EUROPEAN COMMISSION Brussels, 26.2.2020 SWD(2020) 512 final COMMISSION STAFF WORKING DOCUMENT Country Report Cyprus 2020 Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE EUROPEAN COUNCIL, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP 2020 European Semester: Assessment of progress on structural reforms, prevention and correction of macroeconomic imbalances, and results of in-depth reviews under Regulation (EU) No 1176/2011 {COM(2020) 150 final} EN EN CONTENTS Executive summary 4 1. Economic situation and outlook 8 2. Progress with country-specific recommendations 16 3. Summary of the main findings from the MIP in-depth review 22 4. Reform priorities 28 4.1. Public finances and taxation 28 4.2. Financial sector 33 4.3. Labour market, education and social policies 42 4.4. Competitiveness, reforms and investment 52 4.5. Environmental sustainability 62 Annex A: Overview Table 67 Annex B: Commission debt sustainability analysis and fiscal risks 75 Annex C: Standard Tables 76 Annex D: Investment guidance on Just Transition Fund 2021-2027 for Cyprus 82 Annex E: Progress towards the Sustainable Development Goals (SDGs) 84 References 89 LIST OF TABLES Table 1.1: Key economic and financial indicators – Cyprus 15 Table 2.1: Assessment of the 2019 country-specific recommendations implementation 18 Table 3.1: Macroeconomic imbalance procedure assessment matrix – Cyprus 26 Table 4.2.1: Financial soundness indicators, all banks in Cyprus 35 Table 4.4.1: Selected indicators on digitalisation of businesses, 2019 (% of enterprises) 55 Table C.1: Financial market indicators 76 Table C.2: Headline Social Scoreboard indicators 77 Table C.3: Labour market and education indicators 78 Table C.4: Social inclusion and health indicators 79 Table C.5: Product market performance and policy indicators 80 1 Table C.6: Green growth 81 Table E.1: Indicators measuring Cyprus’ progress towards the SDGs 84 LIST OF GRAPHS Graph 1.1: Real GDP growth and contributions 8 Graph 1.2: Tourism arrivals and revenues 9 Graph 1.3: New and pure new loans for house purchase 11 Graph 1.4: Housing price developments 11 Graph 1.5: Key labour market developments 12 Graph 1.6: Real effective exchange rates 13 Graph 1.7: General government budget balance and gross debt 14 Graph 2.1: Overall multiannual implementation of 2011-2019 CSRs to date 16 Graph 4.1.1: Government debt projection (% GDP) 28 Graph 4.1.2: Revenue from environmentally-related taxes 31 Graph 4.2.1: Private debt, percentage of GDP 37 Graph 4.2.2: Private debt stocks 37 Graph 4.2.3: Changes in private debt-to-GDP ratio and breakdown 38 Graph 4.2.4: Private debt stock and NPLs stock 38 Graph 4.2.5: Breakdown of households indebtedness 39 Graph 4.2.6: Current account balance components 39 Graph 4.2.7: Net international investment position 40 Graph 4.2.8: Net Lending/ Borrowing by Sector 41 Graph 4.2.9: Household savings rate 41 Graph 4.2.10: Demand, output and trade balance 41 Graph 4.3.1: Temporary, part-time and self-employment (without employees) - proportion in employment 44 Graph 4.3.2: The proportion of people at risk of poverty and social exclusion (2005-2018) 46 Graph 4.3.3: Risk of poverty and social exclusion for children below the age of six (%) (2010-2018) 47 Graph 4.3.4: Adult learning participation per ISCED levels. (2010-2018) 50 Graph 4.3.5: Distribution of out-of-pocket payments for healthcare 51 Graph 4.4.1: Investment by category 52 Graph 4.4.2: Productivity factors 54 2 LIST OF BOXES Box 2.1: Commission Structural Reform Support Programme in Cyprus 19 Box 2.2: EU funds and programmes to address structural challenges and to foster growth and competitiveness in Cyprus 20 Box 4.3.1: Monitoring performance in light of the European Pillar of Social Rights 43 Box 4.4.1: Investment challenges and reforms in Cyprus 53 Box 4.5.1: Transition to a more sustainable and decarbonised growth model (in particular in the electricity and transport sectors) 65 3 EXECUTIVE SUMMARY Cyprus’ economy is still characterised by large The long-term sustainability of the growth economic imbalances, which, unless addressed, model of Cyprus is put at risk by rising external may impede its medium-term economic uncertainties and pending structural reforms. prospects. Cyprus’ large imbalances are a legacy Growth relies heavily on specific sectors, such as of the 2013 crisis and include high stocks of tourism, foreign-funded residential construction private, public and external debt and non- and services linked to foreign companies, which performing loans. In this context, there is also a are vulnerable to potential negative external need to step up reforms in key areas to attract developments. There is a need to improve the productivity-enhancing investments, diversify the environmental sustainability of tourism and to economy and help foster inclusive and diversify the sector further. More generally, environmentally sustainable growth in the long investment lags behind in areas that could