VZCZCXYZ0006
RR RUEHWEB

DE RUEHNC #0594/01 2601257
ZNR UUUUU ZZH
R 171257Z SEP 09
FM AMEMBASSY NICOSIA
TO RUEHC/SECSTATE WASHDC 0160
INFO RUEHBS/USEU BRUSSELS

UNCLAS NICOSIA 000594 
 
SENSITIVE 
 
SIPDIS 
 
DEPT FOR EUR/SE 
 
E.O. 12958: N/A 
TAGS: ECON EFIN CY
SUBJECT: CYPRUS: GLOBAL ECONOMIC CRISIS FINALLY HITS 
 
REFS: (A) 08 NICOSIA 0932 (B) JUNE 23 CAROUSO-NETOS E-MAIL 
 
(U) This cable is sensitive but unclassified.  Please protect 
accordingly. 
 
¶1.  (SBU) Summary:  As we begin to see signs of recovery from the 
global economic crisis, Cyprus is just beginning to feel pain.  For 
months the Finance Ministry (MinFin) minimized in its public 
statements the risks to the local economy posed by the international 
economic situation, but on September 12, Finance Minister Charilaos 
Stavrakis, presenting his 2010 budget, said Cyprus' economy would 
shrink by 0.5 percent in 2009.  A recent IMF report on the Cypriot 
economy and a stream of other negative data had already contributed 
to the conclusion that Cyprus is experiencing a recession.  In 
advance of submitting its budget to parliament in October, MinFin is 
currently focusing on deficit reduction, striving to keep the 
deficit under three percent to avoid EU supervision.  In credit 
market developments, the GOC announced plans to issue three-year 
bonds to inject liquidity in the banking system and drive down high 
lending rates.  Separately, Marfin, the island's second largest 
bank, reversed its decision to move its headquarters to Athens (Ref 
B).  End Summary. 
 
Stavrakis: "Don't Use the 'R' Word!" 
------------------------------------ 
 
¶2.  (SBU) In August 2009, the ROC Ministry of Finance revised 
downward its second quarter growth estimate to -0.5 percent, 
following -0.6 percent growth in Q1, signaling that Cyprus had 
technically entered a recession.  This came on the heels of a 
sobering IMF report on the Cypriot economy that confirmed the global 
crisis had hit the island.  The report warned of a highly leveraged 
private sector, large current account deficits, and a large exposure 
of banks to property prices.  The IMF report also predicted that the 
Cypriot fiscal deficit would reach 3.9 percent in 2009 (compared to 
surpluses of 3.4 percent in 2007 and 0.9 percent in 2008).  Left 
unattended, and given present trends, the fiscal deficit could grow 
to 8.3 percent by 2014, according to the IMF. Throughout the summer 
months, Cypriot Finance Minister Stavrakis downplayed the presence 
of serious problems in the Cypriot economy, pointing to economic 
indicators which were relatively buoyant until recently.  Even 
confronted with the IMF report, Stavrakis put on a brave face, 
stating on August 27 it was "wrong to talk about recession; there is 
no recession, there is a significant slowdown triggered from abroad, 
and the less we talk about such things the better." This stance 
attracted fierce criticism, particularly from opposition party DISY. 
 
 
GOC Unveils 2010 Budget and Economic Plan 
----------------------------------------- 
 
¶3.  (SBU) Under pressure to produce results, Stavrakis unveiled a 
five-point plan in late August to contain the deficit and stimulate 
the real economy.  His public discourse also began to reflect the 
need to take action.  The components of his plan, outlined below, 
were incorporated into his 2010 budget proposal, unveiled on 
September 12.  The GOC aims to: 
 
-- raise (one-off) revenue from a "town planning amnesty" designed 
to expedite the issuance of title deeds for thousands of properties 
held up by red tape; 
-- crack down on tax evasion; 
-- freeze civil service hirings for the next 18 months; 
-- target social benefits more effectively (recommended by the IMF); 
and 
-- cut down on "non-productive" public sector spending. 
¶4.  (SBU) Stavrakis' 2010 budget would provide Euros 7.9 billion of 
total spending with revenue of Euros 5.6 billion, resulting in a 
fiscal deficit of 4.5 percent of GDP.  (Note: The current exchange 
rate is Euro 1.00 to USD 1.47.)  Despite these grim numbers, 
Stavrakis said his government remained hopeful that its five-point 
plan would allow MinFin to decrease the fiscal gap by another Euros 
285 million and contain the deficit to less than 3.0 percent in 
2010, in order to avoid being placed under monitoring from Brussels. 
 
