Cyprus - The Government Sector of the Economy

The government sector

The government accounted for about 12 to 13 percent of GDP during the 1980s. The need to stimulate the economy after the division of the island in 1974 caused the government to abandon the old policy of balanced budgets and to adopt expansionary fiscal and monetary policies. The results were large and widening budget deficits paid for by borrowing at home and abroad. Domestic public debt rose from C£7.5 million in 1976 to C£161.5 million in 1988. Public and publicly guaranteed foreign debt increased from C£61.8 million in 1976 to C£602.5 million in 1988. The total public and publicly guaranteed domestic and foreign debt rose from C£760.8 million in 1987 to C£764 million (38.7 percent of GDP) in 1988. The foreign debt service ratio (total service payments as a percentage of exports of goods and services) was 11.8 in 1987 and 10.8 in 1988. Domestic borrowing only was used to cover the budget deficit in 1988. Thus, there was a decline in government foreign borrowing in 1988 to C£602.5 million, compared to C£617.5 million in 1987. Still, the burden of servicing the foreign debt continued to be significant. For instance, servicing the external debt was more than half the revenue from exports of domestically produced goods in 1987.

Furthermore, it was anticipated that the tariff reductions that would result from the Customs Union Agreement with the EEC would produce revenue losses, raising the fiscal deficit to C£126 million in 1992, compared with C£73.5 million in 1987. As a consequence, both public and foreign debts were expected to increase. The president of Cyprus, George Vassiliou, forecast a rise in the per capita public debt from C£2,107 in 1987 to C£3,563 in 1992 and a rise in the total foreign debt to C£1,082 million in 1992.

Given the government's ever-present fiscal deficit, there were concrete proposals at the beginning of the 1990s for the introduction of a value added tax (VAT) to improve the state's finances. The Republic of Cyprus lacked a broad-based consumption tax, and a VAT would generate much revenue. The income tax system was also to be overhauled, to reduce tax evasion.

A specific look at government public finances shows that the Republic of Cyprus maintained three types of budgets: the Ordinary Budget, which included expenditures for government operations and other current expenses; the Development Budget, which included development programs; and the Special Relief Fund, which covered state aid for the housing and care of refugees.

The Ordinary Budget

The major sources of revenue of the Ordinary Budget included direct taxes; indirect taxes; loan proceeds; sales of goods and services; interest, dividends, rents, and royalties; and foreign grants. Revenue in 1987 from direct taxes was C£107 million, or 27 percent of the total revenue for the Ordinary Budget; revenue from indirect taxes was C£151.3 million, or 38.2 percent; and proceeds from loans were C£68 million, or 17.2 percent. These three main sources of revenue brought in 82.4 percent of the total revenue of the Ordinary Budget.

The major expenditures of the Ordinary Budget were salaries, fees, and allowances; public debt charges; and subventions and contributions and subsidies. Salaries, fees, and allowances accounted for 33.9 percent of total expenditures in 1987; public debt charges, 30.7 percent; subventions and contributions, 9.4 percent; and subsidies, 6.1 percent. The Ordinary Budget showed deficits of C£17.9 million in 1985, C£12.5 million in 1986, C£32.1 million in 1987, and C£28.7 million in 1988.

The Development Budget

There was no revenue in the Development Budget during the period 1976-87. If there had been public savings (i.e., excesses of current revenues over current expenditures) in the Ordinary Budget, they could have provided the means to finance all or a part of the investment and other development expenditures. However, for most of the years of the 1976-87 period, there were no public savings. Thus, the Development Budget had to rely on domestic and foreign borrowing to cover its expenditures. The major expenditure items of the Development Budget were investment, capital transfers, and land acquisition. Another sizeable item was expenditures for wages and salaries. Investment expenditures amounted to C£46 million in 1988. Investment expenditures in the period 1985-88 were mainly to finance the Southern Conveyor Project, the Khrysokhou Irrigation Project, the Nicosia-Limassol Highway, several other major roads, and Larnaca Airport. For this reason, construction activity absorbed most of the investment expenditures between 1985 and 1988. Investment's share of the total development expenditures was 60.22 percent in 1985, 76.19 percent in 1986, 75.1 percent in 1987, and 67.74 in 1988.

The Special Relief Fund

The revenues of the Special Relief Fund were C£21.5 million in 1987. Expenditures were C£21.5 million. The fund showed a surplus in the period 1985-88. The main sources of revenue were direct taxes (a special contribution), indirect taxes (a temporary refugee levy on imports), and foreign grants. The main expenditures of the fund in 1988 included investment, C£10 million; current transfers, C£7.6 million; capital transfers, C£4.2 million; and wages and salaries, C£1.4 million.

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