term. (1) strengthen Cyprus’ economic structure and increase its potential growth, such as digital Economic growth has remained resilient so far, transformation, R&D, renewable sources of but is expected to slow down in the coming energy, sustainable transport and the circular years. GDP growth, projected to be 3.2%% in economy. At the same time, to ensure that growth 2019, has remained strong, supported by resilient benefits all groups of the population, more domestic demand. Meanwhile, net exports had a investment is needed in vocational education and negative impact, reflecting a less supportive training, adult learning, early childhood education external environment. The economy is expected to and care, and health. continue growing — albeit at a slower pace — by around 2.8%% in 2020 and 2.5% in 2021, in view Overall, Cyprus has made limited (2) progress of the anticipated weakness of the global economy. in addressing the 2019 country-specific The current account deficit is significantly recommendations. negative, and is set to worsen to around 10%% of GDP in 2019-2021 due to lower exports and There has been some progress: increased imports in the context of strong domestic demand. Unemployment fell to 7.5%% in 2019, in improving the governance of state-owned the lowest level since 2011, and is expected to fall enterprises; further. Inflation remained low, and this trend is projected to continue over the next couple of years. in facilitating the reduction of non-performing loans; Cyprus is expected to record a significant budget surplus in 2019. The headline budget in strengthening the effectiveness of the public balance is set to return to surplus in 2019 (above employment services and getting more young 3.5%% of GDP) and to remain in surplus in 2020 people into jobs and training; and 2021, which would enable considerable debt reduction. To safeguard fiscal sustainability going on the National Health Insurance System; forward expenditure developments should be carefully monitored, especially in the light of on energy efficiency and renewable energy; possible future risks to the robustness of revenues. in improving R&D; and (1) This report assesses Cyprus’s economy in the light of the European Commission’s Annual Sustainable Growth in improving access to finance for small and Strategy, published on 17 December 2019. In this document, the Commission sets out a new strategy on how medium-sized enterprises. to address not only the short-term economic challenges but also the economy’s longer-term challenges. This new Cyprus has made limited progress: economic agenda of competitive sustainability has on four dimensions: environmental sustainability, productivity gains, fairness and macroeconomic stability. At the same time, the Commission published the Alert Mechanism (2) Information on the level of progress and actions taken to Report that initiated the eighth round of the address the policy advice in each respective subpart of a macroeconomic imbalance procedure. The Alert country-specific recommendation is presented in the Mechanism Report found that Cyprus warranted an in- overview table in Annex A. depth review, which is presented in this report. 4 Executive summary in improving the efficiency of the public drop-out rate (‘early school leaving’). However, administration and local governments; the energy consumption remained unchanged, and in the absence of additional measures, this affects in tackling aggressive tax planning; Cyprus’ capacity to achieve its targets for greenhouse gas emissions. The employment rate in reforming the education system; and in increased, and poverty and social exclusion increasing employers' engagement and learners' decreased, but the target seems to be unattainable. participation in vocational education and training; Cyprus performs relatively poorly in achieving the Sustainable Development Goals. More in improving the affordability of childhood specifically, Cyprus underperforms with regard to education and care; the environment (SDG 2, 6, 7, 12, 13, 15), gender equality (SDG 5), and education (SDG 4) except in focusing investment-related economic policy for tertiary education attainment. Cyprus performs on sustainable transport, waste and water relatively well when it comes to good health and management, digitalisation and digital skills; well-being (SDG 3) (3). The main findings of the in-depth review contained in this report and the in improving the effectiveness of the justice related policy challenges are as follows: system and payment discipline; Despite the considerable progress made over in setting up a reliable system to issue and the last two years, the stock of non- transfer immovable property rights; and performing loans remains high. In mid-2019, The share of non-performing loans accounted in accelerating anti-corruption reforms and for 33.5% of the total loans in the banking safeguarding the independence of the sector, which is still one of the highest prosecution.