To design and implement good economic policies and retain credibility with investors and the public any Government needs to present realistic policy-based economic forecasts. This does not appear to be the case with the latest seemingly optimistic economic forecasts of the Cyprus Ministry of Finance which predict that real GDP will decline by 7.3% and that the Government deficit will amount to 4.3% of GDP in 2020.
The GDP forecasts for Cyprus are based partly on figures which underestimate the fall in production in the first half of 2020. Despite declines of 88% in tourist revenue and 12% in value added in the construction sector, as well as sharp falls in turnover in most other production sectors, real GDP was estimated to decrease by just 11.9% in the first six months of 2020. It is noted that in other tourist destinations such as Spain and Italy, real GDP was estimated to have declined by 21.9% and 17.3%, respectively, in the first half of 2020. And with production in the key accommodation and food services and construction sectors in the third quarter of 2020 continuing to be well below levels of the corresponding quarter of 2019 it is difficult to foresee how real GDP in the second half of 2020 will rise by a sufficient amount to keep the decline in real GDP to the Ministry of Finance’s estimate of 7.3%. Even a conservative estimate of a 75% decrease in tourist revenue with its direct and indirect effects on the Cyprus economy should alone produce a decline in real GDP in 2020 of at least 11%.
In addition, the forecast for a Government deficit of 4.3% of GDP in 2020 is based as well on an optimistic outcome for the national accounts in the second half of the year. Such a forecast implies that the Government after recording a deficit of 931 million euro or 4.6% of GDP in the first 7 months will register a small surplus in the remaining months of 2020. The latter outcome is unlikely in so far as subdued economic activity and suspensions of certain tax payments should keep monthly tax collections well below levels of 2019, while Government expenditures are expected to be boosted by the extension of financial support to hoteliers and other tourism-affected businesses until at least October 2020. Indeed, the large monthly falls in all tax revenue components and social security contributions since March are likely to continue with the latest figures showing Government revenues declining by 17% in July.
Ministry of Finance officials may argue that the Government Finance accounts for the full year are prepared on an accrual basis and that deferred taxes will be duly paid after the suspension periods expire resulting in the intra-year shortfalls in tax collections being largely made up in the final accounts for 2020. However, given the propensity of many Cyprus businesses and households to engage in tax evasion final Government revenues for 2020 are likely to be lower than the current officially estimated tax receipts estimated on an accrual basis for 2020 meaning that together with lower projected economic activity the Government deficit for 2020 could be much greater than 4.3% of GDP.
The probable failure in achieving the rosy real GDP and Government deficit forecasts projected by the Ministry of Finance could have detrimental consequences. Firstly, Cyprus could lose credibility with international institutions and credit rating agencies that would become more reluctant to support moderately conditional financial assistance to and investments in Cyprus. Secondly, the Cyprus Government would not have sufficient revenue to back its policy and expenditure objectives including the investments required for restructuring and reforming the economy at a time when the economy needs to diversify away from its extreme reliance on the essentially foreign-funded tourism and construction sectors. Thirdly, if Government forecasts prove to be too optimistic and largely unwarranted fiscal stability would be endangered with resulting pressure on the Government to cut back on its spending and raise taxes.
In sum, these three inter-related adverse consequences stemming from sugar-coated Government forecasts could force the Government into a program with EU institutions entailing the execution of an austerity program as a condition for the receipt for funding from the facilities of the EU. That is, Cyprus Government could be subject to a “Memorandum of Understanding” relating to its economic and financial policies around the time of Parliamentary elections in May 2021.