 
How Will the Numbers Add Up? 
---------------------------- 
 
¶5.  (SBU) The budget provides a relatively modest (3.1 percent) 
increase in total spending.  The civil service payroll, however, 
making up fully a third of total spending, will rise at more than 
twice that rate -- 7.7 percent -- while social spending will rise by 
6.4 percent.  (Note:  The number of civil servants has grown from 
47,704 in 2005 to 51,893 at present).  The government's budget calls 
for a 7.1 cut in operational spending, a first for the GOC. 
Stavrakis said, though, the government would continue spending money 
on development/infrastructure and would not impose new taxes unless 
mandated by the acquis. Development spending is down 9.2 percent, 
but this mostly reflects reduced funding for many projects rather 
than outright scrapping of significant projects in the pipeline. 
Some analysts this week are criticizing the proposed dip in 
infrastructure spending as too large, noting that those projects are 
exactly where any increases in spending should be targeted in order 
to stimulate the economy.  The GOC expects total revenue to rise by 
7.9 percent in 2010, largely fuelled by a rebound (9.2 percent) in 
indirect taxes - mainly VAT.  During 2010, the GOC expects 
unemployment to rise to 6.5 percent from 5.5 percent this year and 
inflation to reach 2.5 percent, from around one percent this year. 
 
 
End of Year Bond Issue 
---------------------- 
 
¶6.  (SBU) In developments on the credit front, Stavrakis announced 
September 2 that the GOC was planning to issue three-year bonds 
worth Euros 3 billion by the end of the year to boost liquidity in 
the banking system and reduce lending rates.  Domestic commercial 
and cooperative banks will be able to use the government-guaranteed 
bonds as collateral to borrow from the European Central Bank (ECB). 
The move is intended to help reduce lending rates, which have 
remained obstinately high in Cyprus, by about one percent. 
Separately, in especially welcome news for the government on the 
public relations front, Marfin Bank announced September 15 its 
decision to stay in Cyprus.  The island's second-largest bank 
reversed its earlier decision to move its headquarters to Greece, 
which had caused intense negative reaction when announced last May 
(Ref B).  Marfin's leadership has initiated a dialogue with 
authorities domestically to enhance the institutional and regulatory 
framework of the financial services sector and minimize barriers to 
entrepreneurship. 
 
¶7.  (SBU) Comment: The government will be under scrutiny as it sets 
out to implement the 2010 budget, with observers watching not just 
the government's inclination, but also its ability to cut spending. 
The recent increases in social spending and public sector employment 
reflect the priorities of nominally-communist but dyed-in-the-wool 
leftist AKEL party that leads the government.  Their plan to freeze 
hiring in the civil service for 18 months should not pose a 
hardship, given that there are reportedly 3,500 to 4,000 vacant 
positions in the civil service at any given time.  Just prior to the 
release of negative economic data two months ago, the government 
added 1,100 positions to the state payroll.  Cutting back in this 
area (and in turn limiting the patronage opportunities public sector 
jobs provide) will be difficult and unpalatable for AKEL.  Any 
effort to tame the civil service payroll line item, which seems to 
have a life of its own, would have to come in the form of increasing 
civil service productivity (e.g. encouraging inter-changeability of 
positions) and, possibly, restricting future pay increases.  Keeping 
the fiscal deficit below 3.0 percent for 2009 and 2010 will be 
challenging, and is likely to become considerably tougher in the 
future.  (Note:  The pressure may be taking its toll on Stavrakis, 
who stayed overnight in Nicosia General Hospital on September 15 
complaining of chest pains; the 53-year-old minister attributed this 
to excessive stress over the last few days, but happily was given a 
clean bill of health and released.) 
 
URBANCIC