two year freeze on CoLA payments in the public sector and the pledge to review the system by the end of June were first steps in the right direction but “their relevance and credibility depend crucially on the degree of ambition and enforcement of the final outcome of the social dialogue currently under way regarding the reform of the wage indexation system,” the Commission said.
The Commission said additional measures must be taken to achieve a durable correction of the excessive deficit in 2012.
Cyprus must also “rigorously implement the budgetary strategy, supported by sufficiently specified measures, for the year 2013 and beyond to ensure the achievement of the medium-term budgetary objective by 2014.”
The island must also accelerate the phasing-in of an enforceable multiannual budgetary framework with a binding statutory basis and corrective mechanism and “take measures to keep tight control over expenditure and implement programme and performance budgeting as soon as possible.”
The government must also improve tax compliance and fight tax evasion.
“Tax administration is inefficient as administrative costs in relation to revenue collection in Cyprus are very high,” the Commission said. “Measures to encourage a move away from informal-undeclared work and tackle tax evasion are necessary. Furthermore, initiatives to render tax collection more efficient should be reinforced.”
By George Psyllides