Cyprus Report Christophoros Christophorou, Heinz-Jürgen Axt, Roy Karadag (Coordinator) Sustainable Governance Indicators 2017 G etty Im ages/iStockphoto/ZC Liu Sustainable Governance SGI Indicators SGI 2017 | 2 Cyprus Report Executive Summary The year 2016 marked Cyprus’s successful exit from its three-year bailout agreement with international lenders. A good performance in fiscal policies, assisted by favorable conjecture for the tourist industry and energy costs, moved the country into a post-program surveillance period. It escaped the danger of economic collapse that emerged in 2011, when a system sufficient for 40-years of growth proved inadequate in responding effectively to a changing environment. Successive governments came to recognize that problems were not only connected to deficiencies in the economy, but also to systemic and structural factors. Also, they recognized a need for strategic planning and policy-implementation capacities, which had been absent or deficient for many years. Solutions to obvious problems required reforms, and decisive action was needed to end a non-meritocratic hiring system that undermined the state’s functioning. The above obligations forced a shift in direction for the government that took office in March 2013. Under a memorandum of understanding (MoU) with creditors, plans for long-overdue reforms were designed. Further to the need to pay back its debt, the country had to create structures and policies warranting sustainable development. Financial indicators in 2016 pointed to better performance than originally forecast; however, systemic and structural reforms progressed at a slower pace. The current banking sector is still two-thirds of its pre-crisis size. Democratic processes and institutions continued to function satisfactorily, but below expected standards. Evident weaknesses impede the enhancement of democracy. The system’s slow response and efficiency levels were further affected by some implementation measures of the MoU. Established democratic practices, concerns for fundamental rights and consultation received little consideration. Clientelistic political relations persist. Local and international pressures aimed at ensuring transparency in political party funding resulted in new legal provisions. Their adequacy is still under evaluation. Anti-corruption rhetoric and enforcement efforts co-existed with new prosecutions for corruption. At the same time, government and political parties continued to interfere with institutional functions. Despite the operation of an administrative court, justices warned that the legal system still faces severe problems. SGI 2017 | 3 Cyprus Report Some progress has been made in implementing legal frameworks. While further improvement in the banking-oversight system is needed, the sector continued to suffer from disagreements between the executive and parliament. Fiscal performance and unemployment rate were better than forecasted. From 15.9% in 2015, projected unemployment in 2016 is expected at 13% and 11.6% in 2017. Cuts to salaries, pensions, benefits and family-support measures remained, while the immovable property tax was drastically reduced. These measures and taxes introduced after 2013 have negatively affected the living conditions of pensioners and other groups. However, a guaranteed minimum income and targeted measures have mitigated the impact on vulnerable groups. The rate of persons at risk of poverty and social exclusion was on the rise in 2015, with a declining trend among some groups. Immigrants (both EU and non-EU) appear highly vulnerable, followed by single women over 65. Despite improvements, measures and policies for the social inclusion of migrants and asylum-seekers remain below international standards. The same is true of environmental policies; inadequate conservation and some government decisions threaten the environment, while Cyprus lags behind EU standards in many environmental measures. In 2016, new power confrontations further undermined trust in public institutions. Intensified conflicts between the executive and parliament caused delays in promoting essential laws and policies. The economic climate has been affected by laws on non-performing loans and foreclosures, as well as delays and contradictory choices on the future of semi-governmental organizations, destined for privatization. Favoritism in appointments and politically motivated interference with institutional functioning persisted, along with a lack of proper planning. Reforms of the public sector grounded in the development of strategic- planning capacity, fiscal responsibility and stronger regulation efforts are hopeful signs. However, the slow pace delays the emergence of tangible results, while the government needs a stronger engagement in massive reforms and extensive sustained efforts over the longer term. Much needed new skills and administrative culture in the government remain hard to see. SGI 2017 | 4 Cyprus Report Key Challenges The main challenges Cyprus faces in the next two years are already identified in the bailout agreement, while others have also emerged. Actions aimed at preventing a recurrent crisis must go further so that sustainable growth is possible. Many of the actions taken, or planned, are a response to the economic crisis. Others must offer remedies to negative repercussions from measures enforced under the MoU. The latter requires close and continuous monitoring and assessment of the situation in order to offer timely and adequate solutions. In some cases, anticipating and addressing possible repercussions is necessary. Moreover, the government should recognize that the crisis is broader than a financial one. Thus the need arises to engage more firmly in structural and procedural reforms and the development of skills and capacities. A successful implementation of reforms also requires a new administrative culture for operational efficiency. Deepening respect for and enhancing fundamental democratic practices warrants administrative consolidation. Within the financial sector, the government needs to act beyond fiscal targets in order to re-establish trust in the economy and increase its competitiveness rating. Effective implementation of the laws on non-performing loans would have positive effects on banks and the market. Clarifying confusion surrounding policies on the privatization of semi-governmental organizations (SGOs) must happen rapidly, as continued confusion may downgrade their market value and damage the stakeholders’ rights. In the interest of sustainability, social and environmental policies must be considered in a comprehensive manner that eliminates persistent and excessive emphasis on business and financial interests. Policies must favor broader social benefits instead. The development of a reliable infrastructure combining public transports and reducing the excessive use of private cars would benefit the economy and the environment, while serving the people. Restructuring the economy to reduce reliance on deeply business-cycle-dependent sectors such as tourism remains unseen. This goal may benefit from the scheme to grant investors citizenship.One option is favoring investments in productive sectors, including research and innovation. Creating planning capacity in the short term, and managing the issues of hydrocarbons as a medium-term target, may be part of restructuring the economy. SGI 2017 | 5 Cyprus Report The taxation system needs more decisive action in order to solve problems in tax collection and tax-avoidance. The treatment of legal and physical persons needs revision so that all liberal professions, companies and salaried employees contribute equitably. Reallocating resources may be the system’s goal – to provide adequate funding for family, pension, health care, and other policies that enhance social equity. A medium-term target should aim at a gradual return to a functioning welfare state, instead of simply reducing poverty risks. Over the long term, a sustainable recovery is only possible through efficient mechanisms warranting greater transparency and law enforcement’s ability to limit the margin of discretion that makes corruption possible. Efficient oversight of corporate governance through clear monitoring measures and mechanisms is still needed. Enforcing the provisions of the amended law on party and elections funding is crucially important for assessing its ability to ensure transparency. Transparency is urgently required in most areas, including media ownership, and the criteria and procedures governing appointments to public bodies at all levels. A basic requirement to this is the elimination of all factors that undermine meritocracy and weaken institutions. Attainment of the above goals would require the government to accelerate work needed to develop strategic-planning capacity and more effective policy- implementation ability. The establishment of bodies with clear mandates for coordination and coherent action appears imperative for swift progress. Reforms and the assignment of powers to bodies or officers require the provision of sufficient resources and establishing supporting units. Reforms of state structures and procedures at the central and local government levels can advance only by planning and implementation units with high levels of strategic capacity. In order to speed the process, existing skills and capacities need to be re-assessed, taking into account voluntary and unplanned retirements. Having the presidency or the cabinet set up a body with powers, resources