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The Challenges for Macroeconomic Policy: Fiscal Policy Polyvios S. Eliofotou Economist, DG Economic and Financial Affairs - EU Commission London, 10 February 2012 The views expressed therein represent my own personal views and NOT those of the European Commission! 2 Outline 1. Scene Setter – Review of recent past 2. Challenges 3. Conclusions 3 1. Review of the recent past 1 January 2008 Cyprus, small, open, services-oriented economy joined EMU EMU institutional framework Stability and Growth Pact's (SGP) provisions Budgetary targets: close-to-balance or in surplus over the medium-term safety margin 4 1. Review of the recent past (ctd.) Figure 1: GDP, General Government Deficit and Debt 10 40 8 44 Gross Debt (RHS) 4 GDP (LHS) 48 52 2 56 0 60 -2 64 -4 68 -6 72 -8 Gen. Govt. Deficit (LHS; % of GDP) % of GDP % change, % of GDP 6 76 -10 80 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011e 2012f 2013f Source: Commission services, AMECO; Commission services' 2011 Autumn Forecast. 5 1. Review of the recent past (ctd.) Figure 2: Fiscal Stance 3.5 ∆ in CAPB Output Gap 2.2 % of GDP 1.5 0.5 -0.5 -2.5 -4.5 -6.5 Structural Balance -8.5 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011e 2012f 2013f Note: ∆CAPB denotes the change in the cyclically-adjusted primary b udget b alance. Source: Commission services, AMECO; Commission services' 2011 Autumn Forecast. 6 1. Review of the recent past (ctd.) Figure 3: Evolution of main revenue items 5 25 18.5 20 4 16.2 15 15.2 3 13.8 12.2 11.2 8.1 11.1 2 5 1 6 p.p.s 0 %of GDP %of GDP 10 0 8 p.p.s -5 -1 -10 -2 -15 -3 2000 2001 2002 2003 2004 2005 2006 ∆ in Taxes on production and imports (RHS) Taxes on production and imports (LHS) 2007 2008 2009 2010 2011e 2012f 2013f ∆ in Current taxes on income and wealth (RHS) Current taxes on income and wealth (LHS) Source: Com m ission services, AMECO; Com m ission services' 2011 Autum n Forecast . 7 1. Review of the recent past (ctd.) Figure 4: Evolution of main expenditure items 20 2.0 16.2 15.6 15 13.6 1.5 13.3 11.5 9.2 1.0 5 0.5 0 0.0 -5 % of GD P % of GD P 10 3.5 p.p.s 4.5 p.p.s -0.5 -10 -1.0 2000 2001 2002 2003 2004 2005 ∆ in Compensation of employees (RHS) Compensation of employees 2006 2007 2008 2009 2010 2011e 2012f ∆ in Social transfers other than in kind (RHS) Social transfers other than in kind 2013f Source: Commission services, AMECO; Commission services' 2011 Autumn Forecast . 8 1. Review of the recent past (ctd.) Table 1: Evolution of main expenditure items % Change Total Expenditure Compensation of employees Social transfers other than in kind p.m. GDP at current prices 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 9.5 10.7 8.8 18.9 2.5 8.8 6.3 6.5 10.5 7.8 3.1 8.9 5.1 7.6 20.6 4.1 6.0 7.9 7.1 8.2 9.0 1.3 10.4 10.3 14.7 18.3 13.9 12.7 3.2 2.7 14.0 8.1 10.2 8.3 8.1 3.3 6.8 7.7 7.0 7.7 9.7 8.4 -1.8 2.8 Period 2011e Average 5.2 8.5 -0.4 7.8 8.9 10.8 4.2 6.2 Source: Commission services, AMECO; Commission services' 2011 Autumn Forecast. 9 2. Challenges •Short-term • Stabilisation • Fiscal Consolidation • Structural reforms to support growth - competitiveness •Medium-term • Build-up of credible + sound fiscal institutions • Improve Efficiency Quality and composition of expenditure •Long-term • Sustainability Ageing-related expenditure • Managing potential natural resource revenues 10 2. Challenges – Short-term Stabilisation of the economy behaviour over the cycle CY high exposure to external shocks Fiscal consolidation need for primary current expenditure restraint Structural reforms to support growth competitiveness 11 2. Challenges – Medium-term • Building credible modern institutions Cyprus is among a handful of Member States that do not have: fiscal rules a binding Medium-Term Budgetary Framework fiscal council existing fiscal framework does not provide a setting for sound fiscal policies Need to: institutionalize expenditure rules, improve efficiency, transparency and accountability of budgetary management 12 2. Challenges – Medium-term • Improve Efficiency Quality and composition of government expenditure stricter control of non-productive expenditure free resources to strengthen the economy's productive potential via enhancing productivity, innovation and better utilization of human capital 13 2. Challenges – Long-term Sustainability Ageing-related expenditure COM / ECOFIN: Assessed CY to be in 'high' risk 2009 Ageing Report pension expenditure to rise by 11½ pps of GDP by 2060 compared to 2½ pps in EU Main factors: Demographic transition, eligibility April 2009 pension reform mainly on the revenue side makes eligibility conditions of old-age pension stricter 26 August 2011 fiscal package pension contributions (3% on gross earnings) from public sector employees More action is needed on the expenditure side 14 2. Challenges – Long-term (ctd.) Managing potential resource revenues Establish legal and regulatory framework for a sound management of potential resource wealth Adopt appropriate fiscal policy rules that insulate fiscal policy from fluctuations in revenues contain fiscal spending and sterilize revenue windfalls 15 3. Conclusions Learn from past mistakes Prudent fiscal policy is a precondition for sustainable growth & employment creation. Credible fiscal institutions - fiscal governance Long-term challenges are always easier to tackle through timely action 16 •Thank you! 17