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Cyprus

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1) REFERENCES

Commission Report [COM(98) 710 final - Not published in the Official Journal]
Commission Report [COM(1999) 502 final - Not published in the Official Journal]
Commission Report [COM(2000) 702 final - Not published in the Official Journal]
Commission Report [COM(2001) 700 final - SEC(2001) 1745 - Not published in the Official Journal]
Commission Report [COM(2002) 700 final - SEC(2002) 1401 - Not published in the Official Journal]
Commission Report [COM(2003) 675 final - SEC(2003) 1202 - Not published in the Official Journal]
Treaty of Accession to the European Union [Official Journal L 236 of 23.09.2003]

2) SUMMARY

In its November 1998 Report, the Commission noted that Cyprus had to continue to prepare for integration into Economic and Monetary Union (EMU), particularly with regard to the independence of its central bank.

In its October 1999 Report, the Commission noted that some progress had been made in the preparation for participation in EMU, although progress was still to be made with regard to the central bank and the liberalisation of capital movements.

In its November 2000 Report, the Commission noted that progress had been made in adopting the acquis in the field of EMU, in particular in the privileged access of the public sector to financial institutions by liberalising interest rates.

In its November 2001 Report, the Commission noted that Cyprus had to amend its institutional and judicial framework regarding EMU before accession.

The October 2002 Report recognises the huge advances made since the previous report. In general, Cyprus is in line with the Community acquis.

In its November 2003 Report, the Commission notes that Cyprus has fulfilled its commitments and the requirements arising from the accession negotiations and is therefore ready to implement the acquis after accession.
The Treaty of Accession was signed on 16 April 2003 and accession took place on 1 May 2004.

COMMUNITY ACQUIS

The third stage of EMU began on 1 January 1999, a date that is synonymous with far-reaching changes for all the Member States, even those not participating in the euro area from the outset.

The main economic focus will be on the coordination of national policies (national convergence programmes, general economic guidelines, multilateral surveillance and the excessive-deficit procedure). All countries will be required to comply with the stability and growth pact, to renounce direct central bank financing of the public sector deficit and privileged access by public authorities to financial institutions, and to have completed liberalisation of capital movements.

Those Member States not participating in the euro area will conduct an autonomous monetary policy and take part in the European System of Central Banks (ESCB) on a restricted basis. Their central banks will have to be independent and have price stability as their primary objective. Lastly, exchange policy is regarded as a matter of common interest by all the Member States, who must be in a position to take part in the new exchange-rate mechanism.

Even though accession implies acceptance of the goal of EMU, compliance with the convergence criteria is not a pre-condition. However, these criteria remain key points of reference for stability-oriented macroeconomic policies, and as such they must in time be met by all Member States on a permanent basis.

EVALUATION

The first regular report back in 1998 recognised the efforts made by the Cypriot authorities in the field of economic reform to prepare the country for accession to the European Union. The 2000 report noted some progress in the adoption of the acquis in the field of EMU. The authorities have maintained their commitment to meet the economic requirements of accession. The private sector largely dominates the economy. Cyprus is a functioning market economy and should be able to cope with the competitive pressure and market forces within the Union.

Economic activity in Cyprus is healthy and the island has seen several years of dynamic growth. Between 1997 and 2001 the economy grew by an average 4.2% annually, thanks to internal demand but also the rapid development of tourism. In 2001 real GDP growth was affected by the slowdown of foreign demand, aggravated by the sharp decline in tourism following September 11. The 2003 Report notes that in 2002 GDP growth in Cyprus nearly halved to 2.2%, mainly on account of the weak performance of the external sector, employment and tourism, which accounts for around 20% of GDP. The Commission considers that growth is set to remain relatively weak in 2003.

