The Cypriot economy continues to show strong resilience amid mounting external pressures and is expected to maintain its current positive growth path, according to the Cyprus Fiscal Council (CFC).
However, in an interim report published on 4 August, the Council warns that public spending, growing faster than both nominal GDP and medium-term revenues, poses a serious risk to fiscal stability.
Despite geopolitical tensions and high uncertainty, the Council projects that inflation will remain stable, employment will stay high, and growth will remain dynamic. Public finances continue to improve, with public debt shrinking and revenues exceeding historical averages, driven by the combined effects of inflation and economic expansion.
Yet, the Council identifies several vulnerabilities. It points to structural weaknesses in public spending allocation, rising inequality affecting labor relations, and a widening budgetary imbalance. This imbalance, it stresses, is masked by temporary revenue boosts and must be urgently corrected.
Budget risks and structural pressures
The Council expresses concern over the government’s fiscal path, especially the risk-laden approach of front-loading expenditure increases with planned savings only in later years. It deems this strategy "inherently high-risk" and warns that actual spending may exceed current projections through 2028, potentially breaching fiscal rules even if public debt falls below 60% of GDP.
While debt reduction is on track, helped by strong revenues and a nominal GDP surge, the Council urges caution. It notes that the long-term trajectory remains uncertain due to the permanent nature of expenditure increases and the temporary nature of revenue growth. The debt-to-GDP ratio could dip below 60% in 2025, but sustaining that trend will require greater discipline.
Growth set to normalize
Government revenues have grown significantly in recent years, outperforming historical norms. This has been aided by rising employment, nominal wages, and improvements in tax collection.
However, the Council forecasts a normalization in revenue growth rates in the medium term, warning that the state is absorbing an increasingly large share of the economy. This growing government footprint could crowd out private investment and reduce disposable income, creating long-term distortions.
It cautions that most of the revenue gains are being used to cover inflexible expenditures, which will be hard to adjust as revenues stabilize. The executive branch, the report suggests, risks being trapped in procyclical fiscal practices that undermine long-term planning and prudent management.
Rising public spending
Public spending continues to rise faster than nominal GDP, a trend the Council describes as fiscally expansionary. If left unaddressed, this could require tax hikes or more borrowing. Government liabilities to the Social Insurance Fund already stand at €12.5 billion, nearing 40% of GDP.
The public wage bill is also growing. Salaries rose 7.3% by May 2025, in line with budgets, but upcoming reforms—including a revision of the Cost-of-Living Allowance (COLA)—could drive it higher. The Council warns that any unplanned wage increases will force the government to either cut spending elsewhere or exceed its commitments under EU fiscal rules.
Green transition and wildfire costs
The Council also points out the urgency of addressing climate-related fiscal risks, citing the devastating wildfire in mountainous Limassol in July as a wake-up call. It criticizes the slow progress on the country’s Green Agenda, including the National Energy and Climate Plan, EU Emissions Trading Scheme II, and climate mitigation spending.
These environmental challenges, along with pressures on infrastructure, digital transformation, defence, and cybersecurity, are expected to exert significant primary and macroeconomic pressures in the years ahead.
The Council calls on the government to begin integrating climate adaptation and resilience spending into its fiscal plans. The lack of such preparation, it warns, may jeopardize both budgetary targets and broader economic stability.
(Source: CNA)