With regard to public finance, the general government deficit climbed to 5.2% of GDP in 1997 as a result of the slowdown in economic activity in 1996 and the rapid increase in government spending. In response to the deteriorating fiscal position, in 1999 the authorities introduced the Strategic Fiscal Consolidation Plan (SFCP). The programme aimed to reduce the deficit to 2.0% of GDP by 2002 and to reach fiscal balance by 2005. In the period 1998-2001, general government gross debt as a percentage of GDP held more or less steady at an average of 55.5% of GDP, declining to 54.6% of GDP in 2001. The fiscal consolidation programme aims to ensure that the debt-GDP ratio continues to fall. As a result of the economic slowdown, the budget shortfall worsened, to 3.5% of GDP in 2002, instead of the 2.6% forecast initially. For 2003 the Commission expects the fiscal deficit to exceed 5% of GDP. The government has adopted a new fiscal consolidation programme, since the former programme has become defunct.

Inflation has generally been kept under control, averaging 2.7% and falling back to 2% in 2001 after reaching a spike of 4.9% in 2000. The peg to the euro, trade liberalisation, increased competition in domestic markets, fiscal consolidation and relatively low wage pressures are among the main factors keeping inflation down. Monetary policy has also succeeded in controlling inflation. The 2003 Report notes that inflation climbed to 2.8% in 2002, mainly in response to domestic factors such as VAT increases linked to EU harmonisation. The expected rate for 2003 was 4.6%, again for reasons mostly linked to tax harmonisation. In August 2003 inflation stood at 2.4% year-on-year.

On the exchange rate, a number of important changes in monetary and exchange rate policy have been introduced to adjust to the liberalisation of capital flows. To increase flexibility of the exchange rate regime in response to the increasing challenge of greater capital mobility, the Central Bank of Cyprus widened the fluctuation margins around the central parity vis-à-vis the euro to +/-15%. The Cyprus pound has essentially remained stable while reserves have increased. The 2003 Report states that, despite the higher exchange risk following the widening of the fluctuation bands against the euro in 2001, the Cyprus pound remained stable against the euro in 2002 and 2003.

The current account deficit, heavily influenced by energy prices and defence outlays, has fluctuated around a relatively high average of 4.5% of GDP, with no clear downward trend. Although tourism has grown vigorously and the fiscal deficit has been steadily brought down, there has been no clear improvement in the current account deficit over time. The 2003 Report notes that the current-account deficit, which widened in 2002 to 5.3% of GDP, was financed for the most part by large inflows of foreign direct investment.

In the field of structural reform, good progress has recently been achieved in trade and price liberalisation and privatisation. Cyprus has also worked towards an extensive adjustment of the financial system. Liberalisation of the financial markets has progressed, posing new challenges for monetary and exchange rate policies. The 2003 Report notes that structural reform is continuing slowly but some long-term issues remain. The crisis in the tourist sector in Cyprus has underlined the increasing economic dependence on this sector. The new strategic development plan for 2004-2006 is designed to reinforce other areas of the country's economy. The liberalisation of the telecom, energy, air transport and postal services sectors planned for 2003 has been carried out in some sectors but not in others.

With regard to the independence of the central bank, the statutes of the Central Bank of Cyprus required some changes. The 1963 law which governs its activities provides for a representative of the Ministry of Finance to sit on the Bank's board and to take part in decision making. The 2002 report notes that Cyprus has largely aligned its legislation with the acquis in the area of central bank independence.

On 1 January 2001 a law came into force to eliminate the interest rate ceiling. Upon accession, Cyprus will be required to renounce any direct central bank financing of the public sector deficit and privileged access of public authorities to financial institutions. The Central Bank of Cyprus Law of 2002 includes an explicit prohibition of direct financing of the public sector by the Central Bank. In order to complete preparations for membership, Cyprus's efforts should now focus on strengthening the administrative capacity of the Central Bank of Cyprus. The 2003 Report notes that alignment with the acquis has been completed.

Negotiations on participation in EMU were closed in December 2002. Cyprus has not requested any transitional arrangements. Cyprus is generally meeting the commitments it has made in the accession negotiations in this field.

This summary is for information only and is not designed to interpret or replace the reference document.

Last updated: 19.03.2004
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